Changing Tax Law in East and Southeast Asia
This book is the product of a symposium held in July 1996 at the International Institute for Asian Studies, Leiden University, on the subject of recent tax reforms in six Asian countries (Hong Kong, China, South Korea, Japan, Indonesia, Taiwan) and the European Union (with particular focus on the Netherlands). The book comprises 9 chapters - six on the individual countries mentioned in brackets, one on EU tax policy, with the remaining two chapters being devoted to the fairness of recent Chinese tax reforms and Chinese tax reforms concerning foreign investors.By Dr John Azzi
Reviewing a book of seemingly unconnected country reports is not easy. For one thing, there is the stark difference between the income levels of the countries selected. Also, the countries selected are at different stages of their economic development, which complicates the task even more. However, what emerges from reading a book of this nature is each country's relentless drive to encourage inward foreign investment through manipulation the taxation system.With this in mind, the value and strength of this book lies in its description of the approaches to tax reforms adopted by some countries where information on tax laws and tax data is not as easily or readily attainable. Students and commentators on comparative tax law would find the chronological account of recent reforms and economic changes in the individual country reports of some benefit. The strength of the book also lies in its exposition of problems confronting countries in the region as they seek to open their economies even more and at the same time account to prevailing global forces of transparency and liberalization.
For instance, Zhang notes that the reform of the Chinese tax system is still unfinished, but it quickly becomes apparent that as a result of increased liberties allowed in investment activities, mounting tax law complexity, and rising taxpayer rights and expectations, China is facing a whole new direct tax avoidance industry which is exacerbated by the non-unified tax system in place. One problem is that in the Hong Kong Special Administrative Region (HKSAR) tax authorities seem to have the system under control, on the evidence of the low incentive for avoidance reflected in low statutory tax rates and an adherence to simple, efficient, and effective means of assessing and collecting tax when developing tax laws.
Most Southeast Asian countries have recently overhauled their tax laws, specifically to deal with international tax avoidance. In 1995, the Korean government introduced robust international anti-avoidance measures (e.g., transfer pricing; thin capitalization, and tax haven rules) and raised the profile of international co-operation between tax administrations largely to preserve the integrity of its tax incentives regime. Similar rules were introduced in Indonesia at around the same time. Anti-tax haven (i.e., controlled foreign company (CFC)) rules have been recommeded for Taiwan.
In other respects, the book provides some valuable insights into the problems encountered with the VAT system, which has been introduced by all of the countries covered in the book, with the exception of Hong Kong. As Zhang observes, a major problem with broadening the tax base by introducing a Western style VAT is the need to co-ordinate it with existing taxes, especially the business tax.
Discrimination
Another transitional problem highlighted by Zhang is the discriminatory tax-sharing arrangement between central and local governments in China which, he argues, exacerbates the financial gap between the rich (i.e., economically more developed) and the poor provinces because of the absence of an effective financial equalization system and the lack of any real local autonomy. Zhang predicts that the gap between the rich and the poor will inevitably widen as Chinese lawmakers allow people first to become rich ('Xian rang yibufen ren fu qilai') before instituting the strict legal order of the rule of law. Other countries also use fiscal laws to effect economic change. Korea imposed a discriminatory rate of corporation tax on closely held companies in 1975 as a means of forcing the proprietors of these companies to go public. In other instances, deductions for interest incurred in acquiring real estate not needed for the operation of the business were disallowed in order to discourage property speculation.
According to Professor Yan, the pursuit of non-discriminatory taxation has been at the forefront of Chinese policy efforts to encourage and attract foreign investment. Despite Professor Yan's defense of Chinese tax reforms as regards foreign investors, discrimination inevitably occurs where two tax systems operate - one for domestic enterprises and the other for foreign enterprises with Chinese-foreign joint ventures being preferred to foreign direct investment. The dual system has also contributed to the prevalence of corruption. Although surprisingly, according to Dr Vording, non-discrimination is not a very useful concept in China's tax policy.
Discrimination of a different kind is prevalent throughout the region. The Asian countries covered, with the exception of Japan and Hong Kong, all offer comprehensive tax incentives in the form of tax holidays (e.g., China, Indonesia, Taiwan, Korea), to those carrying out specified tax-exempt economic activities. Depending on the nature of the business conducted in China, a foreign investor may be entitled to an exemption from income tax for 2-5 years with reduced tax rates applying thereafter; 3-5 years in the case of Korea; and in Taiwan, technology-based foreign investors can enjoy a 5-year exemption from corporate income tax.
Western-style market
Since the enactment of the Foreign Capital Inducement Act in 1966, Korea has progressively introduced a whole host of tax preferences designed to meet the country's growing demand for capital and technology. Interestingly, the Korea report also provides an insight into the recent structural and financial problems afflicting the country. The account of policy reforms indicates that Korea has had a history of protecting crony capitalism through inappropriate and overly protective measures, which were at odds with the liberalization and modernization of the economy. For instance, during Korea's Third Five-Year Economic Plan (1972-1976), a Presidential decree issued on 3 August 1972, attempted to save the 'precarious capital structure of most businesses'. Loans affected by the new decree amounted to 80 per of the money supply (M1) for that year.
Tax reforms in Japan have equally created mixed economic consequences. Professor Fuke observes that the significant increase in public expenditure in response to the oil crisis of the early 1970s, the depressed level of tax revenues generated during this period of slack economic activity, which when coupled with 'fatal defects' in the corporate income taxation system, effectively created a massive 'public finance crisis' but also promoted 'more privatization and deregulation throughout the 1980s and 1990s'. As a means of ameliorating the huge budget deficit, the government introduced the initially unpopular comprehensive consumption tax in 1989.
An important point, raised (to varying degrees) in most of the chapters, is the intricate relationship between the success of any tax reform measure and its effective administration. This point has particular relevance to China as it tries to transform its socialist economy and institutions into a Western-style market economy. Both Zhang and Vording highlight the need for urgent reforms to China's tax administration system, given the break-neck speed at which tax reforms are being implemented and the scope for corruption.
The need for the effective administration of tax laws is not unique to East and Southeast Asian countries. Even the most advanced European countries need to step up their tax law enforcement efforts to deal effectively with the increased mobility of capital and other factors of production. Vording argues that EU governments would gain most by establishing a supranational authority to enforce a harmonized tax system with national governments retaining tax sovereignty by setting minimum tax rates and tax bases. This is the best instrument to achieve 'neutrality of taxation', although the option of tax co-ordination (i.e, the act of unilaterally harmonizing national tax bases in accordance with EU directives) is regaining its appeal.
In sum, the individual country reports provide a useful historical overview of the fiscal policy priorities that some of the ex-tiger economies were pursuing immediately prior to the East and Southeast Asian economic and financial meltdown. However, as with any book dealing with tax reform measures which, by necessity, are constantly updated, the laws examined have either been abolished or become redundant. Notwithstanding, the book's utility lies in its parallel exposition of the tax systems and reforms in economically, politically and legally diverse countries which are geographically connected (with the exception of the Netherlands and the EU). In this regard, Zhang and Fuke's book is useful but not entirely without its flaws.
Changing Tax Law in East and Southeast Asia Towards the 21st Century (1997 Kluwer Law International). Edited by Zhang and Fuke, 295 pp. ISBN90-411-0491-7.
Dr John Azzi is a Senior Research Associate at the International Bureau of Fiscal Documentation (IBFD), Amsterdam and the Director of Legal Studies, Robert Kennedy University, Zurich. E-mail: Dr.Azzi@KennedyUniversity.edu.