At the end of December last year, Academia Sinica academic Gregory Chow (鄒至莊) wrote an article in the Chinese-language version of the Financial Times on tax reform in Taiwan that focused on the issue of reforms based on a expenditure tax and merits further thinking.
A look at the current tax system from the point of view of the targets for taxation shows that many economists favor an expenditure tax because income is a return on labor provided by workers and the contributions they make to society. In general, the higher the tax paid by a person, the more that person contributes to society. However, if, as a result of this, a person is taxed more the more they work, tax becomes a punishment for hard work and workers will be less willing to work.
Spending, on the other hand, is an act in which people consume already produced goods. The more a person spends, the fewer social resources there are. Since an expenditure tax can stop the loss of these resources, it is a more positive form of tax. Of course, such a tax also encourages saving and is beneficial to the accumulation of social capital.
In view of this, many academics dealing with finance and taxation are studying how to come up with an expenditure tax system to replace the current income tax system. However, earlier consumption taxes were indirect in nature and were levied as goods were sold. Those familiar with economic theory are probably aware that the sales tax burden that gets shifted to consumers is influenced by the price elasticity of demand. The price elasticity of demand for necessity goods is less flexible and can for the most part be shifted, while the demand elasticity of luxury goods is larger and can therefore cannot be shifted as easily. For example, if sales taxes are shifted by increasing prices, sales levels will drop and as a result, manufacturers will absorb a greater proportion of the tax burden.
However, the value-added taxes in most countries allow manufacturers a business-tax discount when they sell their goods, which, in the end, still results in consumers having to absorb this tax burden. What is unavoidable in all of these systems is that the price elasticity of demand retains a certain amount of influence on the shifting of tax burdens. Ultimately, a value-added tax is a regressive tax that hits low-income households harder. When coupled with how such a tax shifts more of the tax burden over to necessity goods, it becomes even more regressive.
In 1955, British economist Nicholas Kaldor published An Expenditure Tax, in which he proposed a direct form of expenditure tax based on income minus savings. Such a system was tested in the late 1950s in India and Sri Lanka. However, it was levied there alongside income tax and eventually scrapped because it was considered a failure. Although many economists have since promoted this idea, it has never gained acceptance and replaced the income tax system that has now become so ingrained in societies.
However, a look at the design of sales tax systems in other countries shows that many use a variety of remedial measures aimed at the shortcomings of the regressive nature of the tax. Of these, Chow talked about the payments made by governments to lower-income earners in the form of assistance. What he did not mention is that many countries do not levy taxes on essential commodities, such as food and clothing, while levying higher and more selective special sales taxes on luxury goods, as well as commodity taxes.
Taiwan’s financial difficulties stem from past governments’ unwillingness to raise taxes out of fear that it would lead to public complaints, and memories of spiraling bond obligations following previous efforts to match increased government spending, while the public tax burden has remained one of the world’s lowest, at just 12.8 percent.
Taxation in Taiwan is cursed by being too light and uneven. With all the policy incentives and tax breaks available, high-income earners have many avenues for evading their obligations. The tax burden thus falls on salary earners and low-income households. The progressive/regressive structure of the entire tax system is severely twisted and is in need of a complete overhaul. What is most unfortunate in all this is that the various attempts at tax reform in Taiwan have never worked as intended.
The recent tax changes have been focused on solving the government’s fiscal problems and structural changes to the tax system will likely be limited. However, the Cabinet has at least taken a step in the right direction. In the interest of future developments in society at large, it would be good if Taiwan’s tax system was given a complete overhaul to make it fairer and more reasonable.
Norman Yin is a professor of financial studies at National Chengchi University.
Translated by Drew Cameron