Shortly after taking office in June 1990, Finance Minister Wang Chien-shien publicly pledged that he would give priority to overhauling Taiwan's widely criticized tax system. His determination to carry out extensive tax reform is in response to long-term public discontent because the system allows too many people to enjoy unjustifiable tax exemptions and fails to prevent widespread tax evasion. According to estimates by some financial authorities, about 90 percent of the people either do not have to pay any income tax at all, or they enjoy partial exemptions under existing law.
Two months after taking office, Wang followed up on his pledge with a draft revision of the income tax law. The draft contained four major reforms, but the revision was immediately opposed by people whose vested interests were threatened by the proposed changes.
One proposal will require that servicemen and all elementary and junior high school teachers pay tax on their base income. Under existing law, their salaries are tax exempt. Another proposal affects an even larger number of citizens, because it calls for taxing retirement pensions, housing allowances, overtime pay, and other sources of income previously untaxed or partially exempted.
Also proposed is a requirement that all ROC citizens and alien residents should pay taxes on income from overseas sources. Up to now, only companies have to pay business income taxes on earnings abroad. The fourth proposed reform seeks to eliminate numerous loopholes in the law that have been used extensively for evading taxes. Among such tax dodging techniques is the practice of setting up dummy companies abroad which then invest in Taiwan as overseas Chinese firms, claiming tax advantages intended to encourage foreign investment.
Tax evasion is alarmingly widespread in the business community. It has long been an open secret that the vast majority of the firms in Taiwan keep a set of false books in order to avoid taxes on part of their revenue. According to some estimates, about two-thirds of the nation's national income has never been taxed because of the various legal tax exemptions and illegal tax evasions.
This large proportion of untaxed income does not even include the unreported income from underground economic activities, which have long been rampant and have never figured in the official data on Taiwan's GNP. Detailed analysis of this gray area of the economy remains to be done, but some estimates put its size at about 25 to 30 percent of Taiwan's real GNP.
Public outcry against the numerous tax exemptions and evasions is growing more strident as the gap between high and low-income groups widens. According to the Directorate General of Budget, Accounting & Statistics, the income gap has continued to grow since 1980, when the aggregate income of the wealthiest families in the top 20 percent of the population was 4.17 times the total income of the poorest families in the lowest 20 percent. Last year, this index of income inequality rose to 4.94. The widening income gap has contributed to a rise in the crime rate and many other social ills.
The various tax exemptions and evasions are particularly unfair to salaried citizens, who have to pay taxes on their total income. These taxpayers are left to bear a heavy burden of government expenses and public works outlays. Minister Wang's proposals are aimed at correcting such inequities by broadening the tax base through the removal of tax exemptions that no longer can be justified and by taking effective steps to prevent tax evasion.
The strongest opposition to the reform was aroused by the proposal to levy taxes on the income of the 500,000-strong armed forces personnel. ROC servicemen objected that they are seriously underpaid and, in addition, follow a longer workday schedule than civilians while receiving no overtime pay. Their occupation is also risky, and a large percentage of them have to endure constant hardships.
Enforcement problems—no taxes are collected from Taiwan's ubiquitous street vendors, a major loss to tax coffers and an unfair burden on legitimate businesses.
Reflecting the views of his officers and men, General Chen Hsing-ling, the Chief of General Staff, said, "It is unfair to require military personnel to pay income taxes unless their salaries are raised substantially to levels comparable to the pay of civilian government employees." Defense Minister Chen Li-an also expressed sympathy for the views of military personnel on this issue: "It is understandable that the armed forces strongly object to the proposal requiring them to pay income taxes, considering the meager salaries they get and the hard life they lead."
In response to the backlash from the armed forces, Minister Wang points out that the issue of income taxes for military personnel should not be linked to the question of whether servicemen are unreasonably paid or not. In his view, the government should address the pay issue separately. Wang explains that the proposal to levy income taxes on military personnel and teachers is based on the principle of fair taxation. "We are trying to establish a system under which anyone whose income reaches the taxable level must pay taxes, regardless of occupation," he says. Wang also pointed out that any increased government revenues resulting from income taxes paid by military personnel and teachers would be used to lower the tax burden of the general taxpayer by raising the taxable income threshold and increasing the deductions for dependents.
Wang estimates that the increase in revenues from taxes on salaries and other forms of income will enable the government to raise the yearly deductions for each family from US$1,660 to US$2,400, and increase exemptions from US$1,550 to US$1,700. The reform would exempt a two-income family of four with an annual income below US$13,500 from paying any taxes, and likewise exempt a single-income, four-member family if its annual income is below US$11,055.
The Finance Ministry's plan to tax the foreign income of all residents was defended against criticisms by Wang Cheng-i, director of the Finance Ministry's tax department. He cited two main reasons for the new tax. One is that citizens are now free to send capital out of the country and invest it abroad. As a result, more and more citizens will be accumulating retained earnings overseas on top of their local earnings, and this new source of income should be taxed appropriately, just as companies must pay taxes on what they earn abroad. If this step is not taken, there would be an incentive for companies in Taiwan to avoid taxes by investing overseas in the name of individuals, instead of under their corporate identities.
Some critics agree to the need for the new tax, but they doubt that the ministry will be able to collect it because of insufficient information on potential taxpayers' overseas income. Such information must be provided by the host countries, usually through arrangements made under bilateral tax agreements. Because of the lack of diplomatic relations, the ROC has signed such agreements with only a handful of countries. This makes it very difficult, if not impossible, for the ministry to gather the necessary information on the incomes of residents from countries not covered by these agreements.
Critics also worry that the proposed tax may dampen the desire of foreign companies to invest in Taiwan. "Since many foreign nationals doing business in Taiwan generally live here for more than 183 days in a year, they are counted as residents of Taiwan," says Hou Chao-chu, a professor of economics at Soochow University. "This means that the new tax provisions will also apply to them, and they will have to pay taxes on income from their home countries or elsewhere outside Taiwan. The result could be that foreign nationals would be less willing to come and do business here."
Finance Minister Wang Chien-shien (at left)—"We are trying to establish a system under which anyone whose income reaches the taxable level must pay taxes, regardless of occupation."
Finance Minister Wang has already intensified the crackdown on tax evasion. In particular, he has singled out companies suspected of investing in Taiwan as false overseas Chinese investors in order to take advantage of tax privileges geared to encourage legitimate foreign investment. This form of tax dodge follows a fairly set pattern: A company registers a holding firm in a foreign country or area, such as Bermuda, where income tax is low or even nonexistent. The investor then uses the name of that paper company to invest in Taiwan as an overseas Chinese, a status that entitles him to preferential tax treatment as granted in the investment law and other legislation. The arrangement can save the investor as much as 30 percent of income tax due. It is said that investors—with a little help from friendly foreign banks and accountants—can easily set up a paper company overseas without actually having to remit any money out of Taiwan.
The establishment of paper companies abroad made up about 25 percent of Taiwan's registered outward investment in 1989, according to estimates of the Investment Commission of the Ministry of Economic Affairs. Recent news stories about such cases immediately drew the attention of government financial officials, including Minister Wang. He said the Finance Ministry would put a close watch on Taiwan's outward investment in the future and would also review earlier cases, meting out severe punishment to those found guilty of evading taxes by such artifices.
But Wang's decision to clamp down on the cases caused serious concern at the Ministry of Economic Affairs. Economics Minister Vincent Siew was worried that the Finance Ministry's crackdown threat might discourage investment back into Taiwan at a time when spending on new plants and equipment is seriously lagging.
Speaking in defense of these investments, Kao Hsin-yang, executive secretary of the Investment Commission said the overseas Chinese status of the various investors involved was certified a correct by the Cabinet's Overseas Chinese Affairs Commission, and their investments here were approved by the government in accordance with the applicable laws. "I would say that the investors were trying to save on taxes, not dodge taxes," he said.
Kao added that the issue could be examined from another angle as well: "If investors send their money out of Taiwan and fail to bring it back home for new investments, the Finance Ministry will not be able to collect any taxes on these capital amounts. I think the Ministry should revise the tax laws that induce Taiwan investors to use overseas registered companies for local investment."
Despite the continued criticism and strong opposition, Finance Minister Wang is determined to proceed with tax reform. Over the last few months, he has been making speeches and using other publicity opportunities to promote his draft revision of the income tax law which is scheduled to be enacted before the end of 1990 and to enter into force at the beginning of 1991.