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Official Gazette

Thursday, November 21, 2019

Reforming personal income tax policy

Updated: 09:03’ - 04/01/2006

Do Ngoc Huynh, Ph.D.
Tax Policy Department, Ministry of Finance1

I. Introduction

In developed market economies, the personal income tax is one of the major pillars of the tax system, and also an important tool for the State to pursue the target of mobilizing revenues for the state budget, contributing to ensuring social equity in income distribution and realizing other socio-economic development objectives. The development history of tax systems around the world indicates that the role of the personal income tax increases in proportion to the level of socio-economic development, specifically the level of average per capita income of the population. If developed countries such as the United States, Japan, and the United Kingdom consider the personal income tax as a major element of the tax system, governments in developing countries, especially countries recording high growth rates such as China, Thailand, and Malaysia, have also paid attention to the role of the personal income tax in tax policy in order to meet the requirements of ensuring budget revenues, contributing to social equity and implementing socio-economic development policies.

For Vietnam, after the economic reform policy to transform the centrally planned economy into a market economy introduced in the middle 1980s, a new tax system for the market system was applied uniformly to all economic sectors to replace the old revenue system applied separately between state and non-state sectors in the centrally planned system of the late 1980s and early 1990s (Tax Reform Phase I). The Ordinance on Income Tax on High Income Earners was promulgated by the State Council (currently, the National Assembly Standing Committee) and took effect April 1, 1991. This ordinance has been since revised in 1992, 1993, 1994, 1997, 1999, 2001 and 2004. The revised contents have met urgent needs of solving emerging issues such as tax schedules and tax rates, and regular and irregular income. However, basic and long-term issues such as requirements of ensuring equity, efficiency, and long-term, stable budget revenues have not yet been dealt with comprehensively and reasonably, although they have received attention.

In the context of international economic integration and significant changes in Vietnamese socio-economic conditions, it is necessary to radically and comprehensively reform tax policy in general and personal income tax policy in particular in order to meet the requirements of budget revenues, long term stability of the tax policy and achieving strategic targets of socio-economic development set by the Party and the State.2

On the basis of assessing current personal income tax policy in combination with studying and considering international experience, this paper purposes a modern personal income tax policy to apply in Vietnam in the medium- and long-terms. Although focusing on state budget revenues, equity, and efficiency, the new personal income tax policy will pay attention to ensuring the simplicity and feasibility of the tax policy under Vietnamese socio-economic conditions.

II. Assessing current personal income tax policy in Vietnam

These are the main features of current personal income tax policy in Vietnam:

(i) A high threshold level of tax exemption leading to a small number of taxpayers and a low level of tax revenue: According to current regulations, the threshold of tax exemption for Vietnamese people is five million VND/month. It is much higher than the GDP per capita or income per capita (around 484,000 VND/month in 2004). On the condition that the income distribution of the whole population is highly steep at one end, the number of individuals having high income subject to the tax is very small in comparison to the whole population. The number of Vietnamese taxpayers accounted for only 0.46% of total population (362,000 people) in 2001 and reduced to 0.3% of total population (239,000 people) in 2003 because the threshold level of tax exemption was raised from VND two million to VND three million. This figure was further reduced on July 1, 2004, when the threshold of tax exemption was increased from VND three million to VND five million.

Regarding tax revenues, the contribution from this tax to the state budget has been modest. In 2003, personal income tax revenue accounted for only 2.22% of total budget revenues from taxes, fees and charges, or 0.48% of GDP. The ratio of personal income tax revenue to total tax revenue in Vietnam is relatively low in comparison with that in developing countries (16%) and developed countries (44.6%). As for the structure of personal income tax revenue, the share of tax revenue from regular income for foreign taxpayers accounted for a large proportion of around 60%; this share for Vietnamese taxpayers was around 30% while the remaining share was from taxing irregular income.

(b) Taxable income has still not been comprehensively and clearly classified: According to international practice, there are usually the following types of taxable income: labor income, business income, capital income, income from real estate, and other types of income. However, types of taxable income in Vietnam are not well defined; of which, only a part of labor income and other certain types of income are subject to tax. In the category of labor income, income in forms of professional allowances, remote area allowances, in-kind benefits (lunch, mid-working shift meals etc.), business-trip money… do not belong to the taxable income. Income from interests of deposits and banking accounts, bonds, debentures, and dividends is temporarily not subject to tax. Remaining types of income, including business income, capital income, income from real estates and other types of income for self-business individuals and households, currently do not fall within the scope of the personal income tax.

(c) There are no relevant and systematic deductions: Under international practice, specific and basic deductions (for spouses, children, and dependents) are designed to ensure the equity and ability-to-pay principles of the personal income tax. There are thresholds of tax exemption of VND five million per month for Vietnamese taxpayers and VND eight million per month for foreign taxpayers. However, they are applied commonly to all taxpayers, regardless of their marriage status and family conditions. As a result, the tax burden on a single taxpayer and a married taxpayer with family/dependents would be significantly different although they have the same level of taxable income.

(d) Discrimination in the tax schedule for Vietnamese and foreign taxpayers: According to the current personal income tax policy, there are two separate tax schedules applied to Vietnamese and foreign taxpayers. Although there are the same 4 positive tax rates from 10-40%, the threshold of tax exemption and the structure of the tax schedules are different. The thresholds of tax exemption are VND five million/month for Vietnamese taxpayers and VND eight million/month for foreign taxpayers. As to the structure of tax schedules, the highest marginal tax rate of 40% is applied to taxable income from VND 40 million/month for Vietnamese and VND 80 million/month for foreigners.

(e) A self-assessment scheme has still not widely been applied to complement the withholding scheme: Currently, taxpayers having many types of income usually do not voluntarily register, declare, and pay tax because the mechanism of checking personal income is not comprehensive and has faced many difficulties in implementation. According to international experiences, only with a well-designed tax policy in a relevant legal framework for tax administration, under which a self-assessment scheme is widely applied, would it be possible to limit/avoid tax evasion and minimize losses of tax revenues.

III. Orientations for reforming personal income tax policy in Vietnam

1. Objectives and requirements of reforming personal income tax policy

1.1. Ensuring tax revenues for the state budget

Ensuring tax revenues for the state budget is a main objective of personal income tax policy. To ensure a relevant and stable budget revenue structure, based on rough estimations, the government needs to collect a minimum level of around 1.5-2% of GDP (7-10% of total tax revenues) from the personal income tax in the year 2010 and higher in the following years. This level is in conformity with the socio-economic development strategy for the 2001-2010 period and the requirement of increasing budget revenues to cover decreases in custom duties and from state enterprises due to equitization and reforms in the state enterprises system. At the same time, raising the ratio of personal income tax revenue to total tax revenues is also aimed at meeting the requirement of long-term stability of the modern tax system in Vietnam, of which the personal income tax will become one of the three major taxes, including value added tax, corporate income tax and personal income tax.

1.2. Ensuring harmony between requirements of equity, efficiency, simplicity and feasibility

Designing and applying an equitable, efficient, simple and feasible personal income tax policy is important to the Vietnamese economy. The new personal income tax policy needs to ensure the requirement of equity in the tax obligations of taxpayers, including horizontal equity and vertical equity. The efficiency (neutrality) of the personal income tax is important through minimum effects on labor efforts, job selection, and resource allocation. At the same time, the personal income tax also needs to ensure the requirement of simplicity and feasibility, especially in the aspect of tax administration, in order to promote its role and function in practice and save costs in terms of time and resources for taxpayers and tax authorities. According to international experiences, there are usually conflicts between these objectives and there is no common formula of solving these conflicts for all countries. Therefore, it is necessary to consider socio-economic conditions in each stage of development in order to design a reasonable tax policy for harmonizing these objectives; of which, it is essential to design combined plans and relations between objectives in the short, medium and long terms.

1.3. Ensuring the requirement of tax administration reform and modernization

The requirement of tax administration reform and modernization should be regarded as a central and urgent task of the public finance sector to improve the effectiveness of tax administration and to avoid negative impacts on the investment environment and the economy in general. A new personal income tax policy should be designed to ensure simplicity and transparency, particularly in procedures of declaration, recording, payment and administration, gradually applying modern information technology to facilitate taxpayers and tax authorities. 

1.4. Ensuring comprehensiveness in implementing tax reforms to 2010

In order to promote the real effects of the personal income tax and the entire tax system on the economy, it is necessary to study and reform personal income tax policy comprehensively and systematically in relation to other tax policies and the whole tax system in accordance to the master program of tax reforms to 2010. Of which, it is necessary to pay attention to the relations of taxpayers, tax objectives, tax rates, tax administration between the personal income tax and the corporate income tax, the long term relations between the ratio of tax revenues from direct taxes and indirect taxes and between the ratio of tax revenues from the personal income tax and corporate income tax in the group of direct taxes.

1.5. Ensuring internationalization of the tax system

In the current context of economic integration, it is indispensable to design a personal income tax policy that is relevant to international practices and standards in order to create a favorable business environment and attract investment capital, technology and highly qualified labor from foreign countries. This is also the requirement from foreign partners in the process of negotiating to join the World Trade Organization (WTO). However, the government needs to consider prudently and carefully when deciding which and when international practice or standards are suitable to Vietnamese socio-economic conditions. 

2. Orientations for designing the personal income tax

2.1. Expanding the scope of taxable income and taxpayers in combination with relevant tax deductions/exemptions in order to ensure the requirements of mobilizing budget revenues and ensuring the equity of tax policy;

2.2. Building the tax schedule and tax rates relevant to the structure of income distribution and income levels in the entire society, ensuring budget revenues and the efficiency of tax policy, compatible to the taxable capacity of the people and not causing significant effects on socio-economic activities;

2.3. Diversifying, and enhancing the effectiveness of, methods of declaration, payment and reporting with appropriate mechanisms and measures to enhance the feasibility of the tax policy, contributing to improving and pushing up the process of modernizing tax administration.

3. Recommendation on the principle contents of personal income tax policy

3.1. Taxpayers

Taxpayers should be individuals with consideration of marriage status and family conditions. According to international practice and experiences from other developing countries, it is also necessary to make self-employed individuals/ households subjected to the personal income tax in order to ensure equity in tax obligations, the comprehensiveness of the tax policy system, and the simplicity of tax administration.

3.2. Taxable income

To ensure the exhaustive scope and equity requirements of personal income tax policy, all types of income should be regulated as taxable income. Of which, standards/norms for income classification should be based on the nature and source of income, as follows: (i) Labor income, including wages, salaries, bonuses, allowances, and other income received from the provision of labor services; (ii) Business income, including all types of income from self-employment activities (industries, construction, commerce, transportation, services, etc.); (iii) Capital income, including income from interest (saving deposits, bank accounts, bonds, debentures, etc.), dividends, capital gains received through investment activities in all types of investment and assets, except real estates (fixed assets); (iv) Real estate income, including land and housing rental income, profits attained from transferring land use rights and other revenue from real estate; and (v) Other income, including all other types of income, such as gifts, prizes, lotteries, etc.

3.3. Taxing method

It is advisable for Vietnam to apply the mixed method of a global, comprehensive taxing method and the schedular taxing method in the initial stage of development with relevant implementation plans. In the above taxable income types,  the schedular taxing method should apply for capital income and real estate income  because they are specific incomes significantly affecting the ratio of saving-investment-consumption, investment choices, and development of financial and real estate markets as well as tax administration.  The remaining types of income should be subject to the global taxing method.

3.4. Tax base and tax deductions

Tax base is determined by subtracting tax deductions/exemptions from total taxable income, practically calculated by subtracting regulated deductions/exemptions from total taxable income in a certain tax period. Income regarded here is net income (total income less necessary related expenses).

To ensure the equity of personal income tax policy, it is necessary to design a system of deductions that is relevant to socio-economic conditions, income levels and living standards of people of all strata. According to international practice, it is advisable to set up specific deductions for different types of income and basic deductions for taxpayers and their families. Regulating specific deductions is necessary because it would make significant reductions in the burden of tax administration as well as contribute to pursuing social targets. Basic deductions including personal and family deductions (for spouses, children, and other dependents), and/or deductions for basic social services, such as education and healthcare, have become popular in designing personal income tax policies in the world.

3.5. Tax schedule and tax rates

It is necessary to unify the tax schedule for both Vietnamese and foreign taxpayers. This is important to ensuring the equity and fairness of tax policy. It is possible to choose the measure of designing a uniform tax schedule with a special deduction scheme for foreigners to encourage them and ensure their high level of living standards. Designing the tax schedule and tax rates is also very important because they would have considerable effects on tax revenue, and the equity and efficiency of tax policy, as well as the burden of tax administration. There should be a few tax brackets (3-4 brackets). The gaps between brackets should be wide; while the highest accumulative tax rate should not be high (under 40%) with a reasonable lowest tax rate (around 5 percent). For capital income and real estate income applying the schedular taxing method, it is necessary to design tax rates reasonably in order to develop financial and real estate markets (say, 10% or 15%).

3.6. Tax administration

It is necessary to reform tax administration to ensure transparency and publicity, enhance tax information, assistance and consulting services to taxpayers, reduce tax administration and compliance costs, and apply modern methods and procedures in conformity with international practice. According to international experiences, in the process of building a tax administration system, it is indispensable to consider the following requirements: ensuring effectiveness; simplifying administrative procedures, reducing tax administrative and compliance costs; encouraging voluntary compliance; regulating relevantly each type of taxable income and taxpayers; reasonably determining the priority order and schedule; reforming relevant pilot programs; and conforming with socio-political regimes.

In Vietnamese socio-economic conditions, building a tax administration mechanism for the personal income tax should be based on the principle of expanding the scope of the self-assessment method in combination with implementing thoroughly the withholding method in order to collect payable tax amounts from all taxpayers precisely, adequately and in a timely manner. On the schedule of implementing the self-assessment method, in the initial stage, this method should be compulsorily introduced for self-employed households/individuals and high-income professionals. The compulsory scope of application should be gradually expanded to individuals who do businesses in the financial and real estate markets. When the average per capita income of the whole society reaches a certain level, the self-assessment method should be applied to all individuals who have various types of income or income to which the withholding method cannot be applied.

In conclusion, studying and designing a personal income tax policy in the current context of socio-economic development in Vietnam is relevant to the program of tax reforms to 2010, supported by a major proportion of the people and in conformity with the international trend of tax reforms. In the coming years, the personal income tax should be one of the major taxes of the tax system, play an important role in ensuring budget revenues and contribute to implementing social equity as well as building a relatively balanced and stabilized tax system in the medium and long terms. To meet the requirements of equity and efficiency, the personal income tax should be designed to include all types of income and all individuals having income with reasonable regulations on tax reductions, tax schedule and tax rates that are relevant to socio-economic conditions and in conformity with international practice. Because the Vietnamese economy is in a transitional stage, personal income tax policy should be designed simultaneously with improving the tax administration system and preparing necessary conditions for implementation.-

Notes:

1 All contents and arguments in this
paper are those of the author. They do not necessarily reflect opinions of affiliated
institutions.

2 The Prime Minister issued Decision No. 201/QD-TTg of December 6, 2004, promulgating the master plan of tax reforms to 2010, under which the personal income tax law shall be enacted in 2007.-

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