US embassy cable - 05TAIPEI3150

UNCLAS SECTION 01 OF 03 TAIPEI 003150 
 
SIPDIS 
 
SENSITIVE 
 
STATE PLEASE PASS AIT/W AND USTR 
 
STATE FOR EAP/RSP/TC, EAP/EP AND EB/IFD/OIA 
 
USTR FOR TWINELAND 
 
USDOC FOR 4420/USFCS/OCEA/EAP/LDROKER 
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TREASURY FOR OASIA/ZELIKOW AND WISNER 
TREASURY PLEASE PASS TO OCC/AMCMAHON 
TREASURY ALSO PASS TO FEDERAL RESERVE/BOARD OF GOVERNORS, 
AND SAN FRANCISCO FRB/TERESA CURRAN 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, TW 
SUBJECT: Taiwan Tax Reform Proposals 
 
 
Summary 
------- 
 
 1.   (SBU) This cable will be the first in a series on 
 Taiwan tax reform proposals drafted by summer intern David 
 Craig.  This first cable will examine the problems related 
 to Taiwan's current tax regime.  Taiwan's regressive tax 
 system places a burden on a narrow-base of tax-paying 
 individuals and companies.  Furthermore, continued increases 
 in government expenditures and increasingly insufficient tax 
 revenues have forced the central government to explore 
 measures to improve the fiscal situation.  End Summary. 
 
National Deficit 
---------------- 
 
 2.    (SBU) The steepness of the rise in government debt 
 over recent years has been an increasing concern.  For 
 2005, Taiwan expects central government debt to rise by 
 8.8 percent, reaching NT$3.7 trillion, while total 
 (central and local) government debt is projected to grow 
 7.7 percent, reaching NT$4.2 trillion by the year's end. 
 According to the Cabinet-level Directorate General of 
 Budget, Accounting & Statistics (DGBAS), outstanding 
 government debt equaled 35.9% of Taiwan's average GNP of 
 the past three years.  Financial experts predict this 
 percentage will reach 39.1% by 2009, nearing the ceiling 
 of 40% set by Taiwan law. (U.S.' total government debt is 
 65% GDP; Japan's total government debt is 164% GDP). 
 
Tax Revenues 
------------ 
 
 3.    (SBU) According to the DGBAS, from 1990 to 2002, 
 government expenditures nearly doubled from NT$1.097 
 trillion to NT$2.139 trillion.  During this period, Taiwan's 
 annual growth rate of GNP averaged 7%; Taiwan's annual 
 growth rate of GDP averaged 8%.  In contrast, tax revenues 
 have grown only marginally, 2.8% annually, failing to keep 
 pace with economic growth.  The 2004 tax burden ratio (tax 
 revenues to GDP) was 12.3%, one of the lowest in the world. 
 When compared with the 27.6% average among OECD countries, 
 it is evident Taiwan is among the least-taxed of developed 
 economies. 
 
Political Ramifications 
----------------------- 
 
 4.   (SBU) Premier Frank Hsieh has stated repeatedly the 
 fiscal problem is serious and cumulative.  According to 
 Hsieh, the fiscal system, established under the 
 authoritarian Kuomintang (KMT) regime, remains outdated in 
 a democratic system.  As a result of numerous political 
 and economic decisions during the KMT era, the Democratic 
 Progressive Party (DPP) government has inherited an 
 outstanding debt of NT$2.4 trillion since it assumed power 
 in 2000. 
 
Preferential Treatment 
---------------------- 
 
 5.  (SBU) Under the current tax system, citizens 
 experience two entirely different tax policies - a 
 burdensome tax for mainly the middle class, individuals 
 and medium-size companies that pay taxes, while the 
 wealthier enjoy substantively discounted taxes. 
 
 6.   (SBU) Finance Minister Lin Chuan recently reported 
 that among the top 40 richest people of Taiwan, only four 
 or five pay taxes "normal" to their income, while eight 
 have never paid any tax and another seven pay taxes 
 equivalent to less than 1% of their income.  Similarly, 
 this past year the top 30 Taiwan electronics companies, 
 using income tax reductions or exemptions offered by the 
 government to encourage domestic investment, experienced a 
 tax rate of virtually zero (in terms of annual total 
 revenues). 
 
 7.   (SBU) Since 1955, nearly 40% of adult citizens have 
 been exempted from paying personal income tax.  Among 
 these are military servicemen and elementary and junior 
 high school teachers who continue to benefit from an 
 outdated policy that grants them exemption from paying 
 personal income tax. 
 
Policy Reform Agenda 
-------------------- 
 
 8.   (SBU) During its assessment of the fiscal crisis, the 
 Ministry of Finance clearly identified the primary goal of 
 reform: fairness.  Finance Minister Lin indicated that 
 currently the purpose of tax reform is not necessarily to 
 increase revenues, but to expand the tax base and make the 
 tax burden more equitable.  On May 30, following a meeting 
 of the Presidential Economic Advisory Committee (PEAC), 
 President Chen Shui-bian proposed the following reforms to 
 the current tax policy. 
 
Alternative Minimum Tax (AMT) 
----------------------------- 
 
 9.    (SBU) As a result of the Statute for Industrial 
 Upgrading, which provides tax incentives that cover 71% of 
 high-tech manufacturing firms, over 4,000 companies have 
 enjoyed a zero tax bill.  The Ministry of Finance 
 estimates the government has lost tax revenue of NT$70.9 
 billion per year.  To resolve this matter, the government 
 will adopt a minimum tax system, which will be applied to 
 business firms as well as high-income individuals. The 
 proposed minimum tax for businesses is 10%.  For 
 individuals, those earning at least NT$10 million before 
 taxes, the proposed minimum tax is 20%. 
 
Value Added Tax (VAT) 
--------------------- 
 
 10.  (SBU) The business transaction tax will increase by 
 one or two percentage points, from its current 5% to 6-7%. 
 An increase of one percentage point would bring added 
 revenue of NT$30 billion a year.  The Ministry of Finance 
 will delay the implementation of this reform until 2006. 
 As Finance Minister Lin indicates, ".the government has to 
 show its will to achieve fairness before it can ask the 
 public to pay more consumption [business] tax." 
 
 11.  (SBU) Unlike the minimum tax, this move does not 
 require new legislative measures.  Current law gives the 
 executive branch power to set the value added tax level 
 between 5 and 10 percent. 
 
Military Servicemen & Teachers 
------------------------------ 
 
 12.   (SBU) The tax exemption for military servicemen and 
 elementary and junior high school teachers will be 
 eliminated.  The salaries of these recipients are no 
 longer as far below average as they once were.  Therefore, 
 the exemption's contemporary application has become an 
 issue of tax fairness.  The new policy will add 
 approximately NT$13 billion to annual tax revenue. 
 
Estate & Gift Taxes 
------------------- 
 
 13.   (SBU) In an effort to promote fairness, these taxes, 
 paid primarily by the middle class, will be reduced from 
 50% to 40%. 
 
Proposed Reform Benefits 
------------------------ 
 
 14.  (SBU) The Ministry of Finance estimates these 
 measures will increase tax revenue by NT$60 billion per 
 year, with the average national tax rate increasing from 
 13.6% to 15% of GDP in three years. 
 
Comments 
-------- 
 
 15.   (SBU) Though these measures will increase tax 
 revenues, they will not immediately improve the 
 government's strained fiscal condition.  Academic 
 specialists view overhaul of the fiscal structure as a 
 grand project that must be undertaken by the whole 
 government, not just the Ministry of Finance.  To view it 
 merely as an issue of tax reform is over-simplification. 
 
 16.   (SBU) To win support for increasing taxes, Taiwan's 
 government must demonstrate its commitment to reform by 
 practicing fiscal discipline, limiting expenses and 
 holding true to those limits.  In the past, 
 recommendations have been submitted, but little progress 
 has been made.  The key to success lies in the degree of 
 commitment and leadership shown by executive and 
 legislative officials.  It is the actions taken by the 
 government, rather than the immediate results, that will 
 have profound implications. 
 
KEEGAN