Tax Reform Boosts Government Finances

State coffers are benefiting from a rise in tax revenue, but Taiwan’s tax-to-GDP ratio remains among the lowest in the developed world.

Revisions to tax policy are bringing increased revenue into Taiwan’s national treasury, giving a boost to public finances as the government grapples with ballooning debt and anemic economic growth.

Analysts and the government had forecast that the Taiwanese economy would expand at a rate of more than 3% this year, but now say year-on-year growth will be closer to 1.5% as global demand flags for Taiwan’s exports. In August, export orders fell at a higher-than-expected rate of 8.3%, according to government data. Exports to China that month fell at an unprecedented 14.8% year-on-year.

Meanwhile, debt is increasing both for the central government, which has not run a budget surplus since 2008, and at the local level, where 20 of the 22 county and special municipality governments are in the red.

The one bright spot amidst that fiscal gloom is burgeoning tax revenue. From January to June this year, Taiwan collected NT$1.2 trillion (US$36.2 billion) in net tax revenue, up NT$106.7 (US$3.2 billion) or 9.8% from a year ago, according to government data.

Personal income tax revenue surged by NT$59.9 billion (US$1.8 billion) and corporate income tax by NT$37.3 billion (US$1.1 billion), while commodity tax revenue rose by NT$5.4 billion (US$163 million) and sales tax revenue by NT$5.2 billion (US$157 billion).

If tax revenue growth from July to December is as high as in the first half of the year, Taiwan will easily exceed its 2015 target of NT$137 billion (US$4.1 billion).

The uptick in tax collection comes after an extended period – 2009 to 2013 – in which revenue fell following a series of moves to reduce the tax burden on corporations. Taiwan lowered the corporate income tax rate from 25% to 20% in 2009, then further decreased it to 17% in 2010.

That controversial decision, which many experts predicted would lead to a shortfall of revenue in state coffers, was intended to woo foreign investment and spur capital spending by local companies, says Dennis Liu, a section chief at the Directorate-General of Budget, Accounting and Statistics (DGBAS). “The government was looking for a way to stimulate the economy, which was suffering from the effects of the global financial crisis,” he explains.

The second cut made Taiwan’s corporate income-tax rate competitive with that of neighboring economies Singapore (17%) and Hong Kong (16.5%), Liu observes.

But some observers say political calculations were behind the move to reduce the tax burden on corporations. “Changing the corporate tax rate to 17% was very much a political move by the KMT (Kuomintang or Chinese Nationalist Party) to improve their chances in the 2012 election,” says one person close to the government, who spoke with TOPICS on condition of anonymity. “The KMT wanted to rally their core supporters in big business.”

“There is too much of a tendency in Taiwan to put party interests over national interests to win elections,” the person adds. “The corporate tax rate really should be closer to 20%, which would help to alleviate some of the pressure on individuals.”

Personal income taxes account for about 75% of Taiwan’s tax revenue, compared with an average of 45% for OECD member countries.

President Ma Ying-jeou went on to coast to victory in the 2012 election, but the lofty forecasts of KMT legislators have not come to fruition. “We hope to encourage international corporations to establish headquarters in Taiwan,” KMT lawmaker Alex Fai said at a press conference following the amendment to the Income Tax Act. “We expect to see this happen in the near future.”

In fact, no multinational companies have established regional headquarters in Taiwan since 2010, despite the lower corporate income-tax rate. Lower taxes are insufficient to attract foreign businesses to Taiwan, observes Cheli Liaw, a partner at Deloitte & Touche in Taipei and co-chair of AmCham Taipei’s Tax Committee. “There is too much uncertainty for multinationals,” she says. “For a regulated business, such as a financial or cable business, it can take years for an investment to be approved in Taiwan. There is a lack of efficiency in the approval process.”

Source of the revenue

So having lowered the business income tax rate while failing to attract a new wave of foreign investment, how is Taiwan able to boost its corporate tax revenue? For one thing, corporate profits are up, Liu notes. Indeed, several of Taiwan’s biggest companies had record years in 2014, including Taiwan Semiconductor Manufacturing Co. (TSMC), whose profits jumped 40% to NT$264 billion (US$7.97 billion), and Hon Hai Precision Industry Co. (Foxconn), which recorded profits of NT$130.5 billion (US$3.94 billion), up 22% from a year earlier.

The government has also increased the number of tax audits, and tax incentives have been eliminated with the exception of an R&D tax credit, Liaw notes. “In practice, the audit on the R&D tax credit is quite rigid. The chance that during the audit the credit will be disallowed is quite high,” she adds.

While businesses cheered the reduction of the corporate income-tax rate, they are less enthusiastic about the government’s decision in 2014 to raise the tax burden on individual earners. As a result of that change, individual tax residents with annual net taxable income above NT$10 million (roughly US$302,000) are now subject to a tax rate of 45% on their income, up from 40% previously.

As AmCham Taipei’s Tax Committee argues in the Chamber’s 2015 Taiwan White Paper, this tax reform will make it harder for Taiwan to attract top-tier foreign talent and causes talented domestic professionals to look for opportunities overseas. The White Paper further points out that Taiwan’s neighbors Hong Kong and Singapore tax individual earners at much lower rates. Given that the top individual income tax rate is just 17% in Hong Kong and 20% in Singapore, the two former British colonies are better able than Taiwan to attract outstanding global talent, the Tax Committee concludes.

“There have been many concerns that Taiwan’s tax structure is not fair to people who are working for their income,” says Liaw of Deloitte & Touche. “If the objective is to tax the rich, then the focus should be on the value of assets rather than earned income. The wealthy make a lot of their money from their investments.”

The Chinese-language CommonWealth Magazine highlighted this problem in a September 2012 report that describes how a jobless 35-year-old scion of an influential Taiwanese political family earns NT$50 million (US$1.5 million) a year – a 6% return – on stocks worth more than NT$1 billion (US$30.2 billion) held through overseas trusts in the United States, Hong Kong, and Taiwan. The man’s financial advisers use hedging techniques in the equity and futures markets to ensure that their client’s rate of return is consistent, irrespective of market conditions, according to the report.

The effective tax rate on the wealthiest 5% of Taiwan’s taxpayers is below 6% because of low taxes on capital gains, according to the island’s Anti-Poverty Alliance.

KMT presidential candidate Hung Hsiu-chu has proposed permanently eliminating the capital gains tax on “big traders” and IPOs. She has also advocated reducing the securities transaction tax to 0.25%, while allowing traders the option to pay an immediate additional 0.05% transaction tax or a 15% tax on any stock gains.

For its part, the Democratic Progressive Party (DPP) is also aiming to reduce taxes on capital gains. Legislator Tsai Chi-chang has said that the DPP is suggesting a 0.3% securities transaction tax and a 0.1% capital gains tax.


Property taxation

In June, the Legislative Yuan amended the Income Tax Act, combining the separate taxations on house and land sales in an effort to generate more revenue from speculative activity. From January 1, 2016, capital gains will be determined on the basis of actual land and building market prices, rather than the value assessed by local authorities, which is often too low, experts say.

The new combined tax is determined by the length of time property is held, so as to discourage short-term speculation. For instance, the highest rate of 45% is imposed on gains obtained from real estate held for less than a year. But income from the sale of properties held more than 10 years is taxed at just 15%.

As the new capital gains tax goes into effect, a luxury tax imposed in June 2011 will be scrapped. That tax, which failed to cool the property market sufficiently, is set at 15% on second homes sold within one year of purchase and 10% on those sold between one and two years after they were bought.

The government has struck an ebullient note regarding this overhaul of the property tax system. Its launch next January 1 “will mark a milestone in Taiwan’s tax reform,” Premier Mao Chi-kuo said in June. “The system will not only promote housing justice, but also bring in additional tax revenues that can be used to help young and disadvantaged people and fund long-term care for senior citizens.”

Deloitte & Touche’s Liaw, however, is skeptical about the benefits of the reforms. The wealthy are not deterred from property speculation by a one-time fee they have to pay in the form of a capital gains tax, she explains. “Instead, the government should raise the maintenance cost of holding real estate,” she says. “Having to pay a regular tax could discourage speculation and generate more revenue for the government.”

With the recent changes to Taiwan’s property tax system, the government expects revenue to grow at a healthy rate next year. Factoring in “income tax on house and land transactions,” tax revenue in Taiwan’s 2016 Central Government General Budget Proposal is expected to grow by 9.1%, or NT$69 billion (US$2.08 billion), the Ministry of Finance said in an email to TOPICS.

Further reform

Still, observers urge additional reform to the tax system, which they say can strengthen Taiwan’s competitiveness. For instance, although the corporate income tax rate has been cut to 17%, the withholding tax rate on most types of income of foreign entities remains 20%. In other countries, the withholding tax rate is typically equal to or below the corporate income-tax rates. Singapore has a corporate income-tax rate of 17%, with a withholding tax rate ranging from 10% to 17%.

An independent tax court to handle tax-dispute cases could also bolster Taiwan’s environment for foreign investment, the AmCham Tax Committee notes in the 2015 Taiwan White Paper, citing Germany, the United States, and Canada as countries from whose experience Taiwan can learn. In all three countries, an independent tax court has been able to protect individual taxpayers’ rights and improve the overall tax system, the White Paper says.

Meanwhile, Taiwan’s value-added tax (VAT) rate of 5% is relatively low by the standards of developed countries. By comparison, South Korea’s is 10%, Germany’s is 19%, and the United Kingdom’s 20%. Japan, which shares many of Taiwan’s fiscal troubles, increased its VAT in 2013 from 5% to 8%. In 2017, Japan plans to raise the tax further to 10%.

Because the tax base of the VAT is large, a small hike in the rate will generate a considerable increase in tax revenue without crimping consumer spending, says Wang Jiann-chyuan, a researcher at the Chung-Hua Institution for Economic Research. A 1% increase in the VAT would boost Taiwan’s tax revenue by NT$60 billion, he says.

“More tax revenue is a good thing, although Taiwan’s tax burden [ratio of tax revenues to GDP] remains among the lowest in the world,” says Liu of the DGBAS. At 16.1%, Taiwan’s tax burden is higher than Singapore’s and Hong Kong’s, but lower than South Korea’s (24.9%).

“We are moving in the right direction though,” he concludes.

Taiwan is not Greece

While Taiwan has not run a budget surplus since 2008 and the majority of its local governments are in debt, the island is not on the brink of fiscal ruin. In fact, it still has ample room to increase borrowing, according to the International Monetary Fund (IMF). In a June report, the IMF ranked Taiwan seventh globally in terms of “fiscal space,” defined as the difference between the debt limit and the actual debt-to-GDP ratio. With a score of 209.5%, Taiwan was ranked behind neighboring economies South Korea (No. 2) and Hong Kong (No. 4), but ahead of Singapore (No. 10).

And yet, recent reports in Taiwan’s local media have compared the island to debt-ridden Greece, which earned a score of zero in the IMF’s report and placed dead last alongside Cyprus and Italy.

Sensationalism is common as a means of competing in Taiwan’s crowded media market, but in this case some of the commentators have failed to do their basic homework. For instance, in a July commentary in The Taipei Times, former presidential adviser Huang Tien-lin argues that Taiwan and Greece have similar levels of national debt. Greece’s debt, he asserted, is 171% of GDP, while Taiwan’s debt is 156%.

In fact, Taiwan’s public debt is currently just over 35.85% of GDP. In a forecast by the Taiwan Institute of Economic Research (TIER), the level of debt approaches 160% only when government obligations over the next 30 years are included. And using the same forecast model, Greece’s public debt is bound to be far higher than 171% of GDP.

Even Democratic Progressive Party (DPP) chairwoman and presidential candidate Tsai Ing-wen has raised the specter of Taiwan ending up like Greece. “We need to treat Greece’s situation as a mirror of Taiwan, and we must propose concrete reforms now,” she said in July.

Finance experts dismiss the comparison altogether. “Under no circumstances will Taiwan become a Greece,” says economist Cheng Cheng-Mount, president of the Taiwan Agricultural Bank, noting the difference in the nature of the debt held by the two countries. Indeed, Greece’s debt is held by external creditors such as the European Central Bank and the IMF, while domestic investors hold the majority of Taiwan’s debt in New Taiwan dollars.

Meanwhile, as a eurozone member, Greece has no currency of its own and cannot control its monetary policy. By contrast, Taiwan’s Central Bank can monetize public debt, since most of that debt is held in New Taiwan dollars. Taiwan can also channel the abundant savings of domestic investors to finance debt if necessary.

New York-based ratings service Standard & Poor’s (S&P) gives Taiwan a long-term credit rating of AA-minus, its fourth-highest. That contrasts sharply with Greece’s rating of CCC-plus, among the lowest in the world. Taiwan’s rating “balances a strong net external asset position, ample monetary flexibility and dynamic private-sector companies with a moderate level of government debt,” S&P said in April, adding that it expects sustained economic growth “to consolidate the debt position.”