As Vietnam enters the fourth decade of its transition to a socialist-oriented market economy, consumption is becoming more conspicuous, from the explosion of craft breweries to the arrival of global brands this year like H&M and 7-Eleven. 

To keep up, the Ministry of Finance (MoF) plans to raise special consumption tax (SCT) and value-added tax (VAT) rates and cut taxes on small businesses. 

While it isn’t the first time tax proposals have been floated, it was one of the rare times that the Vietnamese Government has had to step in and instruct the ministry to put a hold on a series of proposed tax hikes to “make life easier for local businesses” and “the growth target more achievable”, shortly after the proposal was met with a massive public backlash.

“International norm”

To be sure, the Vietnamese Government is desperately seeking new sources of tax revenue. After dedicating almost 5.7 per cent of GDP to large infrastructure projects in recent years, a higher percentage than any Southeast Asian country and almost as high as China’s 6.8 per cent, the government is now struggling to keep splashing out on infrastructure even though such spending is crucial to supporting its growth-propelling export industries. 

The root of the problem is clear. From just 51.7 per cent in 2010, Vietnam’s debt-to-GDP ratio has increased rapidly, to 63.7 per cent in 2016, leaving the country with shrinking space for borrowing. 

With public debt thought to hover around 64.7 per cent since the beginning of this year, inching quickly toward the legally-mandated ceiling of 65 per cent of GDP, it is of concern that the rising debt-to-GDP ratio stands out as one of the steepest increases in the region despite the country’s impressive economic growth, a World Bank report from July noted.

Public debt issues, however, are not the only problem facing the government. Rising expenditures have been coupled with shortfalls in income. 

According to government data, Vietnam’s tax-to-GDP ratio has fallen over recent years, from 23.5 per cent of GDP in 2010 to 21 per cent in 2016, mainly due to the implementation of tariff reduction commitments under trade agreements, falls in crude oil prices and cuts in the corporate income tax (CIT) rate from 32 per cent to 20 per cent to stimulate investment, growth, and job creation.

These changes have clearly contributed to the growing fiscal deficit. The State budget deficit was estimated at $11.5 billion in 2014, or 6.6 per cent of GDP, despite the government setting a 5.3 per cent cap the previous year. 

It fell to 4 per cent in 2015 but then rose to 4.4 per cent last year, according to the Asian Development Bank (ADB), which also insinuated that the figures are more opaque than the government acknowledges. 

This is in part due to an accounting trick that considers the sale of equity in State-owned enterprises as revenue. “Excluding those receipts, fiscal deficit reduction would be much more modest,” an April ADB report said.

Where revenue collection is concerned, oil revenue faces uncertainties and import-export duties and foreign grants have already been declining, so the focus now falls on raising more domestic taxes, including VAT as well as personal income tax (PIT) to sustain the State’s future financial health. 

In the biggest tax shakeup in years, MoF in August proposed a series of tax hikes and fees, including raising VAT from 10 per cent to 12 per cent starting from 2019. Beyond that, it also recommended a new soda tax, higher duties on cigarettes and trucks, and a CIT of 15 per cent for businesses with revenue of VND3 billion ($132,000) a year or less and 17 per cent for those earning between VND3 billion and 50 billion ($132,000 and $2.2 million). 

The higher taxes were designed to “achieve the overall restructuring of the economy” and move in the direction of “production and consumption,” the ministry said, insisting that raising indirect taxes such as VAT is essential and an international norm. 

“The VAT rate of some regional countries may be lower than in Vietnam, but the proportion of tax revenue from consumption taxes, including VAT, in total State budget collections is higher,” Mr. Pham Dinh Thi, Director of MoF’s Tax Policy Department, said.

The budget and the poor

As a percentage of total government revenue, domestic tax collections increased to 59 per cent and 68 per cent during the 2006-2010 and 2011-2015 periods, respectively, according to the Ministry of Planning and Investment. 

The amount went as high as 75 per cent of government revenue in 2015 before the State collected almost $35 billion in local taxes last year. VAT already accounts for 27.5 per cent of the State budget, far more than the average of 21.4 per cent in European economies, where VAT stands at 21.3 per cent on average. 

Given VAT’s already high contribution to the State budget, a simple tax hike would not solve everything, argues a research fellow at the Harvard Kennedy School. Mr. Vu Thanh Tu Anh, Director of Research at the Fulbright Economics Teaching Program, believes the cause of Vietnam's high public debt and State revenue losses is not its inability to collect revenue but the inefficient use of State budget funds. 

“Raising VAT to top up to the State budget would not get to the root of the problem, it would simply add to overspending and result in more ineffective mega-projects that will remain half-finished for years,” he said. 

Others also believe that raising VAT is a bad idea. VAT is “blind”, Mr. Nguyen Duc Thanh, Director of the Vietnam Institute for Economic and Policy Research (VEPR), told VET. It doesn’t distinguish between the rich and the poor, men and women, or the old and the young. 

Both low-income and high-income earners spend most of their money on essential products, and these products cost the same for both poor and rich people, tax included, he said. Therefore, the burden is heavier on low-income earners. 

“Raising VAT would have negative impacts on economic efficiency and social equality, and is definitely not the optimal solution for the country to deal with its high public debt and balance the State budget,” he said. 

Chairwoman of the Tax Consultants’ Association Ms. Nguyen Thi Cuc told VET that Vietnam’s VAT rate is at the lower end in the regional context, “but not as low as the finance ministry has described.” While rates vary from 5 per cent in Taiwan to 25-27 per cent in most EU countries, VAT ranges from 7 per cent in Thailand to 12 per cent in Singapore and 17 per cent in China in Southeast Asia. 

“Once approved, the proposal would make Vietnam’s the second highest VAT rate in Southeast Asia, only after the Philippines, where goods and services are levied at 18 per cent,” she said.

A World Bank Chief Economist views the low VAT rate as not necessarily the best way to address fiscal equity and fairness, saying that richer households tend to consume more expensive goods and thus pay most of the VAT, while poorer households spend a higher share of their income on current consumption and especially on essential goods, such as food. 

“Any debate on distributional issues needs to focus on the entire tax and benefit system, and not just on one tax in isolation,” Mr. Sebastian Eckhardt was quoted by local media as saying, adding that the proposed increase in the VAT rate is in line with “international practice”.

More for less

Analysts say Vietnam’s tax system is relatively straightforward and modern, especially when compared to other Southeast Asian countries. But there are loopholes, particularly for the foreign companies that have propelled the country’s growth in recent years. 

After two decades of operating in Vietnam, Coca-Cola reported losses of more than $180 million, exempting the company from paying CIT. In 2014, it reportedly made its first CIT payment ever, of a mere $20 million. 

The following year, an unnamed representative at Ho Chi Minh City’s tax department reportedly said that Coca-Cola was ranked first on the agency’s list of suspects conducting transfer pricing, a practice used to hedge tax liabilities by declaring financial losses. 

“Especially now that Vietnam has a very competitive CIT rate, we would recommend closing loopholes and exemptions in the CIT to ensure the corporate sector contributes,” Mr. Eckhardt said.

Moving forward with tax reforms is important for Vietnam to ensure sustainable growth and macroeconomic stability. But even when its gross revenue increases, Mr. Thanh believes the country will not be able to balance its budget if the government cannot curb its expenditure. 

“Cutting wasteful spending and downsizing a bulky and ineffective bureaucracy are where the government’s eyes should be,” the VEPR Director said. “Without reforms to reduce this outlay, Vietnam’s fiscal position is unlikely to improve.”

For a city of 8 million and counting, Ho Chi Minh City’s urban railway network can only be described as an absolute necessity. But construction of the six-line railway, first proposed in 2001, has been dogged by delays caused by insufficient State funds. 

In 2015, Japan’s Sumitomo Corporation and Vietnam’s State-owed construction firm Cienco 6 - tasked with building part of the network - filed for $90 million in compensation, or around $110,000 per day, after work stalled for almost two years due to a lack of funding. 

A recent report from the Tokyo-based Nikkei Asian Review said that Japan’s ambassador asked the Vietnamese Government in May to make good on the delayed payments to the Japanese firms constructing the urban railway; a highly unusual request.

While new public transport projects are underway, including urban railway networks in Hanoi and Ho Chi Minh City, insufficient funding has delayed the projects for several years. 

And with traffic congestion worsening, motorists are now also being asked to fork out more for gas. The question going forward, some analysts say, is how long people will be willing to pay more while receiving less.

VN Economic Times