Strategic Perspective -- René B. Azurin

Just scrap income taxes

Posted on August 18, 2011

Yes, let’s simplify taxes. House Bill 3927 proposes to simplify our income tax system by taxing corporations based on their gross income less "direct costs." This addresses a constant complaint that our tax system is prone to corruption because it is too complicated. It also aims at improving collections by making it simpler for taxpayers to pay the correct taxes. My reaction to such tax simplification efforts has always been, why not go for the ultimate simplification and scrap income taxes altogether?

For many years now, I have been proposing that our present system for taxing income (basically patterned after the US tax system) should be replaced with a system for taxing consumption. Over time, I have argued in several public forums (as well as in this space) that consumption taxes are intrinsically fairer than income taxes. After all, what is fair about penalizing (via taxes) someone whose only "crime" is to be successful at running a business efficiently enough to be profitable? Isn’t it inherently fairer to penalize (via taxes) someone because he consumes resources and therefore adds to the total burden of both the society and the environment?

An economic rationale for this notion is that taxes on income reduce the incentives for businessmen and entrepreneurs to make money through the production of goods and services. In this way, they act as a drag on the impetus for business expansion and output growth. Income taxes are thus inconsistent with the compelling goal of creating jobs for the many millions of our unemployed and underemployed citizens. In contrast, taxes on consumption logically make those who consume more of society’s resources assume a greater share in the cost of managing the society. The more one consumes, the more taxes one pays.

It should not, moreover, be overlooked that taxes on income -- because they prescribe permissible deductions -- are more complicated, more subject to the revenue collector’s discretion, and therefore more susceptible to corruption. In that respect, the current proposal for a gross taxation scheme -- because it limits the deductions to "direct costs" (though I am not clear yet on what this term includes) -- is an improvement. The tax simplification bill -- now being finalized in the House of Representatives’s Committee on Ways and Means -- proposes to tax corporations at a rate of 18% of their gross income (net of said "direct costs") and is being pushed mainly by committee chairman Hermilando Mandanas. Given the avowed objectives, Representative Mandanas should consider simply eliminating income taxes altogether and replacing these entirely with consumption taxes. Taxes on consumption -- in the form of sales or excise or value-added taxes -- are more straightforward, less subject to discretion, and less susceptible to corruption.

Critics of consumption taxes typically argue that such taxes are regressive because lower income earners pay proportionately more of their income than higher income earners do. That objection is easily addressed by exempting food and a few other basic commodities (like generic medicines and public transport fares) from any consumption taxes whatsoever. Because low income earners have been observed to spend approximately 60-70% of their income on food, the non-imposition of taxes on this item alone virtually frees this income segment from sharing any part of the cost of government.

What must be emphasized is that even a pure consumption tax system can be designed -- by varying the tax rate between essential and non-essential goods -- to collect proportionately more taxes from the more affluent income sectors than from the less affluent groups in society. Critically, moreover, a tax system based only on consumption taxes is -- in a liberal democratic society -- more consistent with individual freedoms inasmuch as it affords all citizens complete discretion on how they spend all that they earn, even as their choices of what and how much to consume determines how much they will bear of the cost of governing the society.

Considering recent news reports that the Bureau of Internal Revenue has been falling short of its tax collection targets, it seems timely to propose -- again -- that hard-to-collect income taxes be just scrapped altogether and the required government revenue be raised instead through easier-to-collect consumption taxes. That will replace a messy, susceptible-to-corruption system with a simpler, less corruptible one.

The BIR’s current collection target is P940 billion for this year. Assuming that the aggregate value of goods and services produced domestically amounts to around P8 trillion this year, this means that the target amount can be collected with an effective consumption tax rate of 11-3/4%. Of course, various types of consumption-based taxes are already being collected, like value-added taxes, excise taxes, real property taxes, vehicle registration taxes, travel taxes, amusement taxes, and import duties. A little arithmetic can determine what increments should be tacked on to the current rates to arrive at the required revenue target.

Actually, scrapping income taxes will likely expand the total tax base and therefore allow a desired tax take to be raised with somewhat lower increments in the prevailing rates of existing consumption-based taxes. The argument is that zero income taxes will stimulate investment, promote greater economic activity, and even bring currently underground businesses (the so-called informal sector) out into the open. This could mean increased government revenues even with taxpayers paying lower taxes per capita. In the end, this will mean faster development for the economy as a whole.

Granted, it requires a sense of innovativeness and even adventure to adopt something that isn’t being done anywhere else. One can only hope that those with the power to make this happen have more of the engineering mind-set that evaluates an idea based on the design logic behind it and less of the legal mind-set that insists on a prior precedent to establish validity.

From both an economic and social point of view, a tax system that is less prone to corruption and yet is capable of raising the required funds for government while also being more encouraging of investment and job creation and output growth is certainly devoutly to be desired.