A thorough change in the income tax system is one of the main themes in the current tax reform plan.

The current tax system, and especially the sections of the Consolidated Income Tax which uses the individual or household as the object of taxation, have mainly been built and developed according to the concepts of the 1970 Tax Reform Commission of the Executive Yuan. Despite minor changes over twenty years, it has maintained a highly progressive tax structure as a way of seeking fair income distribution; the fundamental spirit of providing exemptions and deductions to encourage specific behaviors has not changed, either. This highly progressive system with generous preferential treatments is exactly that used in the Western nations in the 1960's. The U.S. system, with the highest individual tax bracket at 90 percent, was a model case.

The result of the highly progressive tax system is very prejudicial to high-income taxpayers. The higher one's income, the more likely was a higher investment-cost in human capital (education, etc.), but still, the higher is one's tax burden. This inevitably affects the work effort of high-income groups. It also discourages savings and investment out of after tax income because income derived from these would also be highly taxed. In the early 1970's, although our country had already entered the take-off period of sustained, rapid growth, average income was still low, so that the proportion of taxpayers affected by the highly progressive system was small. Add to this that most households' income was not high, households of high tax rates would still have high after-tax incomes, and as a result, the phenomenon of reducing work to increase leisure was very rare. From the empirical evidence, the negative influence of the tax system on work and savings in the early 1970's was not as serious in the R.O.C. as in the U.S. or Europe.

However, during the tax reform movement at that time, in order to look after special professional groups, maintain high savings rates to secure investment sources, and encourage overseas Chinese, foreign and domestic investments in industrial sector, several provisions were added excluding the salaries of military personnel and teachers at middle school level and below from the Consolidated Income Tax. Further changes set conditions for tax holidays, accelerated depreciation, investment tax credit, and other kinds of investment incentives. On the one hand was a highly progressive tax structure, and on the other preferential treatments, as in the advanced countries.

However, there is a wide gap between tax administration in the advanced countries and in the R.O.C. High income taxpayers naturally sought to avoid their burden, and tax administration lacked the capacity to stop illegal avoidance; such activity became unconstrained. In particular it was not easy to trace income sources; ordinary middle-income salary earners have clear, traceable sources, while high-income earners have more opportunities to take advantage of legal loopholes or to hide their income sources. This places a higher proportion of the tax burden on middle and low-income taxpayers. This phenomenon of unfairly shared tax burdens has become worse with rapid economic development, as have demands for a change.

The situation in Western nations was similar, especially the adverse impact on the willingness to work or invest. Proliferating modifications merely led to an outrageously complex tax code. This was the reason behind the 1986 American tax reform; most Western countries have simultaneously been making major adjustments in their tax systems and "reducing preferential provisions, broadening the tax base, and lowering tax rates."

Problems in the R.O.C. tax system are profound; a thorough reform is essential. Under principles of "internationalization and liberalization" the system should be harmonized with those of our major trading partners. Consideration should be given to eliminating the exemption for military personnel and teachers as well as unreasonable erosions of the tax base (like leaving out interest income up to 360,000 NT dollars or from stock trading), simplifying tax brackets, lowering the highest rates, and looking into the tax reporting method; these are all concrete proposals to make a thorough reform of the tax system.

The government has relaxed capital outflow and emigration; the tax system will be an important consideration in making these choices. As a major player in the international economy, it is incumbent on the R.O.C. to adapt to the international trends and reform its tax system.