A Taxing Problem: Taiwan’s Comparatively High Personal Income Tax-Rates

For a variety of reasons, Singapore and Hong Kong can manage just fine with significantly lower tax rates.

Over the years, the business community has made the case that Taiwan’s steep personal income-tax rates discourage the recruitment and retention of outstanding skilled professionals, both foreign and local. Often these individuals opt to live and work in the low-tax jurisdictions of Hong Kong and Singapore, and as a result Taiwan is deprived of the contribution of talent that could help boost its economic development.

In response, the government has sought to reduce the tax-rate differential. In January this year, amendments to the Income Tax Act cleared the Legislative Yuan, lowering the maximum personal tax rate from 45% to 40% for net taxable income of over NT$4.53 million (US$151,822) a year, the highest bracket.

But the 40% figure is still far higher than neighboring Singapore’s maximum income tax rate of 22% and Hong Kong’s 17%. The question is how do these two areas manage to obtain sufficient revenue with such low rates? And what prevents Taiwan from copying their example?

One factor seems to be Taiwan’s stagnant salary levels, which have increased only marginally over the last 15 years in contrast to robust salary growth in Singapore and Hong Kong. As a result, those jurisdictions can take in more money from tax collection and thus afford to maintain low-tax regimes, while Taiwan’s tax revenues are comparatively meager.

At the same time, Taiwan, with its population of nearly 24 million, faces much steeper government expenses than its smaller neighbors. According to the Ministry of Finance (MOF), Taiwan’s 2017 tax revenues amounted to NT$2.25 trillion (US$75.75 billion) – compared to the US$37 billion collected in Hong Kong (population 7.4 million) for the financial year 2016-2017 and the US$35.2 billion taken in by Singapore (population 5.6 million). Clearly Hong Kong and Singapore enjoy far more tax revenue per capita.

In 2017, the Taiwan central government’s overall expenditures stood at NT$1.92 trillion, with 79.3% of the money derived from tax revenues, says the MOF. That was an increase of nearly 6 percentage points from the 73.9% in 2007. (The change was mainly due to the substantial drop in profits earned by Taiwan’s state-owned enterprises.)

Last year, 45.3% of Taiwan’s tax revenues came from income taxes (both corporate and personal). Personal income tax receipts accounted for around 22% of the total tax-revenue pie, equaling around 17% of all government expenditures. Business tax contributed 11.5% of the tax revenue, commodities tax 8.4%, and customs duties 6%. (Non-tax sources of revenue include state enterprise profits, fines, and income from public properties.)

Al Chang, a partner with the tax division of Deloitte & Touche Taiwan, notes that Taiwan’s tax structure is actually quite similar to Singapore’s. According to the Singaporean government, corporate income tax amounted to 19.6% of government operating revenues in 2016, and personal income tax 15.3%, a figure close to Taiwan’s 17%.

But Lotus Ma, Deputy Director General of the MOF’s Taxation Administration, notes that taxation on personal income is not a major revenue source in Hong Kong. According to the Hong Kong government’s statistics for fiscal year 2016-2017, “profits tax” – a levy imposed on profits from any trade, profession, or business – at 24.3% was the largest contributor to government coffers.

On the expenditure side in 2017, according to figures from the Directorate General of Budget, Accounting and Statistics (DGAS), social welfare took up 23.9% of all government spending, followed by 20.8% for education, science, and culture, and 15.5% for defense. Economic affairs accounted for another 13.4% of the pie. While defense spending as a proportion of government spending has stayed relatively flat over the years, social welfare has grown from 19.6% of government spending in 2007.

In contrast, Singapore in 2016 budgeted 47.6% of its spending on social development, followed by 27.3% for security and external relations (including 13.8% for defense), and 21.7% for economic development.

According to Huang Shih-chang, an associate research fellow with the Chung-Hua Institution for Economic Research (CIER), the category topping Hong Kong’s spending in 2017 was basic infrastructure at 18.5%, followed by education at 18.2%, social welfare 14.6%, and healthcare 14.5%. Whereas both Singapore and Taiwan need to devote budget to defense, Hong Kong does not maintain its own military.

In its World Economic Outlook for April 2018, the International Monetary Fund (IMF) estimates that Hong Kong’s GDP growth this year will come to 3.6%, while Singapore’s is expected to be 2.9%. The latest forecast from the DGBAS puts GDP growth for this year at 2.6%. However, the real problem in Taiwan is that the benefits of growth are not trickling down to affect ordinary salary levels.

Essentially, notes Deloitte’s Chang, GDP per capita in Hong Kong and Singapore is significantly higher than in Taiwan. The IMF’s April report puts Hong Kong’s GDP per capita at US$48,830 and Singapore’s at US$61,770, while Taiwan’s stands at merely US$25,980.

Hong Kong is a “smaller piece of land, with fewer people, but they generate more output,” Chang notes. He adds that certain industrial sectors in Hong Kong and Singapore, particularly financial services and real estate, are considerably more advanced than in Taiwan, which not only invigorates those economies but also attracts foreign professionals.

Consequently, “they can manage with a lower income tax rate,” Chang says. And in a virtuous cycle, “the lower income tax rate then attracts more investment,” he adds.

Singapore’s higher sales tax

Other factors also play a part in enabling Hong Kong and Singapore to operate with low personal income-tax rates. For example, experts point to Singapore’s relatively high sales tax of 7% (Taiwan’s VAT is 5%), which the Singaporean government says it plans to raise to 9% after 2021. As a result, goods and services taxes (GST) accounted for 15.8% of Singapore’s government revenues in 2016, while the comparable figure for Taiwan in 2017 was only 9.1%.

“One of the reasons why Singapore can have a low income-tax rate is that they compensate by having a higher GST rate,” says Rosamund Fan, a tax services partner with Pricewaterhouse Coopers (PwC) Taiwan. “The lower income taxes encourage spending, and the spending enables the government to collect the GST.” Hong Kong, in contrast, has no sales tax.

In an era of globalization and a growing gap between rich and poor, CIER’s Huang worries there has been too much focus in Taiwan on lowering the highest personal income-tax rates. Rich people, he notes, are globally mobile and can engage in sophisticated tax planning, enhancing their wealth. Poorer people may need relief from the government, and that relief depends on support through tax revenues. From that point of view, “the new maximum tax bracket of 40% is not necessarily a good thing,” Huang says.

He notes that academics have recently been discussing whether increasing the sales tax would better address Taiwan’s issues related to social inequality, as rich people do more spending. But both Fan and the MOF’s Ma say the Taiwan government is reluctant to do so due to fears that it would be inflationary. “In consideration of our standard of living and price stability, we are very careful about raising the VAT rate,” says Ma.

Taiwan, Hong Kong, and Singapore all face the challenge of rapidly aging societies where spending on care for the elderly is likely to skyrocket in the years ahead. But Fan notes that in Taiwan the government bears a greater share of the burden for social security programs.

Whereas the Taiwan government contributes 10% to most labor insurance and health insurance accounts, even for high earners, in Singapore only employers and employees contribute to the Central Provident Fund, a compulsory savings plan for working Singaporeans and permanent residents to fund retirement, healthcare, and housing. “The government [in Taiwan] is running at a deficit, and one of the main reasons is social-security spending,” Fan says.

Opinions vary as to the efficiency of tax collection by the three governments. Chang and Fan both regard Taiwan’s tax collection system as relatively efficient, with Fan stressing that most personal income tax payments in Taiwan are done through withholding from employees’ monthly salaries.

However, Hank Huang, president of the Taiwan Academy of Banking and Finance, says that Taiwan’s thriving underground economy means that its tax collection in may not be as efficient as in Singapore and Hong Kong. He notes that some Taiwanese retail outlets such as night markets and restaurants operate off the books and may not even offer customers a receipt.

While China’s urban areas are moving toward a cashless society, with most payments done through smartphones, Huang notes, Taiwan still relies heavily on cash for its transactions, making it harder to detect underground economic activity. (Hong Kong and Singapore are also lagging behind China in the prevalence of e-payments.)

Another point to be considered is the difference between nominal and effective tax rates, once various deductions are factored in, notes Arthur Chen, Deloitte’s Director for Tax. “The effective tax bracket of high-paid individuals in Taiwan is roughly 30-33%,” Chen says, whereas in Hong Kong it would be about 15%.

Fan adds that high earners in Taiwan are able to find ways to reduce their tax burden with strategic itemized deductions, such as medical expenses and charitable donations, but even so they end up paying relatively more tax.

“Overall if you are a high-net-worth person with relatively high donation expenses, you can save tax and do Corporate Social Responsibility at the same time,” Fan says. “But even after accounting for those donations, you are still paying more tax than in Hong Kong and Singapore.”

Tax equalization

In the case of foreign professionals, it is common for international companies to provide tax-equalization packages for employees stationed overseas. Generally executives receive the net pay they would have received in their home countries after taxation – and the company absorbs the extra tax burden.

As a result, individual foreign professionals enjoying tax-equalization benefits may not be concerned about Taiwan’s high personal income-tax rates, but their companies may be reluctant to send them to Taiwan if there is an alternative. “Once it becomes the company’s cost, it’s still a burden for Taiwan to attract foreign talent,” Chang says.

Interviewees all said it is nearly impossible for Taiwan to drastically change its current taxation system, even with the competitive pressure from low-tax regimes in neighboring countries, as the revenues are too sorely needed for government administration. “To be honest, Taiwan does not have many options,” Fan says.

“It’s hard for us to lower the income-tax rate” substantially, adds the MOF’s Ma. “That’s the reality we have to face.” She notes that unlike Singapore and Hong Kong, the Taiwan government has a large farming population it needs to protect (small-time farmers are exempt from personal income tax). “If they suffer from a typhoon or earthquake, the government will compensate them for their losses.”

Fan also notes that whenever the Taiwan government cuts taxes, it devises ways to make up for the reduction by creating other kinds of revenue. For example, she says, when January’s amendments to the Income Tax Act lowered the maximum personal income-tax rate to 40%, the corporate income tax was raised from 17% to 20%, despite an uproar from some business leaders.

Lai Cheng-i, head of the General Chamber of Commerce of the Republic of China, was quoted in local media as saying this increase would impose a “very heavy burden” on business, as the gross margin in many industries is less than 3%. The tax reform also called for tax rates on small and medium-sized enterprises with taxable income of less than NT$500,000 to be gradually raised to 20% over the next three years.

In addition, the January amendments increased the amount of various allowable deductions. For example, the standard deduction for a single taxpayer was raised from NT$90,000 to NT$120,000, and the special deduction for pre-school children went up from NT$25,000 to NT$120,000. Overall the reform was not only aimed at making Taiwan more attractive to foreign talent, but was also seen as a vote-pleaser ahead of municipal elections at the end of the year. “The tax authorities estimate they will be collecting less taxes after this tax reform,” Fan says.

Given the difficulty of overhauling the total taxation system too drastically, the government has recently focused on measures that apply specifically to foreign professionals. Under the Act for the Recruitment and Employment of Foreign Professionals passed early this year, newly arrived foreign professionals who earn an annual salary of more than NT$3 million (a little over US$100,000), and meet some other conditions, would pay tax on only half the amount of salary in excess of NT$3 million for their first three years in Taiwan.

For all the attention to tax rates, experts emphasize that many other factors go into determining the attractiveness of any destination for expatriates. Deloitte’s Chang notes that foreigners highly appreciate Taiwan’s reasonable living costs and excellent medical care, along with its safe, friendly environment and democratic system. Owing to the lower cost of living, notes Deloitte’s Chen, an American colleague who resided in Taiwan for a few years found that she was able to save more money than in other countries, even with Taiwan’s higher tax rate.