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"Better" alternatives to tax hikes

Released at: 13:32, 04/10/2017

"Better" alternatives to tax hikes

Mr. Noelan Arbis. Photo from HSBC

With a recent tax reform proposal coming from the Ministry of Finance, HSBC Economist Mr. Noelan Arbis tells VET that raising taxes, particularly VAT, is not a bad idea on the surface but the problem lies with its potential effect on growth.

by Duy Anh

With public spending issues and high public debt, the Vietnamese Government plans to boost revenues and achieve financial security by revising the laws on value-added tax (VAT), special consumption tax, corporate income tax, personal income taxes, and royalties. What is your opinion on the use of domestic taxes as a way to balance the State budget?

We believe the government has two main priorities at the moment: to raise GDP growth and to curtail its debt-to-GDP ratio. Obviously, these two things are not mutually exclusive, as faster GDP growth vis-à-vis debt growth would lead to a lower debt-to-GDP ratio. However, the country’s economic growth has been sub-par compared to the government’s target of 6.7 per cent, which makes slowing the pace of debt growth of greater importance. So, on the surface, raising taxes, particularly VAT, is not a bad idea. Private consumption is becoming a larger part of the Vietnamese economy, providing the government with an opportunity to raise additional revenue to pay for its debt.

However, the problem lies with the VAT’s potential effects on growth. Raising taxes may lead to lower private consumption and to lower growth in the short-term, which is counterproductive to the government’s immediate goals. It also takes away from people’s disposable income, potentially lowering savings to finance future investments. It is true that the government needs to raise revenues, but it may perhaps do so through other means, such as reforming its foreign direct investment (FDI) incentives.

After all, Vietnam’s generous FDI incentives are only a part of the reason why investors are attracted to the country. It has many other advantages, including its cheap labor, geography, political stability, and potential for economies of scale, just to name a few. A higher “sin tax” and/or higher property taxes are also things to be considered. Land and housing taxes only accounted for 0.2 per cent of total government revenues in 2014 and were planned to contribute only 0.1 per cent in 2017. That said, raising VAT should not be out of the discussion, but there are other ways to raise revenue as well, particularly as VAT already accounts for a majority of government revenues, at around 27.5 per cent.

Perhaps the most sustainable way to cut the debt-to-GDP ratio is to curtail government spending and its outsized role in the economy, but this may not be a short-term fix. For example, State-owned enterprise (SOE) equitization has become a bigger priority now that the government budget is under pressure, but there remain many challenges that suggest that this may be more of a medium-term solution. Nevertheless, additional efforts to cut government spending should be seen as a positive sign, including reforming healthcare subsidies.

The finance ministry also plans to increase the VAT rate for the first time since the regime was introduced in 1999. Is it a good time for Vietnam to raise VAT?

The government appears to be targeting the VAT increase for 2019, which is prudent given the lower-than-forecasted GDP growth this year. It also gives ample time to both consumers and producers to adjust their expectations and practices to accommodate for the impending VAT increase. However, much will depend on global growth as well given the country’s reliance on exports.

Based on international practice, what would the consequences of the tax hikes, particularly on VAT, be on the overall macroeconomic context and economic growth?

We should expect higher consumption leading up to the VAT increase, as consumers take advantage of temporarily lower prices. All being equal, this should lead to a brief uptick in GDP growth. However, we can also expect consumption to slow following the implementation of a higher VAT. I believe this would only be temporary as increases in income and labor productivity should keep consumption robust in Vietnam, especially as the country’s middle-income earners continue to grow. This is unlike the experience in Japan, for instance, where a higher VAT in 2014 caused consumption to slump and the economy to fall into a deflationary cycle, partly due to stagnant wage growth. Vietnam is in a strong position to take the rise in VAT in its stride.

What key areas should Vietnam be looking at to overcome its long-standing budget deficit issue? Do you think the budget deficit is more important and crucial for the government than the country’s economic growth, given that the VAT hike will likely cause a slowdown in GDP growth and the government’s special interest in achieving high GDP?

SOE equitization, public service reforms, and better cost recovery of public services are some ways that the government could overcome its budget deficit issue. It seems that the government is aware of this, but the pace of reforms has been somewhat sluggish. However, lowering the government deficit should not come at any cost, especially growth. Government spending, if efficient, may lead to greater private sector investments that is good for a developing economy, even if it is being funded by increasing public debt in the short term. As such, increasing the country’s self-imposed limit of a 65 per cent debt-to-GDP ratio, even temporarily, should not be taken out of consideration. There is no hard and fast rule on an appropriate level of debt-to-GDP level for any country. Moreover, the government is incrementally funding more of its debt domestically rather than externally, which should help it avoid the currency mismatch problems that dogged many countries during the Asian Financial Crisis.

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