Are we overtaxed?

Today being the last day for filing income tax returns, and given the pinch (bite?) that comes with this annual ritual, perhaps a great many of us would readily answer the above question in the affirmative. Interestingly, even our tax authorities may actually agree, as Internal Revenue Commissioner Kim Henares has recently been quoted as if to suggest so. This came in reaction to Senate Bill No. 2149 recently filed by Ways and Means Committee chair, Sen. Sonny Angara, proposing to reduce the top income tax rate from 32 to 25 percent. Earlier, Senators Ralph Recto and Bam Aquino had filed SB 749 and SB 1942, respectively, both also proposing to adjust income tax rates to “reflect new realities.”

Are Philippine taxes indeed too high? “Too high” can be construed under different perspectives. Are they too high relative to our neighbors, making it harder for us to attract investments? Are they too high to the point of reducing people’s incentive to work or engage in productive activity, thereby stifling overall economic growth? Or are they too high to the point of actually reducing government’s overall tax revenue collections? Let’s consider each of these perspectives in turn.

Last week, Trade Secretary Greg Domingo revealed that his department is studying the tax regimes of neighboring countries to see if changes are warranted in our tax system to attract more investors in the face of the Asean Economic Community culminating in 2015. “We have feedback from large companies that taxes here are relatively higher than those of our neighbors…. If we find out there is a big gap, we have to narrow that gap,” he asserted. I did some quick research to get a sense of our tax competitiveness in the region, and here’s what I found: On corporate income taxes, we now have the highest rate in the region with 30 percent. Indonesia and Malaysia have 25 percent, Vietnam has 22 percent, Thailand and Cambodia have 20 percent (Thailand reduced it from 30 to 23 percent in 2012 and further down to 20 percent last year), and Singapore and Taiwan both have 17 percent. The average rate across Asia is 22.5 percent.

As for indirect taxes (value-added tax or general sales tax), ours is also the highest at 12 percent; Indonesia’s, Malaysia’s, Vietnam’s and Cambodia’s are at 10 percent. Singapore and Thailand have 7 percent, and Taiwan has 5 percent. If it’s any consolation, we are not the highest in the neighborhood when it comes to the top rate for the individual income tax. Taiwan has the highest at 40 percent, followed by Thailand and Vietnam (35 percent), Philippines (32 percent), Indonesia (30 percent), Malaysia (26 percent) and Singapore (20 percent). Even then, Thailand and Malaysia recently lowered their rates from 37 and 27 percent, respectively; and Asia-wide, the average is only 28.4 percent.

Are tax rates too high for our own economy’s inherent good, based on considerations of economic efficiency—that is, to maximize production, incomes and overall well-being? Economic theory postulates that taxation reduces people’s work effort, whether as employees or as entrepreneurs/capitalists, because taking away part of income in the form of tax dampens the incentive to work and produce more. It is very difficult to know the rate of taxation that would be optimal or ideal, beyond which economic efficiency would begin to decline. But it is easy to conceive that the extreme of a 100-percent tax rate would eliminate work and economic activity altogether—unless government coerces everyone to work (say at gunpoint), or brainwashes everyone to do so. This partly explains why government tax collections would also decline if tax rates were set too high. To the extent that economic activity is dampened by excessive taxation, then there will be less income or sales to tax. The Japanese government raised its sales tax in 1997, aiming to balance its budget; instead, government revenue fell by 4.5 trillion yen because consumption dropped.

Apart from this negative efficiency effect, excessive taxation can also have a compliance or evasion effect. It stands to reason that when tax rates are deemed onerously high, people are driven to find ways to evade or avoid paying tax (and we Filipinos certainly do not lack creativity in doing so). The combined efficiency and compliance effects of taxation explain the shape of the so-called “Laffer Curve,” which graphs government tax revenue collections against tax rates. Economist Arthur Laffer, after whom the graph was named, argued that the curve has a hill-like or inverted U shape. That is, at lower ranges of tax rates, a rising rate would yield higher revenue collections, hence the graph initially slopes upward. This would peak at a certain rate, beyond which further increases in the tax rate will lead the negative efficiency and compliance effects to drive down total tax collections, thereby turning the graph downwards. The Reagan tax cuts in 1981 were premised on the US economy being at this downward-sloping range of the Laffer curve, such that lowering tax rates would actually increase revenues. Federal budget data showed that government revenues had nearly doubled by 1989.

Are our own tax rates so high to the point of being counterproductive? Given the extent of tax evasion in this country, I don’t see it farfetched that reducing tax rates to levels seen to be less onerous could actually raise tax compliance enough to yield an even larger tax take. Senator Angara seems to believe so, and Commissioner Kim Henares just might be willing to take the gamble.

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