Tax for development: Does Vietnam need tax reform?

Patrick Lenain - Former assistant director Organisation for Economic Co-operation and Development

Schools and universities will need to adopt new technologies. Public transportation networks will need to be upgraded. Large-scale logistical hubs will be required to remain integrated in global supply chains. Old-age citizens will need welfare support. Electricity generation will need to decarbonise. Coastal cities will need to adapt to rising sea levels. Military spending will need to protect the country. And it is obvious that health spending remains a priority.

Unfortunately, tax revenue is at present too limited to finance these large investments.

Vietnam’s government collected tax revenue equivalent to 16 per cent of GDP last year, according to the International Monetary Fund. This is less than Malaysia (18.3 per cent), Singapore (18.5 per cent), India (19.7 per cent), Thailand (20.3 per cent), and China (27 per cent). This is also less than before the pandemic, reflecting numerous tax cuts made during periods of confinement.

It is, therefore, no surprise that all international organisations have recommended enhancing tax revenue. It is important to note that these organisations do not recommend hiking tax rates. Instead, they argue for alternative approaches. The World Bank said last April that Vietnam can broaden its tax revenue base and explore the use of new taxes. The Asian Development Bank has suggested more efficient collection of VAT, reforming tax incentives, bringing more businesses into the formal economy, and optimising personal income and property taxes.

The Organisation for Economic Co-operation and Development (OECD) told Vietnam in 2020 that “broadening the tax base and strengthening tax collection is important to mobilise the necessary resources for future investments”.

Broadening and reducing

Indeed, Vietnam’s tax rates do not stand out by international comparison. The corporate income tax rate of 20 per cent is close to the international average. This is higher than the minimum tax rate of 15 per cent recommended worldwide under the OECD Pillar Two model rules. The personal income tax schedule is progressive, with a top rate of 35 per cent, the same as in most Southeast Asian countries. Vietnam’s standard VAT rate of 10 per cent is close to rates in neighbouring nations.

Rather than hiking tax rates, revenue mobilisation can result from other efforts: broadening tax bases, improving tax compliance, and using taxes to protect the environment. This is actually what the government plans to do with Decision No.508/QD-TTg, with the goal of mobilising government tax revenue by 2030.

Vietnam’s government revenue is weakened by numerous tax incentives, loopholes, exemptions, deductions, allowances, credits, preferential tax rates, and tax holidays – so-called tax expenditures. Some of these tax expenditures are warranted, such as well-designed research and development tax credits to stimulate innovation.

However, most of them result from lobbying activities by pressure groups. Indeed, a review of Vietnam’s tax expenditures carried out in 2019 by the Centre for Budget and Governance Accountability concluded that “the main concerns regarding tax incentives in Vietnam are ineffectiveness, redundancy, misuse, attracting footloose companies, not being based on sound economic analysis, and potential for corruption.”

Hence, Vietnam could eliminate large tax incentives without harming its inclusive growth model. Of course, this is easier said than done. Multinational enterprises are typically offered special tax exemptions as an incentive to invest in the country – if not granted tax privileges, they would locate elsewhere. However, this implies that domestic Vietnamese businesses pay higher tax rates than multinationals, which hinders their development.

Faced with the same dilemma, most countries have decided to shed light on tax expenditures. The methodology proposed by the Global Tax Expenditures Database can be used to estimate their cost in terms of foregone revenues. Periodic evaluation of their usefulness is a good practice, with decisions to eliminate tax exemptions that are not proven to be effective.

Strengthening tax administration

Tax evasion is a problem in all countries, including Vietnam. Tentative estimates put corporate tax evasion at close to $1 billion annually, thus depriving the Vietnamese government of scarce resources. The General Department of Taxation has been strengthened, with about 35,000 employees. Tax authorities have imposed high-profile sanctions on tax evaders, with stiff fines and prison time, which are an effective deterrent.

But detecting tax fraud is difficult. Governments around the world have modernised their fraud detection systems to detect sophisticated evasion schemes. IT tools are used increasingly to uncover tax fraud. Vietnam could invest further in digitalised records, automated processes, AI, and other sophisticated facilities to help tax inspectors. Centralised use of administrative data, rather than fragmented datasets in separate government agencies, is also a proven tool to detect inconsistencies in tax filing.

Making it easier to file and pay taxes is also a proven way to improve tax compliance. In Vietnam, despite welcome progress, tax compliance still imposes a costly burden.

According to the World Bank’s 2019 Doing Business survey, companies spent on average 384 hours preparing and paying their taxes, one of the worst performances in Asia. Simplifying tax rules, moving tax forms online, encouraging digital payments, and opening telephone lines dedicated to helping taxpayers are all examples of what can be done to reduce the tax filing burden. The Vietnamese government rightly aims at raising taxpayer satisfaction to 90 per cent by 2025 and 95 per cent by 2030.

Tax compliance is also improved when taxpayers consider that paying taxes is the right thing to do – so-called high “tax morale”. Taxpayers will be more willing to comply if they know they have received something worthwhile in return from the government. High-quality public goods such as schools with good teachers and well-paved roads are likely to boost tax morale.

For now, few taxpayers are happy to pay taxes in Vietnam. According to the World Value Survey, only 40 per cent of taxpayers consider that cheating on taxes is “never justifiable” – well below response rates in other Asian countries. Vietnam needs to build up trust that the government will deliver high-quality services in return for tax payments.

Greening taxes

Taxes are increasingly used to send a price signal discouraging environmental degradation. This follows the well-established “polluter pays” principle – promoted by the OECD since 1972 – which makes polluters pay for the costs imposed on society. By making carbon emissions more expensive, carbon taxes encourage a switch to renewable energies, such as hydropower, solar panels, wind farms, and biomass – thus helping to fight climate change. European countries are well advanced with such carbon pricing, and steps are also underway in China, Japan, South Korea, Singapore, and Thailand.

With its environmental protection tax (EPT), Vietnam has a good tax instrument to protect the environment. Until recently, the tax increased the price of gasoline to encourage the use of public transport. It also encouraged car owners to drive carefully and improve fuel efficiency. However, a first tax cut was made to reduce the EPT on gasoline and the government now seeks a second cut. This would be socially unfair because the main beneficiaries would be affluent car owners who fill up their car tank with low-tax gasoline.

Keeping the EPT at a level that effectively deters carbon emissions would show that Vietnam is determined to fight climate change and to mobilise its tax resources. This would keep the country on its successful path of inclusive growth.