US embassy cable - 05TAIPEI3221

UNCLAS SECTION 01 OF 04 TAIPEI 003221 
 
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 
USDOC FOR 3132/USFCS/OIO/EAP/ADAVENPORT 
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, Finance 
SUBJECT: Taiwan Tax Reform II - The Numbers 
REF: Taipei 03150 
 
Summary 
------- 
 
1.  (SBU) This cable examines Taiwan government expenditures 
and revenues.  According to the Directorate-General of 
Budget, Accounting and Statistics (DGBAS), the 2005 
projected total government expenditures equal NT$1.635 
trillion; total revenues equal NT$1.402 trillion. The 
estimated annual budget deficit equals NT$233 billion, a 
slight (six percent) improvement from the previous fiscal 
year.  End Summary. 
 
Intro 
----- 
 
2.  (SBU) This cable is the second in a series on Taiwan tax 
reform.  The first cable (reftel 03150), released July 25, 
discussed Taiwan tax reform policy proposals.  The third and 
fourth cables in this series will discuss the two proposals 
under consideration to alleviate Taiwan's fiscal problems - 
the Alternative Minimum Tax and Value Added Tax, 
respectively. 
 
Historical Burden 
----------------- 
 
3.  (SBU) In 1989, Taiwan experienced its first significant 
budget deficit - NT$285.8 billion, equivalent to 7.3% of 
GDP.  The budget balance has remained negative through the 
present, with the exception of 1998, when Taiwan implemented 
a fiscal reform package with the National Development 
Council's (NDC) goal of having a balanced budget by 2001. 
These reforms caused a jump in government revenue growth, 
from 6.3% in 1997 to 20.5% in 1998, producing a budget 
surplus of NT$60.9 billion.  Despite this, the following 
year saw another deficit due to a 2.9% increase in 
government spending and a 2.4% decrease in government 
revenues (mainly due to repercussions of the Asian financial 
crisis). 
 
4.  (SBU) According to the DGBAS, from 1990 to 2003, 
Taiwan's annual GDP growth rate averaged 8%; Taiwan's annual 
GNP growth rate averaged 7%.  In contrast, tax revenues on 
average grew only 2.8% annually, failing to keep pace with 
economic growth. 
 
5.  (SBU) Several major infrastructure projects launched 
during the Kuomintang (KMT) era resulted in a substantive 
fiscal burden for the Democratic Progressive Party (DPP) 
after it took office in 2000.  From 1987 to 1997, annual 
expenditure on social welfare increased nearly 800%, from 
NT$37.1 billion to NT$295 billion.  Since taking office in 
2000, the social welfare budget has continued to grow, 
deepening the debt.  In 2005, the central government will 
spend NT$419.2 billion on social welfare. 
 
Revenues 
-------- 
 
6.  (SBU) The projected 2005 total revenue is NT$1.402 
trillion, a NT$53.265 billion increase from total revenue in 
2004.  Taiwan's revenue structure for 2005 consists of taxes 
(68.3% - NT$958 billion), profits of public enterprises 
(19.4% - NT$271.6 billion), public properties (5.8% - NT$82 
billion), fees, fines and indemnities (5.3% - NT$73.7 
billion), and miscellaneous sources, such as tuition and 
donation (1.2% - NT$17.425 billion). 
 
7.  (SBU) The tax system is composed of income tax (NT$437.6 
billion), commodity tax (NT$145 billion), business tax 
(NT$132.7 billion), security transactions tax (NT$98.23 
billion), customs duties (NT$83.5 billion), tobacco and 
alcohol tax ($42.36 billion), estate and gift tax (NT$10.1 
billion), and futures trading tax (NT$8.5 billion). 
 
Income Tax 
---------- 
 
8.  (SBU) A progressive individual income tax from 6% to 40% 
exists.  Personal exemptions of NT$72,000 are allowed for 
the taxpayer, spouse and each dependent.  Taxpayers with 
parents over 70 years of age can take an additional 
NT$108,000 exemption. 
 
Value Added Tax (VAT) 
--------------------- 
 
9.  (SBU) The current VAT is set at 5%.  The Ministry of 
Finance plans to increase this tax by one to two percentage 
points, from 5% to 6-7%, in 2006.  An increase of one 
percentage point would bring added revenue of NT$30 billion 
a year.  Unlike the minimum tax, an increase in the VAT does 
not require new legislative measures.  Current law gives the 
executive branch power to set the value added tax level 
between five and ten percent. 
 
Expenditures 
------------ 
 
10.  (SBU) According to the DGBAS, Taiwan's government 
expenditure structure for 2005 consists of social welfare 
including retirement (25.7% - NT$419.2 billion), education, 
science and culture (19.4% - NT$317.7 billion), economic 
development (15.7% - NT$257.37 billion), national defense 
(15.4% - NT$251.94 billion), general administration (10.6% - 
NT$173.05 billion), obligations (8.2% - NT$134.65 billion), 
and general subsidies and other expenditures (5% - NT$81.67 
billion).  General Subsidies and other expenditures include 
subsidies for special projects, community development, and 
environmental protection. 
 
 
Challenge 2008 - National Development Plan 
------------------------------------------ 
 
11.  (SBU) The Challenge 2008 National Development Plan 
implements fiscal reform to reduce the central deficit.  By 
strengthening the allocation system of government revenues 
and expenditures, central government hopes to eliminate the 
central deficit in five to ten years.  In 2002, the 
government allocated NT$2.65 trillion to jumpstart the 
national development plan.  The Challenge 2008 Plan projects 
to produce an estimated NT$19.3 trillion additional economic 
output over six years. 
 
12.  (SBU) The Challenge 2008 tax revenue reform objectives 
include adjusting the tax structure, pursuing steady and 
adequate tax revenues, and achieving fairness and 
efficiency.  To control expenditure growth, the government 
will review structure, efficiency and scale of fiscal 
expenditures.  Officials believe the Challenge 2008 Plan 
will promote continuous economic growth, more job 
opportunities, and better life quality. 
 
Government Administration 
------------------------- 
 
13.  (SBU) One of President Chen Shui-bian's campaign 
promises was to streamline the government to make it more 
efficient and cost-effective.  In 2005, government 
employment rolls have been reduced by 1,000 employees, but 
payroll expenditures will still total over NT$400 billion 
(NT$14.3 billion more than 2004). 
 
14.  (SBU) Local governments rely heavily on subsidies from 
the central government, which undermines fiscal discipline. 
Passage of a statute in November 2002 giving local 
governments more taxation power has resulted in little 
progress.  "Local governments don't have much incentive to 
impose taxes because that may lead to public complaints," 
said Finance Minister Lin Chuan. "For them it's much less 
troublesome to continue asking for funding from the central 
government."  This state of dependency further exacerbates 
the central government's fiscal condition. 
 
Issuing Bonds 
------------- 
 
15.  (SBU) Central government revenues from sales of 
government bonds have escalated from 10.5% of annual 
revenues in 1994 to 19.54% of annual revenues in 2004. 
Since 2000, the DPP has issued an average of NT$245.2 
billion in annual public bonds, compared with the KMT's 
annual average of NT$191.6 billion from 1989-1999. 
 
2006 
---- 
 
16.  (SBU) According to Commercial Times, Premier Frank 
Hsieh chaired a 2006 budget preparatory meeting on July 25. 
According to the report, central government expenditure will 
decline .8% from 2005 to NT$1.596 trillion.  The science and 
technology (S&T) budget will substantially increase by 19.7% 
to NT$84.3 billion, previously NT$70.9 billion in 2005.  The 
growth is designed to meet President Chen Shui-bian's policy 
target of (national) R&D expenditure reaching 3% of GDP. 
Economic Minister Ho Mei-yueh believes that for every NT$3.6 
billion in government R&D expenditure, private investment 
will increase by NT$10 billion. 
Comment 
------- 
 
17.  (SBU) For 2005, the estimated budget deficit will reach 
NT$233 billion.  The central government continues to resort 
to issuing bonds to control the deficit.  In FY2005, central 
government will issue NT$255 billion in bonds.  According to 
Chen Chien-Hsun, a Research Fellow at the Chung-Hua 
Institution for Economic Research, reliance on bonds to 
finance the increased expenditures may drive up domestic 
money market interest rates and bring about foreign capital 
flows, in turn leading to higher borrowing costs, which will 
crowd out investment.  Furthermore, this will cause the NT 
dollar to appreciate and exports to decline, inevitably 
weakening Taiwan's long-term economic prospects. 
 
PAAL 
 
(This cable drafted by Economic Section intern David Craig)