TRAIN 2, a necessary cure to TRAIN 1

I shudder at the thought that the TRAIN (Tax Reform for Acceleration and Inclusion) stops with Package 1.  As envisioned, the TRAIN is a comprehensive tax reform program consisting of several packages—all packages being a necessary part and parcel of the whole plan, each package complementing and connected with the others—to achieve a fair, simple and efficient tax system.

Of the packages, TRAIN 1 is the bitter pill and the rest (Packages 2-4) are the sweeteners. TRAIN 1 requires sacrifice but the rest give rewards. TRAIN 1 is a revenue-raising measure with a projected revenue intake of P786 billion in five years, the rest are revenue neutral with the main objective of fixing a faulty, unfair, complicated and antiquated tax system.

As designed, it is only when all the packages are passed that we get to reap the fruits of a tax system that is fair, efficient, simple, and I would add, regionally competitive.

TRAIN 1 is a reform on individual income and consumption taxes.  Expectedly, when a tax is imposed on consumption, there is inflation, specially when the tax covers basic commodities like oil and sugar.  Based on DOF reports, the expected increase in inflation due to TRAIN 1 is 0.4 percent.  Unfortunately, there were extraneous events beyond control that coincided with TRAIN 1 causing inflation to shoot up, such as the unexpected spike in the prices of oil, rice and fish, and the depreciating peso, among others.

TRAIN 1’s fault is more of wrong timing than wrong design.

TRAIN 2, on the other hand, is on corporate taxes. It is meant to reduce corporate taxes, at the same time, rationalize the fiscal incentives system.  Of the three bills filed in Congress, one bill seeks to reduce the corporate tax to as low as 20 percent to put the country at par with the rest of the region (20 percent is the dominant rate in the Asean region).

If adopted, this will result in a 10 percent tax savings (from the current 30 percent to 20 percent) that could translate to lower prices of commodities and services.  That is, if businessmen are fair enough not to profit from it but push that savings to their customers to bring down prices.  This should somehow give a relief on inflation caused by TRAIN 1.

But why fear TRAIN 2?

Because like typhoons, signal no. 2 is stronger and more forceful than signal no. 1.  The fear is plainly psychological associated with increasing numbers, and driven by the noise that under TRAIN 2, all incentives will be removed and entities currently enjoying tax incentives will be stripped of that privilege.   This will increase prices as businessmen will try to recover the lost tax savings from their customers.

DOF claims TRAIN 2 will only modernize the incentives system, and not abolish.  But to those affected, it does not matter how DOF calls it—a rationalization, modernization, re-orientation—it all means the same, an end to happy days.  And like a candy taken off from a child’s hand, there will always be wailing and howling.

Looking at the DOF’s TRAIN 2, I would say, ‘removal’ is not the proper descriptive word.  It is more of a redesign.  It is redesigning the whole fiscal incentives system to put discipline on transparency, responsibility and fiscal prudence.

The income tax holiday (ITH) is retained but there will be no more extensions.  The 5 percent gross income tax ‘in lieu of all taxes’ enjoyed by Peza-registered entities will be changed to a reduced income tax (RIT) regime with a rate of 15 percent (50 percent off the current corporate tax rate).  All incentives will have a cap on period of enjoyment and there will no longer be any perpetual enjoyment of incentives.

For those affected by these changes, there is a cooling off period of three-five years before the new regime takes effect to soften transition and minimize disruption.  With this, the inflation expected from the withdrawal of incentive, if any, would not be immediate.  Also, most recipients of tax incentives sell their products abroad, with only 30 percent of their produce allowed for domestic consumption, which would lessen the likelihood of inflation.   Likewise, even if incentives are given, there is no assurance it will redound to lower prices as corporates can opt to keep the benefit to themselves.

I definitely would prefer a lower corporate tax enjoyed by all than to have a high corporate tax imposed on a narrow base, in order to subsidize the privileged ones that comprise the wider base. If we desire to lower the corporate taxes, we must be ready to take a hit on incentives to make this happen.

Having said all these, should we stop with TRAIN 1 and be stuck with a bitter pill forever? Or should we push for those sweeteners under TRAIN 2, 3 and 4? Definitely, I want those sweeteners.