Monday, February 08, 2010

Abolish Income Tax 6: Income tax and VAT trade-off

The income tax system in the Philippines is one classic example of the absence of the rule of law. The rule of law says that rules, laws, regulations and prohibitions apply to all people, no one is exempted and no one can grant an exemption.

A quick look at how the law on income tax is being implemented would immediately show that it is one of the most hypocritical laws in the country. Many rich people do not pay the “correct” personal income tax of 32 percent top marginal rate. Among them are businessmen, professionals, corrupt government officials, those in the informal sector, and personnel and consultants of foreign aid bodies (UN, WB, ADB, IMF, USAID, etc.). The bulk of personal income tax collection by the government, especially the Bureau of Internal Revenue (BIR) comes from fixed-income earners.

So if those who are supposed to pay are not paying and the burden of heavy taxation falls on the helpless workers who are subject to mandatory withholding tax, might as well abolish income tax system. Or drastically cut it to a rate that is not burdensome to the people, rich and poor alike, in order to reduce the level of hypocrisy and the extent of tax evasion.

Taxes and government spending were among the major topics discussed by the 3 speakers on the panel, “Debt and Deficits” during the UP Academic Congress, Beyond 2010: Leadership for the Next Generation last Monday, February 1, at the UP College of Law,

The speakers were Professors Felipe Medalla of the UP School of Economics (UPSE) and former NEDA Director-General from 1998-2000; Prof. Benjamin Diokno of UPSE, former DBM Secretary in 1998-2000, and Prof. Leonor Briones of UP National College of Public Administration and Governance (UP NCPAG).

The two former cabinet secretaries were suggesting that to avoid a fiscal crisis in the near future, revenues have to increase significantly, and one such measure is to raise the VAT from the current 12 percent to 15 percent, while reducing income tax from the current 32 percent (personal income) and 30 percent (corporate income) to 25 percent.

I support the move to shift government revenues from income to consumption. As discussed above, many rich people do not pay income tax and the BIR cannot fully implement that law anyway. People hide their income as much as possible, while they flaunt their consumption: their new cellular phone, new computer, new shoes and clothes, new car and appliances, and so on.

So if people voluntarily show off their consumption, even their profligacy, then collecting higher VAT would be easier. And with reduced income tax, fixed-income earners will have higher take-home pay, which means higher savings and/or higher consumption.

What can greatly compensate for the initial revenue losses of the government as income tax rates (personal, corporate, others) decline, will be the entry of thousands of entrepreneurs and businessmen from abroad who want to escape their high-taxes regime in their home countries and are looking for low-tax economies to put up new businesses, or to transfer their existing businesses.

Of total income tax collections by the BIR in 2008, personal income tax comprised 59 percent of total BIR collections; VAT comprised 22 percent, and other taxes 19 percent.

An earlier panel also on February 1 lecture, was a session on “Jobs and the Cost of Doing Business in the Philippines.” The speakers were Dr. Cielito Habito from the Economics Department of the Ateneo de Manila University and former NEDA chief from 1992-98, and Dr. Cayetano Paderanga of UPSE, former NEDA chief before Dr. Habito.

I noted during the open forum, that one major reason why there are not enough jobs in the country and the cost of doing business is high, is because there are many planners in the government, both at the national and local government units. Planners tend to create distortions in the incentives and disincentives system in society because it is simply impossible to predict how people would behave if certain regulations and restrictions were put in place by the government.

Thus, to remedy the situation, we might consider abolishing a number of planning agencies in the government, like NEDA and the Department of Agriculture (DA), for socio-economic and agriculture planning, respectively.

Consider the food sector. There is no government carinderia, no government restaurant, no government supermarket, and yet people are eating. There are no central planners suggesting or dictating how many thousands of pizza and hamburger, or how many kilos of “sisig” and “kaldereta”, to be produced everyday across the country at what price, at what servings and topping, and so on. Product differentiation and market segmentation allow food producers and sellers to target certain group of consumers and consumers do the same to the various food producers and sellers.

The two speakers were hesitant of course, to support my proposal to abolish, or at least drastically reduce the size and functions of those bureaucracies. What was important for me was to articulate the perspective of less government intervention to allow more competition in the market, to allow personal, parental and community responsibility in running their own lives.

Reforms in both taxation policies and government spending are necessary to combat the endemic corruption in Philippine public administration and to discipline, if not discourage, unwarranted expansion in the size and power of the various bureaucracies that tend to restrict individual freedom.

See also:
Part 5, Consumption taxes, other government fees, November 25, 2009
Part 4, Ayn Rand and income tax, November 02, 2009, and
Part 2, VAT and tax extortion, August 01, 2008

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