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Duterte’s tax reform: Nothing short of revolutionary

IT will probably be only years after President Duterte steps down from office that we will realize that his tax reform program which the Congress—surprisingly, really—approved at breakneck speed is nothing short of revolutionary.

Not even the supposedly radical, communist National Democratic Front ever dared to demand—or even think of—what Duterte’s administration has done through the tax reform law, Republic Act 10963, which was passed the other day.

This is to exempt from any income tax the country’s lower classes—up to those receiving around P20,000 per month. They have been taxed at least 5 percent since 1997, amounting to P14,500 to P50,000 annually. Some 7 million workers are estimated to be exempted from income taxes under the new law, called the Tax Reform for Acceleration and Inclusion Act (TRAIN).

The taxes squeezed from the lower classes for two decades have been actually higher as companies have been required to withhold 10 percent of salaries of all their staff, which they remit to the Bureau of Internal Revenue. In practice, the lower classes mostly no longer file the claims for a tax refund.

President Duterte signs tax reform bill into law.

Even those with incomes P25,000 to P80,000 per month—roughly the country’s middle-class—will see their income taxes significantly reduced by P55,000 to P98,000 from 2018 to 2023. (See chart)

The new income tax rates starting 2018.

I don’t think I am exaggerating when I claim that this part of the Duterte tax reform is nothing short of revolutionary. Such exemption of the poorest workers from income taxes has never been done. Duterte’s TRAIN has been the most sweeping reduction in income taxes ever.

Past presidents of course all had considered such exemptions or reductions as a way of building up their popularity with the people. They all had backed down after their finance secretaries told them that this risked a drastic fall in revenues, which could lead to a fiscal crisis. Their economic teams have also told them, that, counter-intuitively, such revenues from the lower classes are huge and easiest to collect, since it is the companies themselves that remit the 10 percent withholding taxes.

Perhaps the fact that the tax reform program’s main architect, Finance Secretary Carlos Dominguez, unlike nearly all of his predecessors, wasn’t a big-business finance officer or accountant who see only static balance sheets. Dominguez has been for most of his working life a hands-on businessman, who intuitively grasped the fact that tax-rate reductions could lead to increased consumption of goods and services, and therefore to economic growth.

But it is not just Dominguez of course who is responsible for the tax reform program. Primarily, it is Duterte’s achievement since, with his overwhelming popularity, and with the acumen for parliamentary work of his handpicked House Speaker Pantaleon Alvarez and Senate President Aquilino Pimentel 3rd, that the tax reform bill was passed so quickly and overwhelmingly—246 against 9in the House of Representatives and 17 to 1 in the Senate. The sole vote against the tax reform law was that of Sen. Risa Hontiveros.

The tax reform project was quite wisely launched as soon as Duterte assumed office, and therefore the law could be enacted at the height of his political support.

The absurdity of the past income tax rates is obvious in that the highest tax bracket are those earning P42,000 monthly or more. This means that the same tax rate applies whether you’re a lower-middle-class employee earning P42,000 per month or a PLDT or an Ayala executive earning, say, P2 million a month.

The new law drastically changes this, with rising rates for four tiers of income: those earning annually P250,000 but not over P800,000; those earning over P400,000 but not over P800,000; over P800,000 to not over P8 million; and those earning over P8 million.

In Duterte’s mind, his tax reform is about freeing the working class from the burden of taxes, and shifting it to the classes that can afford it, the rich.

Indeed, the main tool for the redistribution of assets in a democratic, capitalist system has been through taxes, so much so that the most equitable countries in the world, such as the Scandinavian nations and Canada, impose taxes on the rich to take from them half of their income. In some welfare-state nations, taxes on the transfer of inheritance are very steep so as to encourage billionaires to invest their wealth more into industries and philanthropy.

However, the economics behind TRAIN is the belief that a consumption-based tax system, one based on taxing purchases of services and goods, is better than a tax system based on incomes, and even serves to stimulate the economy. Thus, TRAIN, while reducing income taxes, will expand the value-added tax system and will raise tax rates on the purchase of sweetened beverages, fuels, tobacco, coal and luxury cars.

This of course will also hit the poor in terms of higher rates of inflation, but Duterte and Dominguez’s calculations—to which the Congress obviously agreed by passing the tax-reform law—show that this won’t be big enough to eat into their increased incomes resulting from their being exempted from income taxes.

The big risk in such a program is whether the revenue lost from the reduced income taxes will be bigger than those raised from the consumption tax. Dominguez calculates that the net impact will be P134 billion in revenues, a significant part of which will be through a more efficient tax collection due to TRAIN’s simplified rates not only for income taxes but for such taxes as donors’ and estate taxes.

But economics is never ever an exact science, and there is really no assurance that Dominguez’s calculations are correct, and revenues may even fall drastically. But revolutions are never, as Mao Zedong pointed out, a picnic.

After Duterte’s TRAIN though, I don’t think any president would even think of imposing taxes on the 7 million he has exempted starting next year.

Even just with this liberation of the working classes from its income-tax burden, Duterte in his 18 months in office has already made his enduring legacy.