Tax Systems and Tax Reforms in South and East Asia

Luigi Bernardi, Angela Fraschini, Parthasarathi Shome

• Publisher: Routledge
• Year: 2007
• ISBN:
  9781134168316
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Business allgemein

This book examines the present status, recent tax reforms and planned tax policies in some South and East Asia countries since the 1990s. The evidence is presented in a user friendly manner, but at the same time uses technically sophisticated methods. The main countries studied are China, India, Japan, Malaysia, South Korea and Thailand.

It is unique for being the first systematic treatment of the topic: hitherto, the information available has been widely dispersed and difficult to access. It should prove to be a natural companionto two previous books on taxation published by Routledge and also edited by Luigi Bernardi.

Part I

A general picture of tax systems and tax reforms in South and East Asia

1 Overview of the tax systems and main tax policy issues

Luigi Bernardi, Laura Fumagalli and Luca Gandullia

Introduction, contents and main conclusions

When compared with other areas of the world’s economy, the case of South and East Asia is somewhat particular. The region is not just fast growing, but also highly integrated, as in North America or in Western Europe, for instance. The participant countries are, however, barely homogeneous, like in South America or, to a lesser degree, in Eastern Europe. There is a lack of a supra-national authority able to provide coordinating policies for single countries and to harmonize their institutions. This particular feature is fraught with consequences for most tax policy issues.

The total fiscal pressure of South and East Asian countries looks somewhat low when compared with that of countries with a similar per-capita income, pertaining to other economic world areas. The main explaining factors can essentially be found, first, in the absence, or in a very small level, of social contributions, and, second, in a still widespread infant stage of personal income tax (PIT). However, a smooth Wagner law is confirmed by the data, so that fiscal pressure is destined somewhat to increase as growth continues. According to a common experience of developing and transition countries, indirect taxes prevail over direct ones. The exceptions are, of course, Japan (but not South Korea) and, more surprisingly, Malaysia. Corporation tax revenue usually stays higher than personal income tax, despite the flood of incentives allowed for corporations. On the contrary, PIT is still in its primary stages everywhere except in Japan. VAT is well established in China, Japan and South Korea, where it prevails on excise duties, and has just been introduced in April 2005 in India. Custom duties, entirely on imports, are still present in India, China and Thailand. A relevant consequence of such a prevailing tax structure is the particular ranking of the implicit tax rates. It is only in Japan and Korea that labor income is more heavily taxed than capital and consumption, while the opposite happens in Malaysia and Thailand. The same may be said for China and India. A low tax wedge on labor (due to the limited role played by PIT and the absence or the irrelevance of social contributions) improves the efficiency, by inducing both supply and demand of labor. Generally speaking, the heavy burden on consumption lessens the equity, as the taxes affect the prices in a regressive way. In terms of welfare (consumer’s surplus) the excess burden increases.

The previous data and information make it clear that any uniform analysis of the South and East Asian countries’ tax policy issues would be quite fruitless. It is far better to consider the following tax policy issues separately: first, those which arise inside the whole area and, second, those more specific to each country. The latter may be organized according to the clusters of some countries which emerge owing to their economic and social characteristics, and also in their tax systems (India and China; Malaysia and Thailand; Japan and South Korea).

Intra-regional economic integration poses severe challenges to the tax structure in the Asian area. As trade barriers come down and capital mobility increases, the challenges for South and East Asian countries become particularly acute, because of their tax administration capabilities and their dependence on foreign trade taxes that are relatively more limited. Three tax policy areas seem more problematic: the building of intra-countries’ agreements on reducing trade tariffs, the revenue consequences of trade reform with reduction in foreign trade taxes and the increasing tax competition for direct foreign investment.

Around the world there has been a substantial growth in common markets, customs union and free trade areas. Also in the Asian area there are two blocs of countries where economic cooperation and integration has been strengthened during the past few years. The first bloc is represented by the Association of Southeast Asian Nations (ASEAN) that recently implemented the ASEAN Free Trade Area (AFTA), making significant progress in trade and investment liberalization by the lowering of tariffs in intra-regional trade. At present a second bloc is represented by the South Asian Free Trade Area (SAFTA), comprising of India and six other countries, where tariffs on internal trade are going to be eliminated. SAFTA is an agreement between the seven South Asian countries that form the South Asian Association for Regional Cooperation (SAARC). SAFTA will come into effect in 2006.

As is well-known, developing countries and emerging markets still rely on trade taxes. For different reasons, trade taxes on imports have often been introduced to protect domestic production and those on exports reflect in part the export of primary products over which the country has some monopolistic power. Standard economic theory suggests that taxes on international trade have a major distorting effect and that efficiency gains deriving from their reduction far outweigh the loss of such revenue sources. The reduction of taxes on import trade often runs into serious political opposition, due to the pressure of domestic producers. Moreover, one of the most important constraints to trade reform in such countries is the conflict between tariff reforms and macro-stabilization goals. The adverse revenue impact of tariff reductions could be redressed in the short run by reducing existing exemptions, by removing highly restrictive non-tariff barriers and by relying on the expected import volume growth. But in the long run it will require the implementation of compensatory revenue measures.

It is in the area of tax competition where the growing economic integration and capital movements between Asian countries pose relevant challenges to the existing national tax structures. As non-tax barriers decline, investment decisions and location of investment become more tax sensitive. Within free trade areas firms can supply different national markets from a single location. The relevant issue here is the temptation for such countries to broaden the scope of tax incentives to attract and compete for foreign direct investment (FDI). The main argument in favor of these national policies is that FDI can contribute to increase the productivity of the domestic economy, but the effectiveness of tax incentives is highly questionable. Almost all South and East Asian countries have made and still make extensive use of tax (but also non-tax) incentives to compete for promoting domestic investment and especially to attract FDI. However, in the next years the use of tax incentives for the promotion of FDI will require a coordinated multilateral approach, at least on a regional basis. Agreements on a regional basis – for instance between the member countries of the ACFTA (ASEAN with China) and those belonging to SAFTA – could create different kinds and varying degrees of cooperation. Countries, for instance, could agree on a limited set of tax incentives, conditioned to certain criteria.

With regards to intra-countries clusters’ tax policy issues, it is primarily necessary to note that in Japan and South Korea, a striking difference emerges in terms of their PIT structure. Looking at the features of PIT, we can point out an important dissimilarity that attests the existence of two alternative theoretical visions in addressing the problem of personal taxation. The original (1940s) structure of the first Japanese personal income tax system was based on an idea of comprehensive taxation, but this was soon transformed into a system founded on a notion of expenditure income. On the contrary, South Korea still maintains a “global” income taxation that aggregates most personal income (inclusive of many forms of capital revenues), taxing it at progressive rates. Therefore, in the debate between the two aspects of equality, Japan and South Korea have taken opposite directions. Whereas the reforms implemented in South Korea in the 1990s put increasing effort in extending the tax base, Japan sets up a complex set of allowances that made the base smaller and smaller.

A second issue that has to be discussed when comparing South Korea and Japan is the way in which the two countries are handling the problem of a troublesome rise of the expense needed for pensions. The growing imbalance due to an aging population constitutes a worrying threat for the pension system. Both Japan and South Korea opted for a sharp increase in the share of social security contributions, but, whereas in Japan the population structure shows the typical features of a developed country (inverted pyramid type), in South Korea the demographical transition is still at an earlier stage so that the pensions’ system imbalance looks less pressing. It is clear, however, that a VAT increase could be recommended in both countries, provided that VAT hits in a non-distortionary way, especially for the aged, whose pensions in these countries are exempt from income tax.

As to the cluster made up by Malaysia and Thailand, at first glance Malaysia presents direct taxes that seem far higher than in Thailand and nearly in line with OECD standards. In fact the value of corporate income taxation accounts for a comparatively high value. Nevertheless, this value is inappropriate for evaluating the real impact of the average fiscal pressure on corporations in Malaysia, since it also includes a peculiar tax levied on petroleum companies whose tax rate is much higher than the “standard” one.

In both the two countries PIT has a narrow weight. It relies on a progressive schedule with many brackets and a widely spread set of tax rates. However, the scarce pervasiveness of the tax, along with the massive use of personal reliefs and personal tax rebates makes the pursuit of horizontal equity almost infeasible. With regards to indirect taxation a peculiar feature in Malaysia is, first, the complete absence of any kind of value added tax. In fact the most important heading of indirect tax is an ad valorem single stage tax, imposed at the import and manufacturing levels. The main problem that arises is the existence of cascading non-neutral price effects. An attention to low income earners in the shaping of consumption taxes can be found in both countries.

After the Asian financial crisis, Malaysia and Thailand also had to find a way to recover their revenues. The main field in which both countries are increasing their efforts is in the strengthening of revenue collection. In order to achieve this goal, one of the fundamental pillars in the agenda of the two governments is the rationalization of administrative procedures and the improvement of the efficiency of tax administration.

Finally, we must consider China and India. Let us first look at direct taxation. In India, personal income tax is imposed by the Union Government. It may look supply friendly: the tax brackets are few and rate graduation is not steep. Taxable income is very similar to global income according to Haig-Simons definition. However, many personal exemptions narrow the tax base, so limiting the effects of the aggregation of incomes. The Chinese system of personal income taxation presents opposite features. The Chinese PIT has a “pure” schedular structure with many different types of income taxed at different rates, no aggregation of alternative sources of earnings and no personal deductions. As a consequence, in China like in India, albeit due to different factors, there is both a loss on the ground of progressivity, and a fall in the total tax burden. With regards to corporate taxation, the main field for tax planning in China is the tax environment created by some special incentives granted to foreign enterprises, in particular, a generous tax holiday which adds to an investment-encouraging tax regime of amortization. While useful to attract foreign investors, tax holidays in time may be harmful because some “race to the bottom phenomena” can ensue, as well as a rise in the relative tax burden on home taxpayers.

In the field of indirect taxation the two countries feature important differences. In China the main indirect tax is the value added tax, which recently has widely been updated. In India until 2004 VAT was absent. From 1 April 2005 VAT has been finally introduced. This reform is expected to be welfare improving, since VAT will substitute for a huge, complex and distortionary amount of sales tax and excise duties. In practice, however, such a large reform will have to get over some difficult challenges, such as the taxation of services, the adequacy of the tax administration and concerning the complex structure of intergovernmental tax relationships. The system of public finance is now, after the reforms of the 1990s, more centralized in China, and most taxes are charged by the central government which transfers part of the revenue to the inferior layers. The system can be powerful to per-equate fiscal capacities among provinces, while weakening their fiscal responsibility. Hence now it is under reform, to avoid harmful fiscal imbalances of the lower layers and in order to increase their budget transparency and fiscal effort.

How much are South and East Asia economies and tax systems uniform?

Like, unlike or cluster economies?

To begin with, look at the top rows of Table 1.1 Our selected sample of South and East Asian countries seems to be made up of dissimilar countries, in terms of their geo-demographical features. China is 9,597 thousand km2 large, Malaysia just 48. India 3,287, South Korea not more than 99. China and India are populated by more than one billion people; Malaysia, South Korea and Thailand stay under 40 million. Therefore, at once, the population to area ratio looks uneven. A historical and cultural perspective confirms this first glance. China and Japan have their roots in long-lasting unitary empires, although they reached their present state in very different ways. India was a British dominion until 1947. South Korea was dominated by Japan from 1919 until 1945. At that time an independent Republic was formed in the whole South Korean peninsula. Subsequently, South Korea emerged as a separate and Western-liking state in 1953, after the war with the communist North region. Thailand has been an independent kingdom since 1932; Malaysia only ceased to be a part of the British Empire in 1957. Races, religions, languages, social aptitudes and institutions are fairly diverse.

Table 1.1 Some economic and social indicators in selected South and East Asian countries, 2003...