Income tax reform has to wait

In a recent Malacañang statement, PNoy rejected the long overdue rationalization of our income tax structure saying that to tamper with it at this juncture may reverse the gains we have achieved to improve the country’s financial standing. He further said that to lower income tax rates will lead to lesser government revenues which may affect the country’s impeccable “investment grade” credit ratings.

I get it. PNoy has worked hard to get the country classified as investment grade. To those unaware, being classified as such is akin to a seal of good housekeeping that tells creditors that the country carries minimal risk and a signal to investors that it is safe to invest in our shores. It has so far resulted in massive savings in interest expense (from foreign debts) owing to the prime borrowing rates we enjoy. As far as investment goes, its impact has been minimal as the seal of good housekeeping is negated by the restrictive provisions of the constitution.

That said, we must also be aware of the social costs of maintaining the status quo in our income tax structure. Truth is, it impacts the common folk, driving them deeper into poverty. See, the present tax code was enacted in 1997 under Republic Act 8482 and it is structured this way:

The problem with the current structure is that the tax brackets were formulated 18 years ago when one peso was worth 2.27 pesos in today’s terms. Through the years, currency depreciation and inflation have eroded much of the peso’s purchasing power. Hence, what R10,000 could buy in 1997 can only afford R4,400 worth of goods today.

Granted, salaries of the lower and middle income classes have increased over the years. Public school teachers, for instance, who earned an annual salary of R195,000 in 1997 belonged to 25% tax bracket. Their take-home pay was R158,750, after taxes. Today, the same public school teacher may earn R290,000 considering tenure and salary increases. However, she now belongs to the 30% tax bracket given her higher income. Hence, her take-home pay today would be P195,000. However, if the diminished purchasing power of the peso is factored-in, her real take-home pay, in 1997 terms, is only R85,500, forty six percent less than what she took home in 1997. Such phenomenon is known in economic parlance as “Bracket Creep”.

So despite the seeming increases in take-home pay, our lower and middle class workers can buy less today than they could 18 years ago. This is why income tax reform is badly needed. Progressive governments worldwide recognize that income tax brackets must be rationalized every six years, at the least. Ours have remained constant for nearly two decades.

The solution is to widen the tax brackets to avoid Bracket Creep and account for the effects of inflation. Senator Sonny Angara proposed a compromised tax bracketing

structure that looks like this:

This rationalized income tax structure leaves more money in the pockets of the middle and lower income folks to live decent, dignified lives.

Granted, government’s tax revenues may diminish as a result of Senator Angara’s rationalized tax bracketing proposal, but such revenues may be recouped by a sharp increase in consumer taxes such as VAT and SIN Taxes. Remember, the more money is left in the hands of the consumer, the more he can purchase goods and services. This translates to greater consumer taxes that go to government coffers.

Another upshot to rationalizing our income tax structure is that it prevents good talent from migrating to other countries where taxes are more equitable. This is especially significant since ASEAN will soon allow the free flow of skilled labor across boarders.

As it stands, the Philippines has the highest corporate income tax rates among ASEAN six. This is how much government levies upon corporations in comparison to our neighbors:

Imposing the highest corporate income tax rate puts us in a slippery slope. With the advent of the ASEAN Economic Community next year, businesses, large and small, can invest freely across ASEAN states without capital controls. All factors equal, why will any investors choose to set up shop in the Philippines when government takes the largest chunk of their income while giving poor services and shoddy infrastructure in return?

Even now, the Philippines gets the second least foreign direct investments (FDI’s) among the ASEAN 6. Last year, our FDIs of $6.2 billion was a pittance to Singapore’ take of $67.4 billion and Indonesia’s $25.6 billion. This year, our FDIs are down my a massive 40%. It just goes to show that being “investment grade” is not the end-all-be-all in attracting FDIs.

Government must consider, too, that doing business in the Philippines is more expensive than it is among the ASEAN 6 what with our infrastructure backlog and expensive power cost. All the more reason to offset these negative factors with a more sensible corporate tax structure.

Senator Angara’s bill proposes to reduce corporate income tax over a three-year period so as to avoid a shock in state revenue cuts. From the current 30% today, the bill proposes to reduce it to 27% in 2016, and 25% in 2017.

Twenty-five percent is not incentive enough to woo investors, but at least it puts us on equal footing with Malaysia and Indonesia.

A more equitable taxation system may also dissuade both individuals and corporations from evading their tax obligations. It can promote voluntary compliance since the amounts taken away by the state are relatively reasonable.

Should Senator Angara’s proposal be followed, the short term effect on government revenues will be anywhere from R30 to R43 Billion. This will surely impact our balance of payments and may even cause a credit rating downgrade. But government should take a long term view on the issue. The cumulative benefits of attracting more investments, attracting talent and firing-up consumption should more than compensate for the short term loss in revenues. Above all, it allows the lower and middle classes to sustain a decent way of life.

The interest expense savings and bragging rights of being “investment grade” are fine perks. But what good is it if the masses are wallowing in poverty. Doesn’t this go against the very essence of “inclusive growth?” If there is any logical starting point to equitably distribute the wealth of the nation, it is through the rationalization of our income tax system.

Our income tax and corporate tax structure is obsolete, inequitable and one that works counter to the interest of the common folk. The sooner government faces up to this truth, the better for all of us. Let's hope the next administration gets over the fixation on investment grade and supports tax reform. Andrew is an economist, political analyst and businessman. He is a 20-year veteran in the hospitality and tourism industry. For comments and reactions, e-mail andrew_rs6@yahoo. com. More of his business updates are available via his Facebook page (Andrew J. Masigan). Follow Andrew on Twitter @aj_masigan.