VIETNAM'S SOCIO-ECONOMIC DEVELOPMENT No.1, SPRING 1995

REFORM OF PUBLIC FINANCE IN VIETNAM

Dang Duc Dam
Central Institute for Economic Management

In Vietnam's economic reforms in the past decade, the reform of the system of public finance has been a central focus. The achievements are quite obvious but newly arising problems are no few either. We have no ambition to present in this paper a comprehensive evaluation of the reform process in the macroeconomic field (which seems a matter of similar importance and complexity) but we have only concentrated our efforts on making a careful analysis of a number of crucial basic problems in the system of public finance.

Vietnam's fiscal policy in recent years was focussed on the elaboration and putting into practice of a system of unified taxation covering all economic sectors without exception, including the state economic sector, which in the former mechanism had to contribute to the state budget in the form of deduction from their returns.

Since early 1989, when most prices had been freed from a prefixation by state authorities, state-owned enterprises have enjoyed extensive rights in their business operation; the state budget no longer relied mainly on state-owned enterprises contributions as in the past, so the reform of the overall system of taxation became an urgent requirement. On August 8th, 1990, the State Council promulgated three laws on taxation: the Law on Turnover Tax; the Law on Profit Tax and the Law on Special Consumption Commodities Tax. They are applicable to all economic sectors. Together with the Law on Export-Import Taxes, which was promulgated on December 29, 1987 and the legislation concerning the adjustment of agricultural tax (issued on January 30, 1989), the above-mentioned laws on taxation have created a unified legal framework for all the sources of state budgetary receipts. The National Assembly of Vietnam has since then passed in review the execution of these laws, examined and amended relevant provisions to make them more suitable to the requirements and tasks for socio-economic development. In July 1993, the Law on Agricultural Land Use Tax was enforced which would bring more efficiency to the legal framework of taxation.

Vietnam's tax system basically is now a modern one corresponding fully to a market economy. It is because of that and increases in the income source from the oil and gas industry that revenue to the state budget has been considerably on the rise throughout the period of implementation of the socio-economic stabilization program 1989-1993. In 1993 alone, the amount of collected taxes made up 15.8 percent of GDP.

Table 1: Structure of state budget revenue (% of GDP)

Source: Ministry of Finance 1994.

Yet according to general assessment, the current tax system of Vietnam is still very complex with too many tax rates and large differences between them. For instance, the turnover tax which is an extremely important tax category, has up to 16 different rates ranging from 0 to 40 percent levied on turn-out. It is also obvious that taxes overlap one another. For instance, a food processing enterprise may have to pay 2 percent of turnover tax for its sales of ice, 4 percent for milk, 8 percent for coffee etc. That complicates the accounting system as well as the tax collecting system. The tax system is too complex and the procedure for asserting tax rates and collecting taxes are still irrational and in disagreement with each other to say nothing of the inefficiency of tax collectors, which causes loss to revenue gathering.

Several foreign financial experts hold the view that many tax rates applied in Vietnam at present are too high, first and foremost in comparison with the efficiency of the tax collecting apparatus. According to the Laffer curve, if the tax rates reach a certain marginal level, the total of collected taxes could not continue increasing in direct proportion with the tax rates, and even somewhat decrease, because the higher the tax rates, the more the people seek by every means and way to evade paying taxes. The weaker the capacity of the tax collecting apparatus, the lower the marginal point of the Laffer curve. So when the tax rates are not yet high enough, the loss of revenue is already very big. This situation perfectly corresponds with the circumstances prevailing just now in Vietnam, especially within the non-state sectors. This explains the phenomenon of why the amount of taxes collected from state-owned enterprises has almost trebled those collected from non-state sectors, while more than one half of GDP has been created by the later.

The tax policy is not only duty-bound to create a source of revenue to the state budget but still assumes an important function of encouraging production and regulating consumption. Nearly all the developed countries have applied investment incentive policies with regard to their businesses by means of reduction of profit tax. The profit tax rates in Vietnam actually range from 30 to 50 percent. Those enterprises operating with foreign invested capital according to the Law on Foreign Investment would benefit from a preferential treatment in taxation ranging only from 15 to 20 percent; i.e. equal to only 40-50 percent of the profit tax rates applied to domestic enterprises.

In principle, the above preferential treatment in profit tax has a definite effect on the attraction of foreign investment, but it has given rise to irrationalities and led to an unequal competition to the disadvantage of domestic enterprises. At the present time, no big effect is observed yet from this preferential treatment, but the pressure exerted on domestic enterprises will gradually increase when the state subsidy system is strictly eradicated and foreign investment will make up a considerable proportion in the total invested capital. Under those circumstances, a tax system with too much difference in tax rates between enterprises with foreign invested capital and domestic capital would not only damage the source of budget revenue, but also hinder the objective of using foreign capital for giving a boost to domestic production. On the other hand, that way of doing things would create opportunities for foreign investors to introduce into Vietnam outdated machinery, equipment and backward technologies, and would still gain the same profit.

Along with the reforms of tax categories, the apparatus designed to manage and collect taxes in the past period of time has been reorganized to make it more efficient from central to local levels. This must be consistently carried on as it creates for the government the necessary conditions to efficiently manage nearly all the sources of revenue and to regulate on time its expenditures throughout the country, thereby ensuring a balanced development between different regions, especially redistributing adequate financial resources to the poor provinces. For that reason, more concentration on tax collection and a stricter managerial procedure of sources of revenue may be a required standard in the reform of the public finance system.

A prime importance of Vietnam's economy is to obtain a high growth rate, and this can be done only by the instrumentality of savings and investment. The amount of savings has risen considerably in past years, from 3.2 percent of GDP in 1985 to 16.3 percent in 1992 (see diagram 1).

Diagram 1: Savings and investment in 1990-1994

From left: 1990, 1991, 1992, 1993, 1994

Source: World Bank - September 1994

Economic stability, firmer legal guarantees of property and an improvement of the banking system constitute factors to encourage savings and to for the use in business and production. However, domestic savings were down at the beginning of 1993, standing at only 11.2 percent of GDP. The main cause of this proportional decrease was the sudden rise of foreign invested capital. This was an unhealthy manifestation, especially when the source of foreign capital proved to be not sure enough, as shown in 1993 which found expression in the bad effects on the process of investment and seriously affected economic growth. We must strive our best to raise the level of domestic savings to about 15 percent in this current year. Along with a change in terms of saving, the investment activities in the national economy also recorded a high growth rate. As compared to 1992, the year 1993 showed an increase by 41 percent, calculated according to current prices and by 32 percent, calculated according to fixed prices. According to adjusted data from the General Statistical Office, the rate of investments compared to GDP in 1991 was 15.1 percent; in 1992 this rate rose to 17 percent and in 1993 to 19.4 percent.

Based on statistical data, Vietnam's ICOR coefficient was low, standing at only 2.2 percent in 1993. It was far lower compared to other developing countries whose respective ICOR coefficients were generally 3-4 percent.

Table 2: Investment, growth rate and ICOR of several Asian countries in the 1970s and 1980s

Source: "In the direction of flying dragons". Harvard International Development Institute.

World Bank officials put forward three reasons for explaining Vietnam's low ICOR coefficient. First, it is due to many big investment projects which were put into operation from the preceding decade (hydro-electric power, oil and gas, and cement) and are now operating at full capacity. Second, it is due to the impact of the removal of the restrictions imposed by the previous mechanism which brought into full play a potentials that didn't need many additional investments. Third, it is due to the existence of many labour intensive and not capital intensive production establishments which have given rise to economic growth in the past years.

The total invested capital of the economy comprises two parts: investments made by the public financial sector and those derived from non-state economic establishments. The state has made only few investments in recent years as it has had to take up situational measures in order to counter inflation and realize socio-economic stabilization. Many cut-backs in investment were made by the state, particularly in social services such as education and public health. These were regarded as investments in the development of human capital which is needed for future growth. There is good ground for anxiety when cut-backs in education must be made. The percentage of public spending on education in Vietnam is about 1.5 percent of GDP which is said to be at a too low level compared with other Southeast Asian countries. The advantage of Vietnam's relatively high level of education is tending to be eroded.

Vietnam's primary education school pupils as a percentage of the total of school-age children has been reduced from 98 percent in 1986-1987 to only 87 percent in 1991-1992. And Vietnam's secondary general education schools, pupil numbers were reduced from 13 percent to 7 percent in the same period of time. This reflects to some extent the decline of education.

One more thing which deserves our attention is the degree of effectiveness and the orientation for big projects of state investment. Some people have thought it would be preferable to use the available capital to invest in small-scale projects which would yield quicker returns through which economic growth rates could be secured. In their opinion, large investment projects are most desirable, but it would be too early for Vietnam to carry them into effect in the immediate future. The reason is that Vietnam has few experiences in this matter and lacks both possibility and capacity for examining and verifying socio-economic effectiveness of such investment projects before their approval. For that reason, Vietnam will run the risk of non-profitability and lack of funds. If such a weakness were not to be overcome in the future, state investments would not bring back the required results, but still cause a curtailment of private investment, thereby reducing to a great extent the economic growth rate.

In recent years, investments of the public sector derived from the state budget have been gradually restored, and recorded a considerable increase from a very low level of 2.8 percent of GDP in 1991 to nearly 7 percent of GDP in 1993. State investments at present are focussed mainly on the development of the economic and social infrastructure. In the long run, private investment will play a fundamental role in the growth of the market economy. But under Vietnam's prevailing circumstance in the years ahead, private entrepreneurs are not yet ready to make sufficient investment in different undertakings owing to an investment environment unstable and not favourable to them. That is why willy-nilly, the state must play the role of a "midwife" for economic growth, no matter that it is still lacking in knowledge and experience in business undertakings.

Together with concentrated investment in the building and development of the infrastructure, the state must select a number of key enterprises with strong profitability prospects for making investments in. By so doing, the state will aim at building large scale businesses with great diversification in products and trade, thereby turning them into economic corporations of national and international importance. Such businesses will serve as pillars of our economy in its industrialization and international competition.

The practice of industrialization in newly industrialized countries, for instance in the Republic of Korea, shows that the businesses, large in scale and diversified in trades and products, constitute one of the four basic factors for the success of industrialization in the present epoch. It is the large scale and great diversification that have helped these businesses get in touch with all groups of consumers in society and overcome economic crises. Those large businesses are the very centre of scientific and technological advances, for market research and technological renewal. At the initial stage of industrialization, the state is called upon to set up and develop such businesses.

The existence and activity of economic corporations as such in Eastern Asia, especially in the Republic of Korea, have not only given a strong impetus to the process of industrialization but also have helped eliminate excessive monopolization, thereby raising the effectiveness of the whole economy. On the contrary, such large scale businesses operating in many other countries, for instance in Brazil, India and Chile have created for the monopolists the conditions to gain control of too large a proportion of the supply of goods and services in home markets and have become one of the structural impediments to continued industrialization and economic development. The conclusion which may be drawn here is that in order to bring large-scale businesses into full play in an active role in the economic growth, the state must elaborate a determined regime and a clear legal framework for their operation. It must have a contingent of officials with moral qualities and professional skills to assume control and supervision of the activities of large-scale businesses by orientating the latter to the accomplishment of the set targets in the strategy of national development.

Vietnam's budget in the early 80s was characterized by a heavy subsidization by the state in every field of activity. In the years 1982-1989, nearly one third of the total expenditures of the state budget was reserved for financing subsidized items, especially for giving pecuniary aid to keep prices at fixed levels according to a system of rations.

The process of liberalizing prices has given rise to the reduction and eventually to the elimination of the system of subsidization by the state budget. In 1990, when nearly all the prices were set free under the influence of the market mechanism, the state budget was no longer responsible for subsidizing rationed foods and goods, for providing direct financial aid to state-owned subsidized industries as in former times but in indirect subsidization through loans with low interest rates that still continued until recent times. In the past decade, due to different motives, Vietnam has been continually in a state of budget deficit. But it would be quite fair to say that state budget deficits have been common place in nearly all countries of the world, ranging from industrially developed to developing countries. Yet Vietnam's budget deficit was rather high, and the deficit has fluctuated in an unpredictable manner even when soaring inflation was brought under control and the subsidy system was basically ended (see table 3).

Table 3: State budget (percent of GDP)

Source: Ministry of Finance

A budget deficit is the result of the state of the total income exceeding the total revenue from taxes and other supplementary receipts of the state. But how does this occur? Is it true that all budget deficits reflect under-development, or recession under-development, or recession of the economy? What measures should be taken to make up for budget deficits? These are problems which must be seriously tackled in Vietnam now.

The conception of how there is a budget deficit greatly differs from one person to another but it many be summed up in two basic arguments.

One group advocates that a budget deficit is the result of a weak economy. If there is an excess of expenditure over income, it would lead to bankruptcy, unemployment and poverty. So the state is duty-bound to have a tight control over its budget spending and make it conform to the source of income. This conception of budget equilibrium is very popular and constitutes a generally accepted behaviour in the industrially developed countries.

Another group states that many countries do not abide by this law and claim budget deficits have become a widespread phenomenon in the world. State budget deficits exist, and how to deal with it are very important to carry out the preset targets. According to World Bank figures in the late 80s, state budget deficits became a widespread phenomenon even in developed countries.

Samuelson and Nordhaus, co-authors of the book entitled "Economics", divided the state budget deficit into two categories; business-cycle deficit and structural deficit. Business-cycle deficit is a deficit reflecting the state of economic decline. A growth rate slows down or dwindles away, accompanied by a reduction of income earnings by both businesses and the population at large which lead to the decrease in tax collections while the needs of budget spending by the state are usually growing in the period of economic recession such as payments made by the state to unemployed people, to job creation and to social welfare facilities.

Structural deficit reflects the restructuring of a state budget. Spending with a view to realizing the objective of expanding investment, structural deficit will have the effect of increasing the "aggregate demand" and creating conditions for promoting investment, raising production capacity and stepping up economic growth.

However, it is not valid that the deeper the structural deficit, the more advantageous accrue for economic growth. This possibility is definitely limited. That limit depends on the particular traits of the economic situation in each country, and at the capacity of the state to deal with its own budget deficit.

When the budget deficit is too big, the state must mobilize funds from different sources for deficit compensation. In the 1986-1990 period the Vietnamese state budget deficit was compensated for mainly by an increase in the supply of money in circulation, or otherwise called the credit of the Central Bank (making up 61% of deficit financing). In the meantime, loans and aids from foreign countries had decreased 66% in the 1981-1985 period to only 36% in the 1986-1990 period. The source of money for deficit compensation derived from credit loans in the country in this period was of little value (only about 3%) (see table 4)

Table 4: Structure of the source of state budget deficit compensation in the 1981-1994 period (percent of budget deficit)

Source: Ministry of Finance.

The structure of compensating for the over-expenditure of the state budget has undergone a fundamental change since 1991. Worthy of note was the issue of bank notes for deficit financing was limited to a minimum in 1991 and completely ended by 1992. This was a considerable contribution to the monetary-financial policy of market prices, to the control of inflation in particular and to socio-economic stabilization in general. But as the budget deficit was tending to always increase, the State has been obliged to borrow funds from inside the country and from abroad to cover budgetary over-expenditure.

Borrowing money from the population to finance the state budget deficit is much better than issuing banknotes. But it also naturally brings about some negative aspects. For that reason, borrowing money from the population cannot be used without limits. On the one hand, borrowing money for budget spending this year will be a financial burden for coming years, especially borrowing on high interest as it is now (about 2% per month). On the other hand, the source of capital investment of the country depends largely on the economized funds of the economy. If the state uses those economized funds in the form of borrowing money from the population to finance a budget deficit, the non-state sectors will have less and less capital for investment in their business undertakings for production development. The problem needing to be solved here is how to define the exact limits between investments from the state and those from non-state sectors in order to secure a rational distribution and use of the limited economized funds of Vietnam's national economy.

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