Download an overview of taiwan`s tax system

AN OVERVIEW OF TAIWAN'S TAX SYSTEM
I. INTRODUCTION
As we have seen from our previous two readings, taxes can be used to finance
government spending, to redistribute income, to stabilize the economy, and to indirectly
control market externalities. We now want to take a brief look at the ROC's tax system
and how it functions.
Taiwan has (16) sixteen basic taxes, which can be listed as follows:
(1) individual income tax (N)
(9) house tax
(2) profit seeking enterprise
(10) stamp tax
income tax (N)
(11) securities transactions tax (N)
(3) estate and gift tax (N)
(12) vehicle license tax
(4) business tax-VAT (N)
(13) deed tax
(5) commodity tax (N)
(14) amusement tax
(6) customs duties (N)
(15) futures transactions tax (N)
(7) land value tax (N)
(16) mine concession tax (N)
(8) tobacco and alcohol tax (N)
Essentially tax revenues are apportioned either to the central government or to a lower
level of government -- such as county or city governments. In our list above, taxes which
are allocated to the central or national government are denoted by (N). Roughly
speaking, 80% of Taiwan's tax revenues go to the central government, although lower
levels of government may obtain some of these funds through legally mandated revenue
sharing programs.
Taxes may broadly be divided into two types -- direct and indirect taxes. Direct
taxes are levied on people, whereas indirect taxes are levied on goods and services. About
60% of Taiwan's taxes are direct taxes, although it is difficult to compute this, since
Taiwan classifies some taxes as direct which are indirect in the US classification (e.g.
property taxes). The most important direct taxes in the ROC are the individual income tax
and business income tax. The most important indirect taxes are the business VAT tax,
commodity taxes and customs duties. Direct taxes are often considered to be a better form
of taxation because they do not favor one good or another. By contrast, tariffs, which are
indirect taxes, can affect the prices of goods relative to each other. This means that some
goods and services are affected, while other goods and services are not affected.
Therefore the market is not entirely responsible for determining prices when indirect
taxes are being used, and there is a loss of economic efficiency because of this. We often
say that prices send producers signals on what to produced and how much to produce.
Indirect taxes tend to distort these signals, and cause the wrong amounts to be produced
and consumed. For this reason, the ROC's tax system endeavors to use direct taxes rather
than indirect taxes when possible.
II. TAXATION AND FAIRNESS
One important criterion which economists use to judge the fairness of a particular
tax is by considering who pays more of that tax relative to their income. If higher income
households pay a higher percentage of tax relative to their income, we say the tax is
"progressive". If lower income households pay a higher percentage of tax relative to their
income, we say the tax is "regressive". Many people feel that a progressive tax is needed
to help redistribute income from high income families to low income families. Most
economies use individual income taxes which are very progressive. In Taiwan, the
individual income tax is also progressive, having five tax brackets. The marginal tax rates
vary from as low as 6% to as high as 40%.
It is interesting to note that many economists dislike a sales or commodity tax.
This is because they feel it is too regressive. This is especially true of taxes on food. The
poor and the rich tend to purchase the same amount of food each year, but the tax on this
food is the same for both groups. Therefore, the tax paid relative to income is higher for
lower income groups than for higher income groups. In Taiwan, there is a business taxVAT (Value Added Tax) levied whenever goods exchange ownership. It could be argued
that this tax is regressive since the poor pay a higher percentage of tax relative to their
incomes than do the rich.
The above discussion is concerned with what economists call "vertical equity".
This means that families with different incomes should be treated differently. Another
type of fairness is concerned with "horizontal equity". In this case we consider families
having the same income. In this case, equity requires that the two families should pay
roughly the same tax. In Taiwan, this type of equity is also hard to achieve. For example,
some individuals in certain professions such as public school teaching and the military are
exempt from the individual income tax. This means that a teacher and a worker who
make the same income do not pay the same income tax. Recently, some people in society
have claimed this is unfair. All taxes which give special exemptions to various groups in
society will have this problem of fairness.
III. FAIRNESS VERSUS EFFICIENCY
As we have seen, taxes can be judged as fair or unfair by using the criteria of
"vertical and horizontal equity". However, taxation is not quite so simple as this.
Sometimes we feel that fairness must be sacrificed in order to reach some other goal, such
as economic efficiency or high economic growth. For this reason, special tax rates,
deductions, exemptions, and tax credits are made available to particular groups within
society. A good example of this is the special tax deduction on interest payments. In order
to encourage private saving in the ROC, the tax authorities allow up to $270,000 NT as
an interest deduction from gross income. Clearly, this provision in the tax code will
benefit most those families whose incomes are high enough to allow such substantial
saving. Similarly, mortgage payment deductions tend to favor individuals who are
purchasing houses, but do not favor renters of houses. The standard deduction tends to
favor single individuals as opposed to married couples.
In a modern economy, the tools of taxation are designed for many purposes. It is
difficult to design a tax system which everyone feels is just and fair, while at the same
time, creates good incentives for efficiency and economic growth. The US tax system is
incredibly complex compared with Taiwan's tax system. Some people have argued that
the tax system can become so complicated that it loses many of its advantages. They have
argued that the tax system needs to be simplified. In the next section we will consider
some of the main features of the US tax system.
Discussion Questions:
1. Choose one of the 14 taxes in Taiwan and explain the basic features of the tax in
English.
2. Explain in English the meanings of tax deduction, tax credit, exemption,
special tax rates.
3. How can we measure the fairness of a tax?
4. What are some examples of a regressive tax in Taiwan?
5. What are some examples of a progressive tax in Taiwan?
6. What are some examples of how the tax system in Taiwan used to promote economic
growth and efficiency?
7. How are tax revenues apportioned to the different levels of government in the ROC?
8. What changes would you like to make to the tax system in Taiwan?
THE ECONOMIC EFFECTS OF TAXES
I. SUPPLY AND DEMAND
In general, taxes affect the economy by altering the supply and demand for goods
and services. There are numerous kinds of taxes, each having its own special effect on the
economy. An old saying is that "when you want less of something -- tax it, and when you
want more of something -- subsidize it". Taxes (and subsidies) affect important
economic variables, such as consumption and saving, employment, investment and
capital accumulation, technological progress, and productivity. We have seen that the
best kinds of taxes are those which have small distortionary effects. Unfortunately, to
raise large amounts of revenue, governments must often tax the economy heavily, and
this can alter incentives and reduce efficiency.
The most fundamental and important tax is the individual income tax. As we have
seen, it is a direct tax since the tax is levied on a person and the tax burden cannot be
shifted to another person. The income tax has been studied very closely by economists.
Economists are interested in knowing whether the income tax can be used to stimulate the
economy when it is in recession, and slow the economy when it is expanding too quickly.
The idea is simple. If the economy is in recession, a tax cut puts more income into the
hands of consumers and allows them to spend more. The additional spending spurs
producers to supply more goods and services, and firms will hire more workers.
Therefore, a tax cut can help bring the economy out of recession. Similarly, a tax increase
reduces spending when the economy is growing too fast. If the economy is expanding too
quickly, there is a strain on the productive capability of the economy. Labor, capital, and
raw materials are all in strong demand. Unless these can be expanded along with the
spending, bottlenecks will occur and the production of goods will not keep pace with
consumers' demand for goods. This causes prices to rise.
Are tax cuts and tax hikes effective? Here economists tend to disagree strongly.
For example, a tax cut during a recession means that consumers will have more income to
spend. But what if these consumers feel uncertain about the future and decide to save the
tax cut rather than spend it? In this case the tax cut may fail to achieve its objective.
Research over the years has shown that for a tax cut or a tax hike to be successful it must
be perceived by consumers and producers as long lasting. A tax cut one year that is
expected to be followed by a tax hike the next year will not be very effective. Consumers
know that the extra income they receive in the first year will be balanced by the higher
taxes they pay in the second year. As a result consumers will save the tax cut in the first
year, and then use it to pay the higher taxes in the second year. The tax cut in the first year
will not change spending very much, and will not be effective at pulling the economy out
of recession.
The corporate income tax also has important effects on the economy. Profits
earned by business can be paid as dividends to stockholders or retained in the firm to
finance new investment and research. A higher tax on profits can result in lower
dividends to stockholders and lower business investment and R&D expenditure.
Economists believe that the corporate income tax can affect the long term growth and
productivity of the economy. Lower investment means that firms will slow their
replacement of old capital with new and productive machines and equipment. With less
after-tax profits, firms will not be able to pioneer and develop new technologies, and will
fail to expand new markets.
II. DO TAXES AFFECT INFLATION?
An interesting question is whether taxes can affect the rate of inflation in the
economy. When we pay a sales tax, we must include the tax along with the price of the
good. Similarly a VAT tax involves a tax at every stage of production, and is levied on
the amount of value which was added to the good at that stage. Does this cause prices in
general to rise and thus contribute to inflation?
Most economists would agree that prices will be higher with the taxes than
without the taxes. But, this is different than inflation. Inflation is when there is a
sustained rise in the price level. If prices are high, but are not rising, we cannot say that
the economy is experiencing inflation. A rise in a sales tax or VAT tax is often criticized
as contributing to inflation. This is not correct for two reasons. First, the rise in the tax
will cause the price level to move from one fixed level to a higher fixed level. After the
adjustment to the higher level, prices will no longer rise and inflation will not exist.
Second, a higher sales or VAT tax will encourage consumers to spend less not more.
With less spending, we cannot tell whether prices (including the new higher taxes) will be
higher than prices before.
Economists believe that inflation results from a money supply which is growing
too quickly. This is not related directly to taxes. In fact, one can have inflation, even when
sales and VAT taxes are falling. If the money supply is growing too quickly, consumers
will respond by spending this money and will therefore cause the price level to rise
accordingly. This sustained rise in the price level (caused by a sustained rise in the money
supply) leads to inflation.
III. TAXES AND LABOR SUPPLY
Recently, economists have become concerned with the effect of taxes on the
supply side of the economy. We have already mentioned that the tax on corporate profits
can affect investment and research. This is a clear supply side effect. Another question is
whether taxes affect peoples' willingness to work. Do higher marginal tax rates affect the
supply of labor?
During the 1980's, in the United States, a popular topic was the Laffer Curve. This
term refers to a curve discussed by Arthur Laffer, an economics professor at the
University of Southern California (USC). The curve is simple to understand. If the tax
rate is zero, then the government gets no tax revenue. Similarly, if the tax rate is 100%,
no person will be willing to work and therefore the government again gets no revenue.
This means there is some rate of tax which will maximize the government's revenue.
Laffer convinced then President Ronald Reagan that US tax rates could be reduced and
yet government revenue could increase. How is this possible? Laffer claimed that a
reduced rate would induce people to work more and thus earn more taxable income.
While rates were lower, taxable income would be higher and the revenue the government
received would increase. Reagan believed strongly in this simple logic and therefore
marginal tax rates were reduced in 1986.
The result of this massive tax cut during the mid-1980's was to lower government
revenue, and raise fiscal deficits in the US. The Laffer curve simply did not apply to the
US, at this time. There are still strong proponents of supply side tax cuts in America, but
the experiment in Reaganomics has proved that things are not always so simple as they
seem.
Discussion Questions:
#1. Why is a temporary tax cut different than a permanent tax cut in its effects on the
economy?
#2. Higher taxes cause inflation. Do you agree or disagree?
#3. How would a tax on interest income affect the economy?
#4. Why do sales taxes and VAT taxes contribute to greater saving in the economy?
#5. What is a tax hike and how is it used?
#6. Americans are fond of saying "Nothing in Life is certain except death and taxes."
What does this mean? When would you use such a comment?
#7. Would a rise in tariff rates cause inflation or merely higher prices?
#8. Do you believe that lowering marginal tax rates in Taiwan would increase or decrease
tax revenue?
THE UNDERGROUND ECONOMY
I. DEFINING THE UNDERGROUND ECONOMY
One of the most difficult problems which economists must consider is how to deal
with the underground economy. The existence of the underground economy undermines
the very foundation of economics as a science. This is because it calls into question the
validity of the data which economists routinely use. For example, when economists claim
that real economic growth was 6.2% last year, they are referring to percentage changes in
the data collected on real GDP. If this data does not include the income which was earned
in the underground economy, the rate of growth can be quite different -- either higher or
lower. Similarly, we frequently hear economists speak of the unemployment rate and its
importance in designing economic policies. However, some people who are included in
the unemployment figure are probably working in the underground economy, and this
causes the quality of the data to be biased. In effect, there are really two economies
which operate together. The first is the observed economy, for which we have reasonably
accurate data. The second is the unobserved economy, for which we have very little data.
Economists are eager to understand the scale of this underground, unobserved economy,
along with the relation it bears to the observed, regular economy.
Perhaps the best place to begin our discussion of the underground economy is
with a definition. Unfortunately, it is not so easy to define such a term. In general, we
may say that any transaction which should be reported to the government, but which is
not correctly done so, is part of the underground economy. Most people think the
underground economy refers to the under-reporting of income on tax returns. Certainly,
this type of tax evasion is part of the underground economy, but there are other types of
activities as well. For example, some individuals and businesses may over-report
deductions, exemptions, and tax credits on their tax returns. In this case, the problem is
not under-reporting, but rather it is over-reporting.
The underground economy can be seen to consist of three major parts. First, it
includes legal income which is not correctly reported to the tax authorities. Second, it
includes illegal activities (which are still subject to tax in the US) such as sales of drugs,
weapons, and other contraband, smuggling, prostitution, gambling, loan sharking, and
bribery. Finally, it includes the usual errors and omissions that naturally occur in
collecting and publishing data on the national income. Therefore, it is important to realize
that not all of the underground economy is illegal activity, although it becomes
technically illegal because of false reporting.
II. MEASURING THE UNDERGROUND ECONOMY
An interesting question is how we might proceed to measure the underground
economy. Since they have no direct data on the size of the unobserved sector, economists
generally attempt to estimate the scale of the underground economy by using indirect
methods. A key factor in their estimation is that most underground economic activities
use currency to finance the expenditure. For example, when drugs trade hands, cash is
usually exchanged. This means that any significant expansion of the underground
economy will be accompanied by an increased demand for currency in the money supply.
Now, if the money supply, which is composed of both currency and deposit money, has a
stable relation to the national income, we can chart the growth of the underground
economy by looking at changes in the currency ratio -- that is, the ratio of currency to
deposit money.
Despite the fact that this method has many flaws, estimates using this method
have been made for numerous countries. Tables 1 shows some estimates of the
underground economy for selected countries. These estimates tend to be
TABLE 1
Country
Underground Economy as % of GNP
Spain
6.0
Italy
10.5
Belgium
11.5
Sweden
13.2
Germany
8.3
France
8.7
England
8.1
United States
8.2
Japan
3.9
Switzerland
4.5
Source: Frey and Pommerehne, "The Hidden Economy: State and
Prospects for Measurement" The Review of Income
and Wealth, Series 30, March 1984, pp. 1-23.
somewhat lower than other estimates that have been made in the past. In fact, estimates
for the underground economy in the US have been as low as 1% (1960) and as high as
50% (1985) of the GNP. Much depends on which method of estimation is used. One
interesting feature of the table above is that Sweden has the highest ratio of underground
activity to recorded GNP. A likely reason for this is the unusually high marginal tax rates
in Sweden. For example, the average taxpayer in Sweden must pay a marginal tax rate of
about 70% on his income. This creates strong incentives to hide income from the tax
authorities.
As we have said, the typical way that the underground economy is estimated is by
looking at the currency ratio. A higher currency ration is felt to be cuased by an expansion
in the underground economy. Thus, we might expect that a rise in income and sales taxes
would lead individuals and businesses to hide income and sales in the underground
economy, and that the currency ratio would rise. Unfortunately, things are not so simple
as this. First, the currency ratio will naturally fall as credit cards and automated tellers
which dispense cash become more popular in the economy. Second, the currency to
deposit ratio will also fall whenever there is a rise in interest rates, since cash pays no
interest, while deposits pay some interest. Finally, there is no reason to suppose that the
money supply has a fixed relation to income, which is an important assumption in the
estimation process. Even if currency is rising due to an expansion of the underground
economy, we cannot link this to income unless money has a stable relation to income.
III. THE UNDERGROUND ECONOMY IN TAIWAN
Despite the fact that most people feel the underground economy in Taiwan is very
large, there has not been many studies of the scale of the underground economy here.
Perhaps the earliest study was undertaken in 1981, and it was found that the underground
economy in Taiwan was between 8% and 25% of GNP. Since that time there have been
approximately ten other studies of the underground economy with the majority of
estimates showing the size to be about 20-30% of GNP. The most significant aspect of
these studies is that the underground economy is growing faster than the observed
economy. This is alarming since it places a higher tax burden on those who comply with
the law.
The key to limiting the underground economy is to have rigid enforcement of the
tax laws and a simplified tax code. It is also important that marginal tax rates remain at
reasonable levels. Taiwan has a very simplified tax code, but it has difficulty in enforcing
the law. It is common practice for firms in Taiwan to maintain two sets of accounts -- one
to show the tax authorities and one to show the true financial state of the firm. Also,
many street vendors are operating completely outside of the recorded economy. Both day
and night markets continue to thrive in Taiwan, and this contributes to a large
underground economy. Taiwan's marginal tax rates are not especially high when
compared with other countries, but it appears from empirical research that changes in
these rates have an effect on the size of the underground economy.
Discussion Questions:
#1. How would you define the underground economy?
#2. Why does the underground economy exist?
#3. What are some examples of the underground economy in Taiwan?
#4. Why are bribes a part of the underground economy?
#5. Sometimes illegal activities can be recorded in the national income accounts. How is
this possible?
#6. How can we measure the scale of the underground economy?
#7. What problems are there in using the currency ratio to measure the underground
economy?
#8. How large is the underground economy in most countries?
#9. How large is the underground economy in Taiwan, and is it growing. Why?
#10. How can we reduce the size of the underground economy?