Many governments in crisis-torn East Asia are struggling under the weight of large budget deficits. In searching for ways to reduce the shortfall in public sector revenues, many of them are looking to tax increases to help them plug the holes in their finances.
Unfortunately, raising taxes during a recession might be the worst possible solution for restoring balance to the public treasury. If this is a response to demands by the IMF and World Bank, these governments should consider that hiking taxes might be more catastrophic than their attempts to meet conditionality requirements set by international institutions after the onset of the crisis.
Indeed, it is hard to imagine a worse course of action than raising taxes when unemployment is rising and economic growth is slowing.
Look at Singapore, arguably the country least affected by the crisis. It continues to look for ways to reduce the overall tax burden. In keeping with plans for greater liberalization of its financial markets, a concession on tax earned from bond trading will be extended to income derived from interest-rate and currency swaps.
There will also be an expansion of exemption from withholding tax on income earned by non-residents from financial market transactions. It has also announced a cut in corporate taxes by half a percentage point even though it ended a temporary rebate on company and personal income taxes.
Consequences
Consider the political costs and economic consequences from increasing the overall tax burden. It is no secret that governments in the region have wasted resources and misdirected public funds due to corruption and cronyism. Taking and squandering yet more of their citizens hard-earned income might even spark a tax revolt leading to a collapse of revenues altogether.
In the case of Japan, the imposition of a consumption tax is widely viewed as the final straw that brought on the current recession by reinforcing negative forces in its economy. And in the US, an economic slowdown brought about by higher levies cost George Bush his re-election bid when he broke his famous "no new taxes" pledge.
Nonetheless, authorities in Jakarta have announced plans to increase taxes on cement, tires and soft drinks. A debate in Hong Kong is raging over attempts to cut the deficit by broadening the tax base through the introduction of a sales tax. China has imposed taxes on income on saving accounts.
Yet there are many better ways to reduce public-sector budget deficits that could provide larger amounts of funds more quickly or outflows could be reduced. On the one hand, improving collection procedures to reduce leakages due to tax evasion can generate additional funds.
In some circumstance, amounts raised by imposing new taxes are trivial compared to losses registered by state-owned companies arising from mismanagement. For example, Indonesia's state electricity company is expected to lose almost 14 trillion rupiah (US$19 billion) in the coming fiscal year. Additionally, there are reports of billions of dollars in losses by major state companies because of poor management and other government revenues are lost to theft and fraud.
Privatizing state-owned assets along with sale of distressed assets brought into the public domain by the banking crises would generate ready access to substantial funds. Besides an immediate injection of funds from sales, conversion to private enterprises will create new taxpayers and remove a drain on government financial resources.
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