Racing against a fiscal meltdown, we lost a lot of time dilly-dallying on the VAT measure. This measure, we will recall, was indicated as a priority legislation in the President’s State of the Nation address last year.
After the House version passed many months ago, the Senate began dragging its feet, complicating the matter by tying up the additional VAT with other things such as the corporate tax rate and franchise taxes. The withdrawal of existing exemptions was also incorporated into the Senate version.
All in all, the Senate produced a version of the VAT bill that was astoundingly dissimilar from the House version. All revenue measures, in principle, emanate from the House. The Senate version stretched that principle to the maximum.
That brought a complex and politically charged job to the bicameral committee. The House panel basically stuck to its version and the Senate panel stuck to theirs. And while the matter was being sorted out, our fiscal situation hovered perilously close to meltdown, suffering four downgrades in our sovereign debt ratings.
Now the job is nearly done. Nearly, because from what we hear about the compromise version, the really nasty task of actually raising the VAT rate will be left to the President. Despite being hobbled by low job approval ratings and new speculation about political destabilization, it is generally expected that the President will do what must be done to save the economy.
While we wait for this final act on the VAT to happen, it should be appropriate to look farther ahead on revenue reforms. One thing that might be looked into with great seriousness is the flat tax.
The flat tax represents the frontline of what many consider a revenue revolution. It consists, basically, of applying the same tax rate on all levels of income.
Most have tax codes become so complicated that even individual taxpayers now have to engage the services of accountants to determine how much they should pay. The sheer complexity of tax rules have exasperated taxpayers and led to low levels of tax acceptance.
The idea of imposing a single tax rate on all levels and forms of income has lingered for many years. Tax experts suspect it because it is too simple. It will definitely imply loss of business for the large accounting firms that have mushroomed in the confused atmosphere of complicated tax codes.
The notion of a flat tax has been dismissed as one of those things that look good in theory but will probably be horrific in actual practice. So, for too long, it was never tried out in actual practice because there was simply to much common sense in it.
In 1994, Estonia went ahead and adopted a flat tax on corporate and personal incomes. The experiment worked well enough.
Soon after, her Baltic neighbors Latvia and Lithuania followed suit. Later on Russia sustained the trend, imposing a 13 percent rate on personal income. Slovakia imposed a uniform 19 percent on corporate and personal income. So did Georgia, Serbia. Ukraine and Romania.
A total of nine countries now apply a flat tax, ranging from Estonia’s 26 percent to Georgia’s 12 percent. None of them have descended into chaos.
In fact, the system seems to be working well.
A flat tax will improve compliance and eliminate evasion, precisely the characteristics of our badly performing revenue system. It will do so because, instead of taxing individual income earners, the flat tax will allow revenue authorities to tax payrolls instead.
In our system, fixed wage-earners bear the burden of income taxes because they are taxed at the source. After that, they have to file a return.
A flat tax will simplify that. It will require only monitoring of the payrolls and not individual taxpayers. That will take the bureaucracy out of revenue generation.
I suspect this will produce magical results for our ailing, complicated revenue system, expand the tax base and dramatically improve compliance.
It is time to rethink the reason for the increasing complexity of modern income tax systems. The principal reason for that complexity is "fairness."
In a small country like Luxembourg, for instance, tax collectors and taxpayers work with 17 different tax brackets. The idea behind that is, in the name of "fairness", to ensure that those who make more should pay more. But the over-all efficiency of collection suffers in the process. It has also, in many cases, discouraged wealth creation, which has immense social benefits in and of its own.
With a flat tax, those who make more will still pay more. Maybe not disproportionately more, which seems to be the inspiration behind complicated but ill-enforced tax codes. But still more.
Instead of bleeding those who are more efficient at wealth creation, we ought to complete the equation a bit more. The central virtue of tax collection is that it allows governments to spend to benefit the poor.
With a flat tax and improved revenue generation, what governments ought to do is to skew the expenditure side more to benefit the ends of social justice. The income tax is a blunt instrument for achieving social justice. Public expenditure is a more precise instrument.
With better revenues because of less evasion and less corruption in the process, governments should be better enabled to address the needs of the poor through expanded spending on education, health care, infrastructure development, public housing and other social services.
If governments were perfect instruments of the social good, taxes effectively collected should be a beneficial thing. That assumes a lot of course in a condition of severely imperfect government.