Reforming the PHL tax system is a question of when, not if

By Benjamin E. Diokno | Posted on September 22, 2015 11:06:00 PM

The call for reforming the 19-year-old personal income and corporate income tax systems is getting noisier. Keeping the tax system in its present form might prove costly for the Philippine economy since it is out of sync with its Association of Southeast Asian Nations (ASEAN)-6 peers.

And with ASEAN integration, not only will the Philippines have the poorest public infrastructure among its ASEAN-6 peers; it, too,will have the most uninviting tax system in the ASEAN region.

Will President Benigno S. C. Aquino III use what remains of his political capital to reform the 19-year-old Philippine tax system?

Most likely not. Mr. Aquino quickly doused any hope that measures that seek to reform the personal and income tax systems would pass. He echoed the Department of Finance’s (DoF) argument that a cut in personal income tax rates and corporate tax rate without corresponding adjustment in other taxes will result in investment downgrade by international rating agencies.

DoF’s position is debatable. Here are some reasons why there is slim risk that the country would default on its foreign debt.

In the first place, foreign debt as a percent of total debt is at its rock bottom.

Second, the Philippines has been a good borrower. It continued to pay its foreign debt even during its worst times, even to the extent of sacrificing its infrastructure and social needs.

Third, the Philippines has the resources to service its foreign and domestic debt. Right now, it has a guaranteed annual inflow of some $25 billion to $26 billion overseas remittances coming from Filipino workers abroad and the promise of increasing business process outsourcing income. It has hefty gross international reserves of more than $80 billion, equivalent to close to one year’s imports requirement.

FOREIGN MASTERS VERSUS LOCAL ‘BOSSES’
Mr. Aquino scared his ‘bosses’ of the specter of rising deficit and hence a potential downgrade by international ratings agencies. Seriously? This scary scenario came from someone who’s been notorious for underspending — delivering public goods and services much lower than what Congress authorized him to deliver.

In 2014, the Aquino administration targeted a budget deficit of P266.2 billion or 2.0% of gross domestic product (GDP). Actual deficit was only P73.1 billion or 0.6% of GDP, and this is not because of higher-than-targeted revenue intake. The lower deficit was due to simple incompetence or poor budget planning or both: planned spending of P2.284 trillion versus actual spending of P1.982 trillion, or a difference of P302 billion.

In 2015, the same sad and horrible story is unfolding. While the budget deficit target is P283.7 billion or 2.0% of GDP, actual deficit as of end July is only P32.2 billion, or only 11.4% of planned deficit. At the current rate of project implementation, the Aquino administration would be lucky to have a 1% deficit-to-GDP ratio for the entire year. Another opportunity lost.

President Aquino’s position on tax reform reveals his true color: he is more afraid of the threat of a downgrade by foreign ratings agencies than incurring the collective wrath of Filipino taxpayers, who have to contend with the increasingly burdensome 19-year-old tax system. Through inflation, all taxpayers, bar none, have been bumped up into a higher income tax bracket and therefore have to pay higher taxes than what was originally intended.

If Mr. Aquino insists that the present income tax system should remain untouched, it is yet another proof that he is truly insensitive to the welfare of his “bosses”. Questions: Is this what continuity is all about? What is the position of Interior and Local Government Secretary Manuel “Mar” A. Roxas II on this issue? Is he going to continue slavishly Mr. Aquino’s insensitivity?

The Aquino administration refuses to see the clear vote of non-confidence of international foreign investors. The Philippines has consistently lagged behind its ASEAN-6 neighbors in attracting foreign direct investment (FDIs). This year alone, during the first semester, the inflows of FDIs fell by 40.1%: to $2.019 billion from $3.373 billion logged in 2014’s comparable six months.

PHILIPPINE TAX SYSTEM OUT OF SYNC
In preparation for ASEAN integration, the Philippines refuses to respond positively unlike some of its ASEAN peers (Thailand, Vietnam, and Malaysia) by reducing the tax rates to more competitive levels.

Thailand cut its highest personal income tax rate from 37% to 35% and its corporate income tax rate from 35% in 2010 to a very attractive 20%.

Vietnam, the country which went through decades of ravaging wars but now slowly but surely overtaking the Philippines, has drastically cut its corporate income tax rates to 22%, from 35% in 2010.

Malaysia, a country that is more developed than the Philippines, will cut down its already low personal income tax rate from 26% to 25%.

Singapore, a city state that has attracted the highest FDIs among ASEAN-6 countries, has the most inviting income tax package: 20% highest marginal personal income tax rate and 17% corporate income tax rate.

Both the House and the Senate have proposed the reduction of both the personal and corporate income tax rates. But on the advice of his finance gurus, Mr. Aquino promptly rejected such proposals.

Assuming a potential revenue loss due to lower income taxation of P40 billion, that is only 1.6% of total budget. One might look at it as a tax break or a reward to those who have been religiously paying their income taxes. The beneficiaries of a tax cut will use the tax reward either for consumption or investment. In both cases, they will stimulate economic expansion. (See Table)

Part of what was lost due to the tax break might be recovered through higher consumption and greater investment.

The tax break of P40 billion pales in comparison with the planned deficit: it is only 14.1% of the planned deficit of P283.7 billion in 2015. Actual deficit might turn out to be, at best, only one% of GDP, half the original target. Hence, there is absolutely no threat of runaway deficit this year.

One other thing is lost in the debate: a tax cut is generally seen by economists as expansionary; it is seen by bean counters as taxes foregone.

A tax cut will stimulate the economy nearly as fast as higher government consumption spending, and speedier than public infrastructure spending

A tax cut, especially if it’s fair, efficient, and moderate so that it would not threaten the budget deficit to soar unsustainably, might be just what the economy needs at this time when economic growth is normalizing.

Tax reform is urgently needed in this country. The present tax system is out of date, inefficient, onerous, and out of sync with tax systems in integrating ASEAN region. Reforming it is a question of when not if. Do we do it now or do we have to wait for the next President and Congress to do it?