Huge Asian budget deficits don't have to mean new taxes

By James T. Areddy

HONG KONG (Dow Jones): At first glance, record-sized Asian budget deficits would suggest a pressing need for higher taxes because less-than-stellar economic growth expected over the next few years will limit government revenue.

Yet tax experts play down that possibility and predict governments will focus on a more-immediate desire to solidify economic recovery. In most countries, governments are saying they believe recovery remains too fragile now for more taxes or even much belt-tightening, which means deficits will become a more permanent feature of the Asian landscape.

In fact, experts see merit in reducing some tax rates in the face of the gaping budget deficits. That is particularly true where lower taxes would prompt more investment and economic restructuring, such as the way Malaysia has made bank, insurance and brokerage company mergers more attractive by adjusting technical tax law.

Until Asia's 1998 recession prompted the drastic spending that is now helping to revive economies and pay for bank restructuring, balanced government budgets and low tax rates were key ingredients of the so-called Asian economic "miracle." But economic growth rates are expected to lag for some time at below pre-crisis levels, which will depress official revenue intake and drag countries uncomfortably further into the red, analysts said.

"We're at a new phase in Asia where a number of countries are running budget deficits and will be for some time," according to Jim Walker, chief economist of Credit Lyonnais Securities (Asia) Ltd. "It probably would be better if there were higher tax rates."

He reasons that funding the deficits isn't the immediate concern. But as governments increasingly compete more for external funding with companies and home-buyers, interest rates will be driven higher, curtailing growth prospects.

In a new report, the Asian Development Bank takes up that point by saying the region's historically high budget-deficits will ultimately require reins on spending, and that will threaten prospects for domestic demand.

The fiscal balance of the four biggest Southeast Asian nations -- Thailand, Malaysia, Indonesia and the Philippines -- will be in deficit to the tune of 4.8 percent of gross domestic product in 1999, compared with a surplus of 1.7 percent of GDP in 1996, according to Goldman Sachs & Co.

In Singapore, Hong Kong, South Korea and Taiwan, the gap will be 2.5 percent of GDP this year compared with a 1996 surplus of 0.7 percent of GDP.

Nevertheless, lifting taxes to make up the difference would be "suicidal," according to Allan Aw, regional managing partner for tax at Arthur Andersen & Co. in Hong Kong. In most countries right now, big tax increases would "kill the economy," he said.

Tax-system analysts said that any Asian politician who considers jacking up taxes to balance government books should be dissuaded simply by recalling Japan's disastrous consumption-tax hike to 5.0 percent from 3.0 percent in April 1997.

The move choked off Japanese recovery almost before it began and impaled the political fortunes of Prime Minister Ryutaro Hashimoto. A little over a year later, a disgraced Hashimoto resigned after voters signaled their view that his party had sacrificed the public trust by appearing greedy.

The reason Asian governments will pursue growth before higher tax rates lies partly with the fiscal systems already in place. Since most Asian countries get a high portion of their revenue through either a value-added tax or a national sales tax, government revenue rises when the economy does.

Although the same can be said for corporate and personal income taxes, the "pay-as-you-go" systems are also are "regressive." In other words, they gobble up a larger percentage of income from a poor person than a rich one. Therefore, analysts said higher VAT rates would only worsen the situation for those at the bottom end of the income scale -- some of whom the fiscal spending is aimed at helping.

Still, Asian governments will need to raise money somehow, and analysts said they do see a few avenues for governments to take in the immediate term.

"We think that the governments will have to be far more creative in the way they're going to get revenue," said Arthur Andersen's Aw.

A major one is through more effective enforcement of tax codes. Getting tough on scofflaws is a proven revenue generator since tax collection usually costs only a tiny fraction of money collected. Tax professionals said Asian governments always face acute manpower shortages in this area.

The weapon has already been fired in South Korea, where multi- million-dollar charges of tax evasion have been leveled against the heads of Korean Air Lines and at least one other big business group. The high-profile charges in South Korea may have more to do with politics than procedure, but accounting firms said they say they see enforcement teams growing in many countries.

Rod Houng-Lee, a senior international tax partner at PriceWaterhouseCoopers Inc., uses a simplistic example to show why the tax law in some Asian countries should be adjusted to encourage deal making. Right now in many countries, from a tax perspective, if a bank writes down the value of debt owed by a bankrupt company to US$1.0 million from $10 million in order to entice a buyer for the company, the move is tantamount to handing the buyer a taxable $9.0 million.

Houng-Lee said governments recognize how this is a disincentive and are now changing laws related to foreign direct investment and mergers and acquisitions. "You're seeing a batch of those incentives in the region which are designed to facilitate the restructuring," he said.

Malaysia's recent budget included a number of technical tax changes designed along these lines. It announced that government stamp duty and all expenses related to restructuring debt of a bank now under government control can be deducted from the buyer's income taxes. And for a limited amount of time, half the value of losses incurred by brokerages and insurance companies can be used as a tax credit by a buyer, while capital gains taxes will be waived for a buyer of financial firms in some cases.

The government estimated that these measures will cost it around $290 million in lost revenue and widen the budget deficit to 5.0 percent of gross domestic product in 2000.

In addition, individual and corporate tax rates were reduced and tax incentives designed to spur bank lending were announced.

"As the government believes that total national income will increase with economic growth, the government will endeavor to further reduce individual and company income taxes from time to time," Finance Minister Daim Zainuddin said.

Like emerging economies everywhere, Asian nations are typically poor at collecting taxes and analysts said the VAT systems should be restructured make them more fair.

"The main thing is not increasing tax rates but to widen the tax base to ensure more people pay taxes," according to David Li, an accounting professor at Hong Kong's University of Science and Technology. Lower tax rates mean there is less reason to skip while simpler tax systems make evasion more difficult, he said.

Where tax charges are most likely to go up, analysts said, is for the so-called "sin taxes" levied on alcohol and tobacco.

Meanwhile, as an alternative to direct taxes, almost every government in the region has also either permitted more legalized gambling or started considering it. But analysts see these programs, such as Shanghai's lotteries or the gambling casinos in South Korea and Manila, as minor revenue generators, typically earmarked to fund sports teams, certain health programs and education.

Window 1: Like emerging economies everywhere, Asian nations are typically poor at collecting taxes and analysts said the VAT systems should be restructured make them more fair.

Window 2: ...as an alternative to direct taxes, almost every government in the region has also either permitted more legalized gambling or started considering it.