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Statute for Industrial Innovation

A Lose-Lose Proposition?


A Lose-Lose Proposition?


Taiwan's new Statute for Industrial Innovation slashes Taiwan's corporate income tax rate to the lowest level worldwide. But these tax cuts will blow a gaping hole in state finances, due to lost tax revenues of at least NT$138 billion.



A Lose-Lose Proposition?

By Rebecca Lin
From CommonWealth Magazine (vol. 445 )

On April 16 the lights were shining bright at the Legislative Yuan. Banging his gavel on the podium, Legislative Yuan president Wang Jin-pyng declared the Statute for Industrial Innovation adopted, after the draft was dramatically changed in just a week's time.

The major opposition Democratic Progressive Party (DPP) had been advocating lowering the corporate income tax from 20 percent to 17.5 percent on the condition that all tax incentives be scrapped. Originally insisting that four categories of tax breaks be retained, the ruling Kuomintang (KMT) made a startling about-face, proposing to keep only one tax exemption – on investments in R&D and innovation – while cutting the corporate income tax to 17 percent, a version that came to be called "17 plus one."

As a result, the sparring between the blue (pro-KMT) and green (pro-DPP) camps over the content of the Statute for Industrial Innovation turned into a tax-cut competition. Now that the gavel has come down, the Taiwanese people need to ask themselves who the winners are, and who might end up the losers.

While the Statute for Industrial Innovation consists of only 72 articles, it is a highly complex bill. In an exclusive interview with CommonWealth Magazine, Taiwan's economics minister Shih Yen-shiang admitted that he is not able to explain the intricacies of the bill in a few words. Shih lamented that the statute's provisions on intellectual property rights (IPR) protection, green procurement and industrial park development are being overlooked because everyone is focusing on the "17 plus one" issue. "The basic direction of the statute is encouraging industrial innovation, transformation and upgrading," Shih insists.

So what are the major differences between the Statute for Industrial Innovation and its predecessor, the Statute for Upgrading Industry?

World's Lowest Corporate Income Tax Rate

For fiscal and economic experts, the 17-percent corporate income tax rate is the most crucial magic number in the Statute for Industrial Innovation.

"This represents a major shift in our basic tax policy concept," notes Tseng Chu-wei, chair professor at the Department of Public Finance of China University of Technology.

The new tax rate not only is the lowest in the world, but also equally applies to all companies regardless of their size and industry sector. The government is no longer choosing the winners, but allows everyone – from conventional industries to the high-tech sector, from small and medium-sized enterprises to industry giants – to compete based solely on performance. A uniformly applied tax rate prevents distortions and is a more reasonable approach, says one retired tax official, praising the policy change.

Shih argues that the public has long been calling for light taxation and simple administration and that such appeals have been frequently heard in meetings of the government's Tax Reform Commission. A survey by the Ministry of Economic Affairs found that most representative industry associations support the idea of lower taxes and less red tape. In other words, they want the current 20-percent corporate income tax rate to be slashed further.

According to the Ministry of Economic Affairs, the new 17-percent tax rate will be lower than China's 25 percent and South Korea's 22 percent and roughly equal to the corporate income tax rates of Singapore (17 percent) and Hong Kong (16.5 percent) and it will directly contribute to creating a fair, efficient, lean and internationally competitive tax environment while also reducing companies' tax costs.

Tax Revenue Losses to Outstrip GDP Growth

U.S. projections show that every dollar worth of tax cuts generates 1.5 to 2.5 dollars of gross domestic product (GDP). Based on these projections, the new tax rate, once implemented, would create an extra NT$69 billion of GDP for Taiwan.

Yet while the lower tax rate achieves the goal of light taxation and simple administration, the higher GDP will not necessarily line everyone's pockets. If the tax base is not increased when taxes are cut, government finances and society at large will most likely feel the pinch.

As for sound finances, the Ministry of Finance forecasts that with every percentage point reduction of the tax rate, the state loses NT$16 billion in tax revenue. Including a previous tax cut from 25 percent to 20 percent, implemented only at the beginning of this year, the state's corporate income tax revenue will shrink by 8 percentage points. If lost tax revenue resulting from tax breaks on investment in R&D and innovation are factored in, total tax revenue will shrink by about NT$138 billion. These tax revenue losses will come on top of NT$70 billion in tax cuts resulting from the downward adjustment of the inheritance tax, the personal income tax, and the land appreciation tax over the past two years.

R&D and Innovation Tax Breaks Narrow Tax Base

Standing next to Premier Wu Den-yih, Finance Minister Lee Sush-der seemed at ease despite the expected shortfall in tax revenue, never losing his smile when he spoke to reporters. Confronting the doubts and misgivings about the tax cuts that have been voiced from various sides, Lee acknowledged that government finances are tight, but that tax revenue does not solely rely on the corporate income tax. He said that the tax cuts will cause a tax revenue loss in the short term, but will stimulate the economy in the longer term.

Lee however remained mum on how the fiscal gap is supposed to be closed.

On the other hand the government continues to let the tax base erode. Some wonder whether further tax cuts are necessary, given that the tax system has already been streamlined. A number of scholars have been bluntly critical, opining that since the corporate income tax has already been slashed markedly, the tax breaks on investment in R&D and innovation should be scrapped. The Ministry of Finance conservatively estimates that the tax breaks amount to NT$10 billion per year.

Wang Jiann-chyuan, vice president of the Chung-Hua Institution for Economic Research, believes that rising R&D efficiency would boost the competitiveness of midstream and downstream industries, which would produce a powerful stimulating effect on the economy. Wang cites as an example the year 2008 when the government invested some NT$30 billion in R&D tax incentives while corporate revenue contributed NT$500 billion to the island's GDP.

"R&D is crucial for transformation, in particular for the upgrading of the service industry, which will be the job engine for young people in the future," Wang asserts.

All along Taiwan has been working to boost R&D not only through tax deductions and exemptions, but also through subsidies. The National Science Council and the Industrial Development Bureau under the Ministry of Economic Affairs earmark R&D subsidies in their budgets.

But one crucial problem is that identifying R&D expenses is difficult, and the related costs for tax assessment are high. Since personnel of the National Tax Administration are not familiar with R&D, such tax breaks often turn into loopholes for tax evasion.

Tax officials often complain that when they visit factories in the Hsinchu Science Park to assess taxes, they discover that any activity inside a cleanroom is labeled R&D and that even ordinary janitors in cleanroom suits are listed as R&D personnel.

"The standards for the recognition of R&D expenses are too generous. You can virtually declare anything as R&D," one tax official acknowledges.

"The tax base is eroding, and the fiscal hole continues to widen. The government is the loser," insists a former Ministry of Finance bureaucrat.

Such a state of affairs could not only drive Taiwan's government into the red, but also trigger social conflict, with many people objecting that tax cuts are only offered to the rich.

Carrot-and-Stick Approach

Some scholars contend that now would be a good time for Taiwan's government to consider a new "green tax" initiative. Before prescribing a medicine for changing the overall business environment, the government should first diagnose the ailments that plague Taiwan's companies. Instead, the government has already completely yielded to corporate demands with its repeated tax rate cuts and tax reductions.

"The government has handed out a lot of carrots to business. Now is the best time to bring out the sticks," says an expert who did not want to be identified.

On the heels of tax reductions in one area, tax hikes in others will inevitably have to follow. Explaining the idea behind the "green tax," Huang Yao-hui, assistant professor at the Department of Public Finance and Tax Administration of National Taipei College of Business, notes that green taxes are consumption taxes in that they tax the consumption of social resources. Since companies are the greatest consumers of energy, they should pay higher taxes in that area, particularly because they already enjoy tax breaks on R&D.

"If we go on like this, the state will be bankrupt by its 100th anniversary in 2011," warns Tseng Chu-wei, professor emeritus at the Department of Finance, National Chengchi University. With that remark, Tseng echoes widespread public sentiment.

Translated from the Chinese by Susanne Ganz