Tax System Controversy
Taiwan: 'Island of Inequity'?
Taiwan's finances are in their worst shape in a decade, yet the government continues to push tax cuts as a way to prosperity, angering the overburdened middle class.
Taiwan: 'Island of Inequity'?By Monique Hou
From CommonWealth Magazine (vol. 445 )
On May 1, Taiwan's nine million workers will celebrate Labor Day. On the same day, the country's taxpayers will begin filing their taxes. "Workers" and "taxes" may seem only indirectly linked, but in Taiwan, the connection between the two has left many indignant.
Plenty of economic figures exist to support the public's frustration. None of the numbers are news to anybody, but they have grown progressively worse over the past two years.
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 (Table 1), a far higher ratio than the 56 percent in the United States and the 49 percent average across wealthy OECD (Organization of Economic Cooperation and Development) countries.
In Taiwan, there are 7.54 million households, but only 5.38 million, or 71.3 percent, pay taxes. "Many of those that don't pay taxes are actually high-income earners. These people only pay NT$600 a month in health insurance premiums, and in the future, when premiums are calculated based on household income, this one-third that don't pay taxes may not have to pay health insurance premiums," a former financial official in the central government says.
Twenty years ago, U.S.-based Business Week called Taiwan the "Island of Greed." But Liu Chih-yun, a salesperson in an electronic radiator factory in the Taipei suburbs, thinks it's time for a new moniker.
"If it were up to me, I would say that today's Taiwan is an 'island of inequity.'"
The Truly Wealthy Go Untaxed?
Taipei resident Liu Chih-yun and his wife earn just over NT$80,000 per month. There is little left over after they make mortgage and car-loan payments, take care of their health and labor insurance premiums and their children's education fees, and also pay their vehicle registration, fuel, housing, land, and income taxes.
"I'm not even as well off as the noodle vendor outside my apartment building, who doesn't have to pay taxes, not to mention individuals who live off the stock market or make money off their property holdings," Liu says. The sense of inequity has grown particularly acute in the low-interest environment of recent years as property prices and stocks have soared, sending many individuals' net worth higher at a dizzying rate.
"Those people don't have to pay any tax on their income. Is that fair?" Liu asks angrily.
"Taiwan's truly wealthy people are not the ones you see in public. Rather, they are the quietly anonymous individuals who live in exclusive properties like The Palace," says a former financial official. In an unprecedented move a few years ago, the Ministry of Finance released figures on how much tax Taiwan's richest people paid in 2005, providing a glimpse into the severity of the imbalance. Out of Taiwan's 40 wealthiest people, eight paid no taxes five years ago and 17 paid only 1 percent of their income.
"The taxes that many people pay are totally disproportionate to their incomes," says economist Ma Kai. Many households' accumulation of wealth relies on gains from property and stock transactions, the vast majority of which go untaxed. Even if the wealthy have taxable income, there are many legal or "gray area" tax shelters at their disposal to help them reduce their tax liability, Ma explains.
According to the 2009 IMD World Competitiveness Yearbook, corporate income taxes paid by Taiwan's enterprises are only 3 percent of GDP, lower than the ratio in the other Asian Dragons (South Korea, Sinpapore 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 other words, at least 70 percent of Taiwan's taxable corporate income has fallen through the tax system's cracks.
In Taiwan, the more a company earns, the lower its tax burden. CommonWealth Magazine found that of the publicly listed companies that have made public their 2009 financial statements, the 10 companies that made the most money only paid on average a marginal income tax rate of 9.97 percent. (Table 2)
The 15 enterprises that earned over NT$3 billion in 2009 also paid a marginal rate of under 10 percent. There were 54 companies that reported a profit but did not pay a dime in taxes or even received tax rebates. Compared to the limited tax burdens of these profitable companies, the 21-30 percent marginal income tax rates facing average salaried workers seem exorbitant.
These numbers all illustrate a single point. Salaried workers face a much heavier tax burden than private companies or wealthy individuals. Yet the government is telling the public that to improve Taiwan's international competitiveness and revive the economy, corporate income taxes need to be lowered further.
CommonWealth Magazine's 2010 Tax Reform Survey clearly indicates that the unfairness of the tax system is one of the greatest sources of public anger.
From April 14 to April 17, CommonWealth Magazine conducted a telephone survey of 1,084 adults 20 years of age or older. It found that 79 percent of respondents agreed that all income should be taxed, but 54 percent said the tax system is unfair, compared to only 24 percent who said the contrary. (Survey Table 1)
Government Ignores the Average Person
Of those who thought the tax system is unfair, 79 percent cited six main reasons for their concern: 1) Some people have many ways to avoid paying taxes, but the salaried class has practically none; 2) Companies receive too many tax breaks; 3) The wealthy earn a lot but they pay little tax as a percentage of their income; average people do not make much but pay a high percentage in taxes; 4) The rich do not have to pay too much in taxes; 5) Military servicemen, civil servants and teachers are exempt from paying income taxes; and 6) The tax system is unfair to workers. (Survey Table 2).
Asked about the government's policy to lower the corporate tax rate from 25 percent 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. Also, nearly 60 percent believe that over the past two years, the government has failed to take care of the average person. (Survey Table 3,4,5)
Nobel Prize economist and New York Times columnist Paul Krugman argued in his book Fuzzy Math that tax cuts are not a short-term economic policy tool. Only monetary policy is. The booms in America's economy in the late 1980s and 1990s were not the result of Ronald Reagan's tax cuts or Bill Clinton's tax increases, Krugman argued, but because of loose monetary policy.
But following Reagan's time in office, many countries around the world wanted to lower taxes, citing the Reagan experience to strengthen their arguments.
In his 2001 book, Krugman compared cutting taxes to getting hooked on morphine because it's so addictive, and he criticized George W. Bush's tax cut proposal in 2001 as not only being stupid but also dishonest, fearing that it would only make things worse for the middle class and the poor.
Krugman's criticism could be applied almost verbatim to Taiwan's present day situation.
Over the past two years, the administration of President Ma Ying-jeou has rolled out a number of tax breaks for companies and the wealthy. Only recently, to compensate big businesses for the loss of R&D and other tax breaks when the "Statute for Upgrading Industries" expired at the end of 2009, the government decided to lower the corporate income tax rate from 25 percent to 20 percent. But not wanting to be underbid when the opposition Democratic Progressive Party pushed a 17.5 percent tax rate, the government slashed the proposed rate even further to 17 percent as part of the new Statute for Industrial Innovation passed April 16. The bill also retained tax credits for R&D expenditures by large corporations and subsidies for small- and medium-sized enterprises to hire workers, even though the latter had nothing to do with innovation.
This so-called "17 plus 1 plus 1" package became the biggest tax cut measure in the history of the Republic of China. It was passed at a time when the country's finances are in their worst shape in the past eight years (Table 3), with the budget surplus of NT$40 billion in 2007 being transformed into a deficit of NT$500 billion.
National Pension Fund to Go Bust in Four Years
"Governments must manage their finances in a stable manner, and that's especially true for Taiwan because Taiwan exists amid an unstable cross-Taiwan Strait relationship," says the former financial official. Accumulating foreign exchange and budget surpluses are Taiwan's most two most important pillars and give the country the capability to stabilize situations when facing threats, "but the financial pillar has already collapsed," the former official says.
In 1990, the government's debt was less than 10 percent of GDP but now it is more than 38 percent of GDP, closing in on the legally mandated ceiling of 40 percent.
"If Taiwan continues like this, it will be finished. It was said that the National Pension Fund would go broke in eight years, but now that may happen in four to five years. In the future, copayments under the National Health Insurance system will surely rise and the health insurance program will become commercialized, with its social insurance function vanishing. At that point, the government will no longer be able to raise debt and will eventually be forced to print money, bringing with it inflation," warns Chien Hsi-chieh, a spokesman for the Tax Reform Alliance.
By the end of 2011, when Ma will have been in office for three and a half years, the various tax cuts will cost the government NT$635.8 billion in tax revenues, equal to roughly NT$27,000 per person. As for the heavy debt, if next year's deficit is the same as this year's, then the government will have added NT$1.432 trillion, or NT62,000 per capita, in new debt in 42 months in office. The unprecedented tax cuts and debt prompted the Ministry of Audit, when it made public its report on the final auditing of the government's finances for 2008, to issue a warning: "On the government's financial predicament, the many tax incentives and tax cuts have already seriously eroded the tax base, and the country's finances face a severe challenge."
"When Chen Shui-bian and Ma Ying-jeou were debating, they both had similar positions on taxes, arguing that lower taxes would generate economic growth, leading to higher tax revenues," Chien says. But this positive cycle has never occurred in Taiwan in the past 20 years. This can be seen through figures released by the country's Directorate General of Budget, Accounting and Statistics on government tax revenues as a percentage of GDP. The average for OECD countries is 28 percent and for China, Japan and South Korea it's roughly 20 percent. But the ratio in Taiwan has fallen from 19 percent in 1990 to 12 percent last year. Growth in tax revenues has lagged behind GDP growth since 1996, even though economic growth has fallen to below 4 percent from 8 percent 20 years ago.
Non-employed Wealthy Are Everywhere
A Mr. Wang who lives in Minsheng Community in Taipei does not have a job, but he has three houses to his name. Looking at his tax return for 2008, his total reported income is only NT616,000, and he only had to pay NT13,000 in taxes based on a 6 percent marginal tax rate after standard deductions and exemptions were applied. His reportable income was derived entirely from dividends, and because companies issuing the dividends withheld NT$67,000 for tax purposes, Wang received a tax refund of more than NT$50,000.
Because he does not work, and his nominal income is low, he only has to pay a monthly health insurance premium of NT$600, and his daughter studying in a public university even applied for a financial aid. But in fact, Wang also made NT$4 million on stock transactions in 2008 and kept NT$20 million to NT$30 million invested in the market. That's how he earned NT$600,000 in dividends.
Wang's case is anything but the exception. Non-employed wealthy individuals like him are quite common throughout Taiwan.
One critic argues that Taiwan's fundamental problem is not that tax rates are too low but that the system is unfair, riddled with too many tax incentives and too many loopholes. As long as corporations continue to get hefty tax breaks and capital gains on stock and property transactions remain either exempt from income taxes or are only minimally taxed, the average citizen will continue to feel exploited. Yet, taxing unearned income should not be difficult. All developed countries in the world impose capital gains taxes on income from stock trades or property transactions.
Taiwan's government has been unable to institute a capital gains tax on stock or real estate income because of a lack of transparent information and fears of rattling the markets. In the property market, those fears have left the government unwilling to replace publicly assessed present values (on which "land value increment" taxes are currently calculated) with actual market prices, which would boost capital gains tax revenues dramatically.
"Other countries have all done it. Can the government tell us why only Taiwan can't get it done?" Chien asks.
"If you say it's hard to get accurate information on real estate, I would agree. But all stock transactions are completely computerized. To say it's hard to get information is simply ludicrous. The real reason is the fear that the stock market will collapse," says stock brokerage worker Ruan Cheng-yuan.
"Taiwan is the only country in the world that uses an assessed present value to calculate housing and land taxes," says the economist Ma Kai. The publicly assessed land and house value usually seriously understates actual market values. "The Palace's apartments are publicly valued at only NT$3 million to NT$4 million," Ma says of the luxury property that reportedly has sold its units for up to NT$ 70 million.
The government recently floated the idea of raising housing taxes on residential units with public assessed values of NT$1 million or above, but that sparked an outcry and the proposal was withdrawn.
"Premier Wu said not raising the tax would not have had a big impact because only about 3 percent of all houses in Taiwan had publicly assessed values over NT$1 million. But I think that there are only 3 percent of all houses in Taiwan that have an actual value below NT$1 million," the economist says.
The problem with assessing taxes based on the actual market prices of real estate transactions is that Taiwan's property market lacks maturity, and the brokerage system has holes. In developed countries, property transactions are made through real estate brokers and banks, so the government is privy to all related information, but Taiwan's market is not that transparent.
"Over the long-term, the land value increment tax should be eliminated and a capital gains tax system be imposed. The government has to lay the groundwork step by step for a transparent information system. Assessing taxes based on actual market transaction prices is only a matter of time," says a former government official.
Eliminating targeted tax incentives. Expanding the corporate income tax base. Restoring the capital gains tax on stock income. Taxing capital gains on property transactions based on actual market prices.
Unlike the continuing wave of tax cuts, these moves will bolster tax revenues, and, combined with investments to upgrade Taiwan, are truly the keys to enhancing Taiwan's international competitiveness.
Translated from the Chinese by Luke Sabatier