Taxation in East Asia and PH tax reform bill

* This is my article in BusinessWorld on March 24, 2017.

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The current tax reform proposal of the Duterte administration promises to improve the Philippines’ competitiveness mainly by reducing income tax rates and cutting exemptions in value-added tax (VAT) and other fiscal incentives. The proposal has somehow created three myths in taxation.

  1. REDUCING THE INCOME TAX RATE CAN LEAD TO REVENUE LOSS.

No, for two reasons. (a) The Laffer Curve is a good reminder that tax revenues can go down as tax rates increase. High taxes are disincentives to honest business and that is why many companies are hiring good law and accounting firms to either take advantage of legal loopholes and reduce tax payments, or find technicalities bordering on dishonest tax payment. And (b) Hong Kong and Singapore are good examples that low income tax rates do attract more local and foreign businesses, which further expand the tax base.

  1. THE NEED TO RAISE EXCISE TAX FOR VEHICLES AND OIL PRODUCTS TO COMPENSATE FOR REVENUE LOSS IN INCOME TAX CUT.

No, for two reasons. (a) Vehicles and oil products are necessary for more business creation — petroleum is a public good, after all. Petroleum allows huge trucks, buses, airplanes, and ships to transport more people and goods, activities which again expand the tax base; and (b) raising the oil tax (by P6/liter across the board) further raises the cost of doing business in the country.

In the table, the Philippines is third highest in tax payment as percent of commercial profit.

While the taxes on profit and corporate income is comparable to many of its neighbors, its “other taxes” like VAT, documentary stamp tax, franchise tax, capital gains tax, excise tax, etc. charge high rates. So raising the excise tax on vehicles and oil products is a raise on “other taxes” and that will dent the attractiveness of lower income tax.

  1. NO NEED TO LOWER VAT, JUST REDUCE THE NUMBER OF EXEMPTIONS.

No. For two reasons: (a) Many industries and sectors have succeeded in their lobby for VAT exemption precisely because the 12% is high; and (b) among ASEAN countries, the Philippines, at 12%, has the highest VAT rate%; five countries have only 10% (Cambodia, Indonesia, Laos, Thailand, and Vietnam), Singapore 7%, Malaysia 6%, Myanmar 5%, Brunei 0.

See the column on tax post filing index (PFI), distance to frontier (DTF), 100 being the highest score. The Philippines has a low score of 49.8 mainly due to VAT non-refund policy. Economies with scores of 63 and above either do not have VAT or have VAT but have low compliance time with paying their corporate income tax (CIT) (see table).

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So a good compromise will be to bring the VAT back to 10% and remove all exemptions except for raw agricultural and fishery products.

Another observable point from the above numbers is that many countries in Asia (and other continents) were socialistic in their income tax policy, started after World War II until the 1980s. For instance in 1980, Malaysia, Thailand, and Taiwan have income tax rates of 60%, Philippines has 70% and South Korea has almost 90%. The faster pace of globalization from the late 1980s onwards made many governments realize that the Laffer Curve indeed is correct, that the higher the tax rate, the lower will be the business activities and overall tax revenues.

To plug endless fiscal irresponsibility also known as endless and yearly budget deficit that require endless search for higher taxes, certain public spending and subsidies must be cut and certain government offices and bureaucracies must shrink or be abolished. Governments should learn to live within their means, even live below their means, especially during years without crises so they can have fiscal surpluses and pay their ever-rising public debt stock.

Bienvenido Oplas, Jr. is the head of Minimal Government Thinkers and a Fellow of SEANET. Both institutes are members of EFN-Asia.

Presentation at Ateneo Ignite’s Tax Exchange

I made this presentation at Ateneo  more than two months ago. The 24-slides presentation is available at my slideshare account. I will show a few slides here.

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I got this photo from Mon Abrea, a famous tax consultant and tax simplification advocate. This  is after the event.

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Our tax system is among  the highest, most envy-inspired in Asia. Data from WB-PWC’s Paying Taxes 2016 Report.

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These + other tables mean…

Tax wise, PH is NOT an attractive place to do business in the ASEAN. Highest total tax rate (TTR) in the region plus complicated and bureaucratic procedures. Only developed welfare countries Australia and Japan, and socialist China have higher TTR than PH.

Although in number of hours, VN proves it is indeed a socialist and bureaucratic state; in number of payments, ID’s bureaucracies are most notable.

Tax competition among ASEAN countries is happening. BR, SG and CM keeping  their low TTR, MM significantly cut its TTR last year. Only MY is dueling  with PH in high TTR.

The time to cut the PH’s (a) number of taxes and forced contributions, and (b) income tax rates, was yesterday. So we need to move fast today and tomorrow.

So if we can not significantly cut income taxes, one alternative is…

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Proposal 3: National income tax is zero, allow provinces to impose income tax.

“No tax on work.” Survival and prosperity of societies are based on work of people. Work should not be penalized and discouraged with taxes, the way governments discourage smoking and drinking with more taxes.

National income tax is zero, or 5% max. National government to keep collecting consumption-based taxes (VAT, excise, franchise, vehicle registration, other taxes) and regulatory fees, while devolving more functions to provincial governments.

Provinces can impose income tax. Let there be tax competition, governance competition among them.

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Concluding Notes

Tax and governance competition, infrastructure and security competition among provinces will empower the people and companies to vote with their feet.

Of 3 proposals, most feasible is #1, cut income tax rates to 20% or lower. Higher Q, wider tax base, will compensate for the reduction and propel higher TR.

Proposal #3 will attract the advocates of federalism and more decentralization and denationalization.

Proposal #2 will attract the more daring politicians, business and civil society leaders. Long-term view.

All 3 proposals can lead to more individual freedom, freer markets and limited government.

Tax competition in the ASEAN

* This is my article in BusinessWorld yesterday.

01In two weeks, it will be the deadline for the filing of income tax by individuals and corporations. April 15 each year is a reminder for many people of how much of their monthly or annual income goes to the government, aside from the various consumption-based taxes (VAT, excise tax, vehicle registration tax, and so on) that they pay.

With the ASEAN economic integration that occurred at the start of 2016, there is both business competition and complementation among firms and individuals that are based in the 10 member-countries. And tax competition is among such factors that people look up to. They can put up their manufacturing plants in country/ies which have (1) lower and simpler taxes, (2) lower cost of electricity, (3) lower cost of labor relative to skills, among others. And then sell the products to other ASEAN countries at zero tariff.

How competitive and business-friendly, or non-competitive is the Philippines compared to its neighbors in taxation policy? Let us review the most recent numbers (see Table 1).

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Of the 189 countries covered in the 2016 PWC report, the Philippines ranked 126th or in the third quartile, which is not really a good position. Compare the numbers for the Philippines vs those of Hong Kong and Singapore, which indicate that they are most business-friendly and hence, most attractive to investors.

* 36 payments of taxes and mandatory contributions vs only 3 and 6 for HK ang Singapore.

* 193 hours per year to pay for all those steps and procedures vs only 74 and 84 hours for HK and Singapore.

* 43% of commercial profit goes to paying various taxes to government (local and national) and social insurance state corporations (SSS, PhilHealth, Pag-IBIG) vs only 23% and 18% for HK and Singapore.

In total tax rate alone, here are the numbers for the 10 ASEAN countries for the 4 PWC Reports. The Philippines has the highest rate in the region, followed by Malaysia and Vietnam. Very prominent are the huge improvement or reduction of tax rates for Brunei and Myanmar (see Table 2).

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Tax wise, the Philippines is NOT an attractive place to do business in the ASEAN. It has the highest total tax rate (TTR) in the region plus complicated and bureaucratic procedures. Although in number of hours, Vietnam proves it is indeed a socialist and bureaucratic state; in number of payments, Indonesia’s bureaucracies are most notable.

The time to cut the Philippine’s number of taxes and forced contributions, and income tax rates was yesterday. So we need to move fast today and tomorrow.

Among the significant reform measures are the following:

One is to cut the income tax rate (currently it is 32% for individuals and 30% for corporations) to a flat rate of only 20% or less. Recall an earlier paper of this column where it was shown that

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

TR = t x Q.

If there is only one form of tax, the income tax, then there are two ways to raise TR:

(i) raise t or keep it at a high rate and wait for Q to rise because of increase in population and number of private enterprises, or

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

The second measure is to allow the island-provinces and other far flung provinces to become new countries, and encourage tax competition and governance competition with one another. They should compete with Metro Manila, Cebu, and other big provincial centers.

The third proposal is to have zero national income tax, “No tax on work” proposal, and allow the provinces to impose income tax on top of other local taxes that they collect like real property taxes and business permits. The national government can continue collecting various consumption-based taxes like VAT, excise tax, and franchise tax. The key is to have provincial tax competition without disintegrating the country into many new island-nations. Many social services done by the national government should also be devolved further to the provinces and cities.

Lower tax rates, good governance, quality of infrastructure, and peace and order will prompt provinces to compete with one another, which, in turn, will help empower people to vote with their feet. Companies meanwhile, will be encouraged to go to areas and provinces that give them more peace and order, better roads and cheaper electricity, low or reasonable tax rates that are commensurate with the services that they receive.

By shrinking the national government bureaucracies and empowering the local and provincial governments under the spirit of tax and economic competition, the public will be better served because the leaders know that beyond voting by the ballot, the people are also voting with their feet.

Bienvenido S. Oplas, Jr. is the head of Minimal Government Thinkers, and a Fellow of South East Asia Network for Development (SEANET). minimalgovernment@gmail.com

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