Core
Business World, 21 February 2012

The likelihood of a real, meaningful reform of the tax system is fading fast. The fiscal space that the economic managers are talking about could easily be a fleeting one. It is built on compressed spending rather on stable, expanding resources. With serious past neglect in education, health and public infrastructure spending and coupled with rapidly growing population, the demand for essential public services is expected to vastly outstrip available public resources in the days ahead.

In a few years, the threat of large deficits will reemerge. But with fiscal conservatives more focused on keeping the deficit low and within target, essential public services will be sacrificed, growth will continue to moderate, and per capita income will remain unchanged.

The first lesson in managing tax reform is that the best time to do it is right after a new President is elected, when the mandate is fresh, and citizens are willing to rally behind their newly elected leader. That’s not hard theory; that’s common sense.

The late President Corazon Aquino reformed the tax system within months after EDSA 1. The reform was a success. It raised tax effort (taxes as percent of GDP) to a peak of 17% in 1987. Mr. Ramos did his tax reform towards the end of his term (1997), and it was a failure. The VAT base was narrowed and tax effort progressively declined.

President Aquino III could have reformed the tax system right after his impressive victory in May 2010. But he didn’t. Instead, he came up with his famous words: “No new taxes.” Whoever convinced Mr. Aquino that he can deliver all his political promises has done this country a great disservice.

How can Mr. Aquino deliver on his promises — K+12 education, expanded conditional cash transfer (CCT) program, universal health care, modernization of the armed forces, improved public infrastructure, self-sufficiency in rice, and others — and balance the budget by 2016 without reforming the tax system?

But what’s wrong with the present tax system? Why reform it? The present tax system is low-yielding, inefficient, inequitable and too complicated to implement. Redundant fiscal incentives have been given away liberally to favored firms while putting the burden of higher taxes on non-favored firms. Taxes of cigarettes and liquor are low and have been eroded by inflation. The tax system is woefully inadequate to meet the pressing demand for better public services owing to past neglect and expanding population.

Most experts are convinced that reforming the tax system is necessary in order to sustain the country’s fiscal health. The tax system has to be reformed to ensure the financing of basic services and infrastructure needs of a modernizing nation. It has to be reformed to assure potential investors that government finances are sustainable and that there will be no fiscal catastrophe in the horizon.

But doing all three fiscal goals — delivering on an ambitious expenditure program, balanced budget by 2016, and not reforming the tax system — is virtually impossible.

Sadly, the political environment for a successful tax reform no longer exist. The nation is divided — and sufficiently distracted — owing to the ongoing impeachment trial of Chief Justice Renato Corona. Congress has virtually stopped making laws. The world economy faces a bleak outlook. And the Philippine economy struggles to grow fast enough to put a dent on the interconnected problems of joblessness, poverty and hunger.

TAX REFORM PROPOSALS TWO SUMMERS AGO

Not too long ago, weeks before the presidential elections in 2010, a group of economists — former NEDA directors-general Dante Canlas and Felipe Medalla and myself — appeared before the business community and foreign chambers — to unveil what we consider to be the core elements of a fundamental tax reform for the next President of the Philippines.

The elements of the reform are as follows:

• Rationalize fiscal incentives and reduce the corporate income tax (initially to 25% but eventually to 18%).

Studies show that more than 90% of existing investment incentives are redundant, meaning firms will invest in particular industries even without the incentives. With a low corporate income tax regime, the Philippines will become an attractive investment destination. It also removes the disincentives for those who are forced to pay at 30% when some favored industries get to benefit from generous incentives, sometimes courtesy of politicians.

• Raise the VAT rate from 12% to 15% and reduce the highest marginal rate for personal income tax rate to 18%.

People should be taxed on the basis of what they take out of the economy in the form of consumption than what they contribute to society as measured by income. VAT, it is argued, is mildly progressive since food in its original state is VAT-exempt.

Lower income taxes will put more money in the pockets of fixed income earners, and could stimulate growth. Economic growth is created by people’s hard work, ingenuity, thrift and willingness to take risks. The government should not take away excessively (at the moment the highest marginal tax rate is 32%) the proceeds of growth. Those who create prosperity should enjoy it, through lower taxes and more opportunity to build up personal wealth. Higher tax rates do not always bring in more money. In fact, a lightly taxed economy could generate more economic growth, and more revenue. High taxes kill the goose that lays the golden eggs. Lower income taxes have encouraged more people to work harder and save more. Higher taxes, on the other hand, move people to spend their time working out how to avoid government’s taxes.

• Increase “sin” taxes

In many other countries, governments have used their political authority to raise sin taxes to finance their fiscal growth goals. Taxing people on the basis of their consumption of products that have negative externalities and of which they can choose to reduce consumption and not suffer as a consequence is one way. Consumption of these goods is discretionary, and to some extent, harmful to public health.

The Philippines has the lowest tax rates on cigarettes, alcohol and spirits. If the average tax throughout the region on every pack of cigarettes is $1, in the Philippines, we charge only ten cents a pack. The huge windfall that the government stands to earn from these sin taxes will be reinvested into much needed public programs like health care and conditional cash transfer.

• Impose a presumptive real property tax (RPT) at the central government level.

In order to improve the equity aspect of taxation, the central government should impose a presumptive real property tax (RPT), piggybacked on that imposed by local government units (LGUs). The proceeds from this additional RPT may be used to finance the proposed additional level of schooling at the elementary level. It is simple to administer. Administratively, LGUs don’t have to remit the presumptive RPT to the national treasury. Instead the central government will deduct the said amount from each LGU’s internal revenue allotment (IRA), whether or not the additional RPT is actually imposed by the LGU.

These tax proposals were widely accepted by the business community two summers ago. But when Mr. Aquino uttered his famous words — NO NEW TAXES — the support for tax reform by the Makati businessmen, some of whom have joined Mr. Aquino’s Cabinet, disappeared.

Can we now expect Mr. Aquino to renege on his no-new-tax pronouncement and embrace real tax reform for the country’s sake?