Simplifying the tax system redux

“The only thing that is constant is change,” said Greek philosopher Heraclitus. Here, the constancy of change is colliding with a seemingly irresistible force—inertia against tax reform. But the Asean economic integration in 2015 and the need to be competitive may yet be the catalyst for change.

On Aug. 16, 2010, this author presented in this column “Simplifying the tax system: The way to go,” a proposal to radically simplify the tax system. It called for revamping the complex income tax and shifting to a far simpler percentage tax on gross receipts (GRT), while maintaining the tax on consumption—the value added tax (VAT). The advocacy attained official character after the Management Association of the Philippines (MAP) Board of Governors, led by lawyer Eusebio Tan of Accralaw, approved the proposal.

Simple GRT system

As proposed, this GRT will be progressive with a range of rates set according to ability to pay. Each rate will apply to the gross receipts of businesses in a specific sector, i.e., low rates for low-margin businesses, such as fuel retailers, food stores and traders of essential commodities. Higher rates will apply to businesses at the top end of the transaction chain, such as manufacturers and importers. This GRT has long been used at the local level, including Manila, Makati, Cebu and Quezon cities.

Unlike the annual income tax, the GRT is simple to administer, transparent and may be collected monthly to provide a monthly revenue stream to meet expenditures.

With industry sectoral growth forecast, GRT revenue will be easier to forecast for budgetary planning. A smaller bureaucracy will suffice. With its simplicity, voluntarily compliance will be higher.

Complex Tax Code

The current national tax code is complex and has a gamut of taxes—on income when earned, spent and distributed; on products when produced; and securities when issued.

After death, an individual’s estate assets are also taxed even though these were acquired with income previously taxed. The tax code is finessed such that distinction is made between capital and ordinary real assets, and between capital and ordinary gains—all with different tax treatments.

While goods producers and traders have much input VAT to deduct, service providers have little. The code was the handiwork of experts but taxpayers are not equally gifted to decipher it and comply.

The mindset seems to be that more and higher taxes are better. But taxpayers think differently, thus the low compliance rate.

The Laffer Curve theory suggests that a lower tax rate produces less resistance and results in higher revenues. But policymakers take no heed.

Opportune time

Recognizing that the GRT proposal presents a radical change, we stated in 2010: “The opportune time to introduce the first stage of the GRT may be midway through the term of this new administration. By such time, this paper may have provoked enough discussion to provide better clarity on the feasibility of this proposed final GRT.”

Apparently such was the case as a broadsheet reported on July 14, 2014, “PCCI bats for shift in taxing income.”

To quote: “Instead of taxing net sales (sic), PCCI said a lower rate levied on gross income would be better…. [The] scheme would do away with all the ‘padded’ and optional deductions of corporations.”

We welcome the new adherent.

Mid-term review

We further wrote: “By such time, also, we shall have seen how far we can go with intensified tax enforcement and with better motivated taxpayers.”

There is no question that the current tax administration, headed by Commissioner Kim Henares, is doing a remarkable job enforcing the tax code. On the motivation side, it may have suffered a dent from allegations of taxpayers’ funds having been systematically plundered. Let us look at the fiscal performance, while pondering whether administrative changes can survive an administration change.

In 2013, tax revenues amounted to an impressive P1.535 trillion, or an increase of 29 percent over 2010’s P1.094 trillion. The tax revenue to GDP ratio, or tax effort, rose significantly to 13.3 percent from 12.1 percent in 2010.

Despite recent dramatic improvement in tax collection, the fiscal account remains in deficit as in all years except 1997, when the tax effort was 17 percent. As usual, the deficit is covered with debt and depletion of state assets.

By 2013, the debt had risen 20 percent to P5.681 trillion from 2010’s P4.718 trillion.

Will the current tax system ever generate enough revenue? Perhaps, the chronic deficit is due to misplaced expenditures and leakages?

Objections

A prominent businessman said the GRT leaves no room to maneuver, unknowingly giving the best argument in its favor. Others felt the tax may be passed on to customers, although this has not happened in the case of local government units’ GRT.

Some feared the tax will stoke inflation as it will cascade down the transaction chain from manufacturers to wholesalers then retailers, forgetting that the tax at each stage down the chain should be progressively lower.

A concern is that the shift may dislocate tax revenues. But safeguards are available.

Choose and stay option

Some businesses are unique and different from others, such as startups against going concerns. In such cases, the GRT may not be applicable to the former.

This situation may be addressed with an option to choose between the GRT and income tax.

Once an option is chosen, no switch should be allowed within, say, three or five years.

A simulation may be made to validate the GRT. This will avoid revenue dislocation shock upon system change.

Furthermore, a transitory measure may be instituted to require whichever is higher of the GRT or income tax for the initial year of GRT implementation.

Celtic Tiger

To address its economic malaise that saw many Irish leave for abroad, Ireland instituted structural reforms including deep tax cuts. To the great discomfiture of its high-tax European neighbors, Ireland cut its corporate income tax in 2003 from 32 percent to just 12.5 percent. Its EU neighbors’ taxes were well over 30 percent.

The low tax triggered a flood of inward investments that transformed Ireland. It became a favored location for regional corporate headquarters, manufacturing and logistics base, and was called the Celtic Tiger.

Because of its new inherent economic strength plus additional reforms, Ireland was among the first to recover from the recession following the 2008 financial crisis.

Inversion

When policymakers fail, businesses find ways to skirt onerous tax regimes. US corporations resort to inversion by merging with companies domiciled in a low-tax jurisdiction, and relocate the parent company there to derive tax savings. The most recent case is the acquisition of Irish drug company Shire by American biopharmaceutical company AbbVie. With the Asean integration, our country may not be immune to corporate inversions.

Taxes and competitiveness

High taxes impair business competitiveness and investments. Some foreign air carriers have already cut direct flights due to tax issues. Philippine corporate income tax stands at 30 percent, compared to Thailand’s 20, Malaysia’s 25, Singapore’s 17, Indonesia’s 25, Vietnam’s 22 and Hong Kong’s 16.5 percent.

It is time to shake off fear of the unknown or attachment to the familiar. The unknowns are largely known or foreseeable. Now is the time to seriously look at tax reform. Let us be the Ireland of Asia and perhaps the very low inward investments may rise to a more respectable level.

Perhaps, too, more job opportunities will stem the exodus of our people, thereby arresting the Filipino Diaspora.

(The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines. The author is the Chair of the MAP Legislation Committee and CEO of the Clairmont Group. Feedback at <[email protected]> and< [email protected]>. For previous articles, please visit <map.org.ph>)