Computing rise in tax revenues if rates are cut

* This is my article in BusinessWorld last Tuesday.

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Among the most important liberal economic policies that the Aquino administration should have pursued — to remain consistent with its party affiliation, the Liberal Party (LP) — is to cut income tax rates in the Philippines. Unfortunately, the President failed to appreciate the importance of this measure.

 

While some LP leaders pursued this measure, top party officials and the Department of Finance Secretary took the limited view that tax cut means lower tax revenues. Hence, they objected the measure.

Below is a simple model, not an econometric one, to estimate potential higher tax revenues by cutting income tax.

Tax revenues (TR) is a product of tax rate (t) multiplied by the quantity (Q) or number of taxpayers, individuals and corporate.

(1) TR = t x Q.

Assuming that there is only one form of tax, the income tax for individuals and enterprises, then there are two ways to raise TR:

(i) raise t or keep it at a high rate and hope that Q will remain the same or further rise, or

(ii) reduce t and watch Q to expand faster than the decline in t.

Now there are many types of taxes other than direct income tax:

(a) consumption-based taxes, such as value-added tax (VAT), excise tax, travel tax, amusement tax, etc.;

(b) property-based taxes such as real property tax or RPT collected by local government units (LGUs), vehicle registration tax, franchise tax, etc.;

(c) indirect income taxes such as bank interests withholding tax, capital gains tax, estate tax, documentary stamp tax, etc.;

(d) product-based taxes such as royalties and excise tax for extractive industries — mining, natural gas, geothermal, coal, petroleum, etc.;

(e) LGU taxes such as barangays, business permit taxes, community tax, etc.;

(f) others.

Then there are many types of mandatory fees and permits:

(a) National: drivers license fees, passport fees, airport terminal fees, NBI clearance fees, police clearance fees, professional clearance fees, etc.

(b) LGUs: residence tax/cedula, barangays, city/municipality/provincial permits and fees.

So there are various types of tax rates, to be noted as

t1 — direct income taxes
t2 — consumption based taxes
t3 — property based taxes
t4 — indirect income taxes, and so on

So the government’s TR goal can be summarized as:

(2)  TR = ∑ [(t1 x Q1) + (t2 x Q2) + t3 x Q3) + …]

For the income tax cut campaign, it can be shown that reducing t1 from 32% (individual) and 30% (corporate) to only 25%, or 20% or 15%, will result in a higher number of individuals paying their taxes correctly.

The rise in Q1, number of people and companies who will pay individual and corporate income taxes will be expected from the following:

(ET) Existing Taxpayers who underdeclare their real income and report lower income to pay lower taxes;

(NT) Individuals who never declare any income even though they earn;

(FA) Filipino potential taxpayers abroad, professionals and entrepreneurs who work and do business abroad than here, partly due to lower tax rates and higher income opportunities there, and they will return home;

(FT) Foreign Taxpayers, professionals and businessmen abroad especially in high-taxes welfare states of the European Union and North America, who want to leave their country and do business in Asian economies with lower tax rates.

(ET + NT) are local groups surfacing, (FA + FT) are foreign-based groups coming here. Together, they will significantly raise Q1 and hence, TR can increase even if t1 has decreased. Or:

(3) Q1 = ET + NT + FA + FT.

Examples and hypothetical case studies:

At t1 = 32%, if average tax collection is P250,000/person/year and Q1 is at 8 million people, then:

(4) TR1 = t1 x Q1 = P200,000 x 8M = P1.4 trillion

If t1 declines from 32% to 20%, corresponding to average payment of P120,000/person and Q1 rises from 8 million to 14 million people, then:

(5) TR1’ = t1’ x Q1’ = P120,000 x 14M = P1.68 trillion.

Now Q2 should also rise because Q1 (equation 3) has increased.

At 12% VAT, assuming that average VAT payment per person is P20,000/year, and there are 50 million people who pay VAT,

(6) TR2 = t2 x Q2 = P20,000/person/year x 50M = P1 trillion

Assuming that VAT is raised from 12% to 14% and average VAT payment rises from P20,000 to P25,000/person/year, and there are now 53 million VAT taxpayers, then:

(7) TR2’ = t2’ x Q2’ = P25,000 x 53M = P1.23 trillion

So TR collection via status quo, from equations (4) + (6):

(8) TR1 = P1.4T + 1.0T = P2.4 trillion.

Vs. TR collection via income tax cut, from equations (5) + (7):

(9) TR2 = P1.68T + P1.23T = P2.91 trillion.

There is an increase in TR by P510 billion or P0.51 trillion.

Again, the above numbers are hypothetical and made only to illustrate the point that reducing income tax rate can actually increase, not decrease, total TR of the government. The challenge now is to find out what would be the projected:

(i) increase from Q1 (individuals) to Q1’ if individual income tax is cut from 32% to 25% or 20% or other lower rates;

(ii) increase from Q1 (corporations) to Q1’ if corporate income tax is cut from 30% to 20% or other lower rates;

(iii) increase from Q2 to Q2’ if VAT remains at 12%;

(iv) increase in average VAT collection per person if VAT is raised from 12% to 14%, and corresponding change from Q2 to Q2’.

If these numbers are generated and estimated, then the realistic projected increase in TR as a result of income tax cut can be shown and quantified.

Meanwhile, members of the LP can proudly declare that they are consistent in pursuing liberal economic policies — liberate the individual and private enterprises from overbearing and heavy taxes, fees, royalties, charges and penalties.

Bienvenido S. Oplas, Jr. is the head of Minimal Government Thinkers, and an economic consultant at the Alas, Oplas and Co. CPAs. minimalgovernment@gmail.com

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