Wednesday, September 19, 2007

Tax Cut 6: Retreat of High Income Tax Philosophy

One important indicator of how socialist or (forced) collectivist leaning a country is, is the level of tax rate that citizens are forced to surrender their income to the state. Economies that emphasize forced collectivism and coerced contribution to social welfare have high income tax rates, say more than 40 percent. At this rate, the hard-working, high-earning, and performance-driven citizens are left with less than 60 percent of the fruits of their hard work, unless they learn to cheat their income tax payment and the tax system is easy to be manipulated, or the tax administrators and collectors are corrupt and easy to bribe.

The decades after WW2 saw many countries, especially their politicians, hugging socialist thinking. That is, in order to hasten the development of their societies, a big portion of the income and savings of the rich and high-earning people should be confiscated through high income tax rates, and the money be distributed to the poor and the weak, including the lazy and irresponsible, so that there will be more equality and more social progress. This thinking has pervaded until the early 80s, so that by 1980, the vast majority of countries have top marginal income tax rate of 50 percent or more. Exceptions were HK in Asia, Switzerland in Europe, and Argentina in South America, among others. A lot of tax cheating also happened in many countries where income tax rates are very high, resulting in lower tax collection by governments.

The wave of globalization in the 80s made many politicians and their respective technocrats realize that they need to relax a bit their level of income confiscation as there was an emerging “income tax competition” among countries. A number of their people and businesses are moving elsewhere where income taxes are lower or easier to comply. So that by 1990, more than half of Asia-Pacific countries have top marginal income tax rate of less than 50 percent. The same pattern was observable in South and North America. Europe remained enamored with social democratic and other variants of “limited socialism” ideology, except Switzerland and the UK. For African countries, there was tax rate reduction but still high, except in Jamaica.

The continued wave of globalization, especially the formation of GATT-WTO in the mid-90s, compelled more governments to further slash their income tax rates. By 2000, until 2005, only Japan and some European countries, have marginal income tax rate of 50 percent or higher. The philosophy and practice of high income tax rates, for both personal and corporate incomes, have retreated.

In addition, the new trend now for some countries in income taxation, is low, flat (or single rate) tax. This is particularly true for many formerly Eastern European countries. Russia is one of those countries that have recently embraced the flat tax philosophy and subsequently implemented it. This is after a realization by many governments that high income taxes not only push many of their productive and entrepreneurial citizens to migrate to other countries, but high and multiple-rate taxes encourage cheating, of lowering the declared income so that the corresponding tax rate will also be lower.

The tax burden for the citizens can be computed as:

Tax burden = tax rate + cost of compliance.

Regulations on tax exemptions for dependents, expenditures that are tax-deductible, plus the multiple tax rates or tax brackets, can be confusing, so that people have to spend extra time studying these things, or have to hire tax consultants to make their compliance easier. Hence, the attractiveness of low, single rate income tax.

But while it is true that many governments were compelled by new circumstances to reduce their income tax rates, this did not mean that they have fully abandoned socialist-leaning philosophy. Almost coinciding with the reduction of income tax rates, they introduced new, or hiked the existing, consumption-based tax rates, like value-added tax (VAT), sales tax, excise tax, vehicle tax, property tax, amusement or entertainment tax, travel tax. In addition, they also introduced new or hiked existing government fees and charges, like passport fee, visa fee, driver’s license fee, airport/seaport terminal fee, business permit fee, mining/quarrying fee, and so on.

This is a new ballgame for the citizens aspiring to have bigger leeway and freedom how they should spend their earning and savings given their household-specific needs and priorities. Meanwhile, the fight for even lower income tax rates compared to existing levels, if not the abolition of income tax, is a pressing challenge for the citizens, the free market-oriented NGOs and research institutes in particular. A zero income tax with high consumption-based taxes like those mentioned above, should be a good compromise and advocacy.

On another note, a friend with MGM, James Miraflow, wrote a short paper, "Debt and Taxes". It was a good paper, short and focused, and lots of good and updated data. In his closing paragraph, James asked, "Will this go forever (debt & taxes)? Will the public forever pay for debt of an ill-managed government?"

Sadly, I think the answer to his questions are YES to both. Government indebtedness started with Marcos government in mid-60s, perhaps even with earlier Presidents, and it's been the trend until now, until 2 or more Presidents from now. Government, especially big government, is a system of treachery and lies. Promise people of "subsidy here, welfare there". But just keep silent on "taxes here, fees & charges there, borrowings over there."

In order to break the cycle of debt and taxes, some people propose the abolition of the Automatic appropriation law (PD 1177) for public debts, agrarian reform, and a few other areas. I think that law is correct. If I lend someone money and I have no guarantee that he will pay me back, say automatic deduction from his monthly salary, or automatic forfeiture of his car or appliance/s, why would I lend him in the first place?

What is wrong is the need to perpetually borrow in the first place. If one cannot raise this income and revenue, why spend that much so that he will go on borrowing endlessly?

Increasing revenue through more or higher taxation is definitely a No-No. One reason, look at the WB and IFC's "Doing Business" annual studies. Number of business-related taxes for medium-size companies around the world, the Philippines has among the most number of taxes in the whole of Asia, even beating socialist China and Vietnam in having the most number of business-related taxes.

Increasing revenue through privatization, this I fully support. Large-scale privatization, even at a big bargain, get the money, and use it mainly if not entirely, to retire public debts, both domestic and foreign debts. Don't use privatization proceeds to increase budget for public education, military modernization, agri modernization, etc. Let the savings from lower interest payment and principal amortization be used for public basic education, etc.

Privatization without deregulation is bad, of course. It only transfers state monopoly corporation to private monopoly corporation. The economy should be deregulated, with or without existing government enterprise/s in certain sectors.

Government corporation always live on unfair playing field. First, they use tax money (money we could have used to buy additional milk for our babies, additional room for our house for our expanding family, additional food, etc.) for their capitalization. Second, they use tax money for their continued existence as they often live off on continued subsidies. Third, they almost always occupy monopoly position in whatever sector they were situated. So the twin evils of over-regulation and monopolization is the hallmark of most govt. enterprises.

Liberalization, deregulation and privatization ("LDP"). These are among the important policy tools if we want an economy that can harness unlimited entrepreneurial energy from the citizens. Liberalize, have 1,000+ hotels/food chains/pharma companies, etc. doing business in the country. Have 10 or more telecomms companies do business here. Singapore has only 4 M people, but has 5 or more competing telecomms companies. The Philippines has 88 M people, about 26M subscribers, being served by only 3 telecomms players.

Deregulate and abolish (at least downgrade) many regulatory government bodies. These bureaucracies decide who can enter bus line business and who cannot. They decide who can put up new airlines or shipping lines or telecomms or cable tv operators, etc., and who cannot. The amount of arbitary powers in their hands are big, so that if they decide to limit the number of players per sector to only 2 or 3, then us consumers have to endure the lack of choices and options.

See also: 

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