Equity in taxation essential

Everyone must carry his or her just share of the cost of government. Unfortunately, this is an objective that is difficult to achieve. It does not however mean we should forget trying to make that happen.

One reason why many taxpayers feel bad about paying taxes is the knowledge that he or she is being made a fool and he can’t do anything about it. Not only are there so many tax evaders getting away with it, the tax system is also inherently unfair to the working class.

Our tax policy makers should not just focus on trying to collect as much as they can. Our tax laws must also be fair and just. This is what Sen. Sonny Angara is trying to do. Unfortunately, our fiscal policy makers at the Department of Finance are shortsightedly focused on potential losses in collection.

Sen. Angara has described our current tax system as “outdated” and “inequitable”. He correctly points out the current taxation system makes middle-income earners pay taxes at the same rate as billionaires. Angara thinks it is unjust to our thin middle class who are hit the hardest.

“Updating our tax system is an issue of equity. It’s not an issue anymore of macroeconomics. That’s all meaningless if the average person has nothing left for his family,” Angara observes.  Angara is correct. A manager or even a supervisor working for one of our larger corporations earning about P500,000 a year or a little over P40,000 a month is paying income tax at the same rate as Henry Sy, Lucio Tan or Jaime Zobel de Ayala.       

 AIM Prof Ronald Mendoza thinks “there is scope for considering income tax reforms when too many people with such disparate incomes end up with the same (in this case the highest) tax bracket. This goes against the principle of progressivity, and it most likely exacerbates inequality.”

This is because of the evil called bracket creep. Prof Mendoza explains:

“It seems one primary concern for many in the middle class is the growing sense of over-taxation. One way this can happen is if the tax brackets are not adjusted for inflation – over time, this will likely result in rising nominal incomes pushing a growing number of income taxpayers into much higher tax brackets, even as their real (or inflation-corrected) incomes have not increased (or not by as much).”

The P500,000 when the current tax brackets were designed in 1997 is not the same P500,000 today. The peso then is only worth 43 centavos now, Angara told me. Because the tax rate remained the same, the working class is effectively squeezed. 

“Tax brackets should be adjusted to make (these) more sensitive to current salaries of Filipinos. Because at present, a person who makes P50,000 a month -- who is considered middle class -- is already in the top tax bracket and is also paying the same tax rate as the billionaires in our country,” Angara points out.

Dr. Mendoza agrees and also observes that even our 32 percent top tax rate is way too high compared with some of our Asean peers.

“The Philippines has the second highest average tax rate (after Vietnam and Thailand). On the other hand, Singapore has the lowest marginal tax rate at both ends of its tax bracket spectrum, at 20 percentfor the wealthiest and two percent for the lowest qualifying income tax payers. (Compare this with 32 percent and five percent for the Philippines.)

“If we also consider the value-added taxes in Asean, the Philippines comes on top (or near the top) of the most taxed in the region.”

That is also what Sen Angara is saying. He pointed out that a Filipino earning P500,000 (equivalent to $11,000) annually is taxed the maximum 32 percent while in Singapore, where the top tax bracket starts at $250,000, the tax rate is only 20 percent.

In Indonesia, the top tax bracket of $43,000 is taxed 30 percent; Malaysia’s top tax bracket of $30,000 is taxed 26 percent; and Thailand’s top tax bracket of $123,000 is taxed 35 percent.

Angara’s Senate Bill No. 2149 seeks to adjust and compress income tax brackets, and reduce the maximum tax rate from the current 32 percent to 25 percent by 2017. That means, the country’s top income tax bracket will be pegged at over P1 million (equivalent to $22,000) and taxed 25 percent by 2017.

According to InterAksyon, a recent hearing on Angara’s proposed bill drew support from tax experts. A lawyer from accounting firm Punongbayan and Araullo, suggested the automatic adjustment of the tax brackets and tax rates based on the consumer price index every three years, without the need for legislative action.

A lawyer from Isla Lipana and Co., another accounting firm, said lower taxes would result in higher capital inflow and higher purchasing power.

A representative of the Financial Executives Institute of the Philippines, on the other hand, stressed the need to simplify the tax system for easier compliance and improved collection.

Angara wants to fix this. We’re really not complying anymore with the command of the Constitution that we should have a progressive tax system,” Angara complains.

Worse, economists say “bracket creep” could contribute to “fiscal drag”—a weakening of aggregate demand due to excess taxation of a growing number of taxpayers.

Dr. Mendoza warns “as more taxpayers are pushed to the same tax bracket (wherein incomes still have a high disparity even within that bracket), then the progressiveness of the tax system may decline over time.”

Mendoza said “progressivity of our tax rates is better achieved by imposing higher tax rates on those with greater capability to pay, i.e. the wealthy. Progressiveness becomes less likely when more and more people fall into the same tax bracket and face the same tax rate.”

But the Department of Finance is opposing any reform measure that reduces potential tax collections. Dr. Mendoza admits that “providing relief implies a possible reduction in tax revenues (at least in the short term)…

“Initially, Senator Angara’s proposal could decrease total revenue by only three percent. In 2016, the decrease could rise to about 15 percent.”

But Dr. Mendoza also explains potential losses in tax collection by reducing the tax rates for the middle class may be mitigated by increased expenditure and economic activity because they will have more money to spend. That potentially means more tax collections.

As we have seen, it is the middle class, thin as it is, powering our consumer-led economic growth. On the other hand, the wealthy scooping most of the benefits of economic growth only contribute to excess liquidity in the system that causes problems for the BSP.

Many in our middle class are young BPO workers spending in the malls that are sprouting all over the country like mushrooms after a rain. Giving the working class more money to spend by adjusting tax rates will also even marginally improve the quality of their lives and help contribute to social equity otherwise known to P-Noy as inclusive growth.  

Dr. Mendoza observed “reforms in public finance cannot just focus on the spending side (e.g. shutting down PDAF, promoting bottom up budgeting, and improving transparency and participatory governance reforms in budgeting). Addressing revenue-side issues will go a long way in winning back the hearts and minds of taxpayers.”

A sense of fairness in the tax system will go far in encouraging better tax compliance. We need not worry too much about an initial decline in tax collection. That may even spur government officials to be more efficient in running their operations and making sure leakage through corruption and needless spending is minimized. 

Indeed, more money available for government doesn’t mean its agencies have the capability to spend it, as we are seeing now. All that excess tax collections only end up sleeping in bank accounts of government agencies dragging our economic growth down. Middle class taxpayers could have made better use of those excess taxes in an economy boosting way.

The efforts of Senator Angara, Bam Aquino, Ralph Recto and Rep Miro Quimbo among others to make our Tax Code more sensible are appreciated. If all they can do now is to adjust the rates to account for the deterioration of the peso’s value since the rates were designed, it would already be a big step forward. Not to index our tax rates to inflation is oppressive and legalized stealing.

I am not hopeful anything positive can happen in the remainder of P-Noy’s term in the area of tax reform. Then again, we could be pleasantly surprised.

Boo Chanco’s e-mail address is [email protected]. Follow him on Twitter @boochanco