Thursday, June 10, 2010

New tax cut to create social injustice or to upgrade economy?

Under Taiwan’s newest law, the “Industrial Innovation Act,” business income taxes will be cut from 25 to 17 percent. On April 30, the amendment passed its third round of reading in the Legislative Yuan. It is estimated that the tax cut will cause total government income to fall by up to NT$34.3 billion (US$1.07 billion), reported the United Daily News.

But in the mid-to long-range, the promotion of economic industrial development, and the expansion of the tax base, will increase the tax income according to the ruling Kuomintang (KMT) legislative caucus. Under their estimates, the tax cut will create government revenues of NT$69 billion (US$2.15 billion).

Island of inequality?

However, in a recent Commonwealth monthly article, the projections were less rosy. A recent cover story, “Taiwan to become island of inequality?” criticized the new tax cuts. “The salaries and wages earned by Taiwan's 9 million workers account for 72 percent of the reported income on which individual income taxes are paid in Taiwan, a far higher ratio than the 56 percent in the United States and the 49 percent average across wealthy Organization of Economic Cooperation and Development (OECD) countries. In Taiwan, there are 7.54 million households, but only 5.38 million, or 71.3 percent, pay taxes.”

“The taxes that many people pay are totally disproportionate to their incomes,” says economist Ma Kai. “Many households' accumulated wealth relies on gains from property and stock transactions, the vast majority of which go untaxed.”

According to the 2009 World Competitiveness Yearbook put out by the Institute for Management Development (IMD), corporate income taxes paid by Taiwan's enterprises account for only 3 percent of the GDP, lower than the ratio in the other Asian Tigers (South Korea, Singapore and Hong Kong), China, Japan and the United States. Reported corporate pre-tax earnings, which account for only 18 percent of all taxable income reported in Taiwan, amount to barely 20 percent of the business income listed in Taiwan's national income statistics.

In Taiwan, the more a company earns, the lower its tax burden. Commonwealth found in looking at the 2009 financial statements of publicly listed companies, the 10 companies that made the most money only paid an average marginal income tax rate of 9.97 percent. The magazine's survey clearly indicates that the unfairness of the tax system is one of the greatest sources of public anger.

Asked about the government's policy to lower the corporate tax rate from 25 to 17 percent, 43 percent of respondents believed it was unfair, while 70 percent felt that the tax reforms of the past two years have been increasingly favorable to businesses and wealthy households.

Big tax cut to create GDP increase

Since coming to power in 2008, the Ma Administration has rolled out a number of tax breaks for companies and the wealthy. This new business income tax cut package became the biggest tax cut measure in Taiwan’s history. It was passed at a time when the country's finances are in their worst shape in eight years.

However, high taxes will scare away money, said Huang Yo-hui, associate professor of the National Taipei College of Business. As an island economy, Taiwan can’t afford to impose high taxes. The tax cut is an adjustment in the right direction over the long term because it will promote international competitiveness, attract foreign investment, and encourage a return of overseas Taiwanese businessmen. Ultimately, it will cultivate more tax resources.

According to the estimate of the Ministry of Economic Affairs, Taiwan’s business income tax rate is lower than that of China (25%) and South Korea (22%), similar to that of Singapore (17%) and Hong Kong (16.5%). With the new cuts, Taiwan will create an environment of fairness, efficiency, simplification and international competitiveness, thus reducing the tax cost of businesses.

Based on the experience of American tax cuts where every dollar cut in tax creates a GDP increase of US$1.5 to US$2.5, Taiwan’s business income tax cut will create a total of NT$69 billion (US$2.15 billion) GDP.

Wang Jiann-chyuan, vice president of the Chung-Hua Institution of Economic Research, said the upgrade to research and development will be a big incentive for businesses in the mid- to down-stream of the supply chain. For example, the NT$30 billion (US$930 million) R&D investment government spent in 2008 brought in NT$500 billion (US$15.62 billion) from private business towards the GDP. Wang added “This is key to the national transformation, and the upgrade of R&D in the service sector will be the lifeline to future employment for young people.”

What’s next?

It is also the right time for government to revitalize the green tax system, said Commonwealth. Tax cuts at the start will be followed by tax increases later. Huang Yo-hui cited an example of the green tax, which is a consumption tax taking advantage of the resources of society. Once you use it, you have to pay taxes, especially for the businesses that consume the most energy. After enjoying the tax cut benefits, it is necessary for the business to pay more tax later.

The United Daily News said it is predictable that the rich will pay less tax because business income taxes are down and the government’s revenue will soon be greatly reduced. But the government should monitor how businesses spend the funds due to the decline of corporate tax. If companies pay less tax and spend the reserved money on research and innovation, human capital and increased employment, it would be the best starting point to create a win-win situation for government, business and the population as a whole.

On the other hand, the side effects of the decline in business taxes must also be guarded against, said the paper. With more retained earnings, the company holds a lot of cash in hand, resulting in the pressure of how to use the funds. Due to the expansion of capital, companies will face the pressure of breaking the bottleneck of business profit. These two pressures may lead enterprises to repeat the mistakes of diversified merger and acquisition (M&A) a common phenomenon in the United States in the 80’s and 90’s, causing companies to lose focus on business operations, and creating the M&A bubble.

Over the past decades, Taiwan has used tax cuts as an incentive to encourage business investment; but times have changed, said the paper. Society is moving faster, with issues of high unemployment, low birth rates and so on. The government has to establish a stable system of social welfare and economic security, which is an integral part of the investment environment. It is not enough just to have a tax cut.

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About Me

The Press Division of the Taipei Economic and Cultural Office (TECO) in San Francisco represents the Government Information Office (GIO), Executive Yuan, Republic of China (Taiwan). GIO maintains nine Press Divisions in the United States, including the San Francisco office. The Press Divisions are in charge of promoting Taiwan's public relations and cultural exchanges. This blog is updated by the Press Division, TECO in San Francisco.