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Faulty rhetoric in tax system reforms

(Article published in the Oct 6,2004 issue of TODAY, Business Section)

It appears that, despite the initial furor and horror expressed when the U.P. professors sounded the alarm on the deepening financial crisis that the country is facing, no further measure will be taken by both the executive and the legislature on the current tax benefits granted to business.  Interest seemed to have waned when a finance official, even before the expected thorough review of the incentives was concluded, made the public statement that barely Php 5 billion can be attained in additional revenues if the suspected perks were to be removed from the tax system.

A major reason for the impasse, in my view, was the faulty rhetoric used by the well-meaning reforms of the tax system.  Rhetoric was the congenital and fatal defect of the revision of our system of tax incentives because the so-called revenues that were said to be “lost” to the government as a result of favorable provisions in the general and special tax laws.  Unfortunately, a “loss” is an emotionally charged word that implies some form of negligence on the part of the loser and a measure of predatory tendencies, if not thievery, on the part of the taker. 

Since a good number of those in decision-making circles are themselves either direct or indirect beneficiaries of businesses enjoying the tax perks under examination (after all, it is an open secret that those who enter politics tend to be from or are sponsored by business and those who are in business tend to enter politics), an unarticulated but general feeling that seriously looking at the tax incentives would unleash an animal which no one seemed at this time confident of controlling.  

What seemed to have happened was that everyone who felt that they were under attack, and that really means “everyone”, period, circled their respective economic wagons to defend home and hearth.  With everyone on the defensive against the erosion of their tax privileges, there was no one out there left to attack.  Hence, the errie silence on review of the current situation on tax incentives.

But the review of tax incentives needed not necessarily be framed in such a heavy emotional baggage.  In the seventies, Harvard Law School Professor Stanley S. Surrey, who was Assistant Secretary of the U.S. Treasury for Tax Policy from 1961 until 1969, advocated the view point that tax incentives be recognized for what they really are, namely, expenditures of tax money.  In other words, they do not represent losses; tax incentives simply are another way in which the government spends money, exactly the same as when Congress appropriates money, for lean or for pork, out of the treasury. 

Surrey bases his thesis on the given that in the US, as we have it here, the general tax law is a tax income.  Ideally, everything that is conceptually income should be subjected to tax.  However, it is recognized that some income is involuntarily spent by the taxpayer.  For example, whatever he needs for his own personal sustenance and the basic support of his dependents.  Clearly, it is not fair to impose a tax on what one earns that is inexorably spent anyway on one’s basic needs.  Hence, the personal income tax law includes an amount called “personal” exemptions, representing that the government thinks is needed to keep the taxpayers’ body and soul together.

Outside the set of “involuntary” expenditures of income lies a whole slew of amounts likewise removed by law from the taxable base.  These amounts should have been taxed; but for some valid reason or another, are not subjected to tax.  The amount of tax that should have been collected but was not collected is called a “tax expenditure”.  In Surrey’s view, which to my mind seems very correct, a tax expenditure, which is the result of tax incentives, is essentially the same as expenditure authorized in the budget.  They both are utilizations of the taxpayers’ money.  They are not “losses” anymore that what is spent by the government in payment of the salaries of teachers can be considered a “loss”.

This conceptualization, in my view, removes the gut resistance provoked by the use of the word “loss” to a reasonable reassessment of the over-all picture of the country’s tax incentives.  No one is subliminally labeled as a thief; every simply comes forward to justify why he is a worthy recipient of government funds.

Once we accept Surrey’s premise, and I do not see any reason why not, then it becomes a clinical exercise to ask a few questions, some of them very hard, to determine whether this or that tax incentive should remain in the statute books.

The most common justification of a tax incentive is that the grant modifies the behavior of the taxpayer into some form that is beneficial to society at large.  Tax incentives are favorite vehicles for the attainment of social goals.  The classic example is the charitable deduction.  It is conceded that charitable institutions perform an essential role in society, a role which the government by itself cannot shoulder.  Thus, a tax incentive is given in the form of permitting the taxpayer to deduct a certain amount from this taxable income that is equivalent to what he gives to qualified charities.  The cherished hope is that the private sector, given the additional disposable income in the form of taxes foregone by the government, would be moved to help in the work of the charities.

The first question to ask, therefore, is what social goal, is presently being served by the tax incentive.  My stress would be on “presently” since times changes and needs change with the times.  The Greek philosophers, and I am sure thinkers before them, had long recognized that the only thing constant in this world is change.  Thus, without any recrimination, each and every incentive now in the statute book should be asked to point out what social good is achieved by the concession.  It is exactly the same question that our lawmakers ask, or should ask, with respect to any item of expenditure in the budget.

Assuming that the social goal that once justified a tax incentive is still a valid one, then the question to ask is whether tax incentive in reality moves people to move towards that goal.  We could be certain about the goal; but are we sure of the effectivity of the tax incentive in achieving that goal.  For instance, the social goal of the grant of tax exemptions on qualified retirement plans, --i.e. tax deduction of employer’s contributions to the retirement plan; exemption from tax of the earnings of the trust set up to fund the plan; and exemption from the benefits received by the employees when they retire under the proper conditions—is apparently social security for the employees, reduced financial strain on the employers,  and industrial peace for both the employees and employers.  How much, we should ask, have these goals been achieved by the exemptions granted by Republic Act No. 4917, now incorporated in the income tax code?

There could be unanimity with respect to objectives as well a consensus that the tax incentive does its assigned work, agreement is a commodity that is now increasingly becoming rare in this country, but is the method of granting tax incentive the right way to achieve it.  In other words, could the same social goal be achieved by other means.  Surely, there are other ways of spending money in treasury: direct expenditures, interest subsidies, loans, guarantees, etc.  How does the tax incentive compare in terms of efficiency and effectivity with these methods of government assistance?

Surrey, in his study published in 1970 by the Harvard Law Review, argues that, in the United States, tax incentives do not have clear advantages over other forms of government expenditures.  He insists that generally tax incentives are inferior to other forms of spending government money.  He says: “Again, as a generalization, I think it unlikely that clear advantages in the tax incentive method will be found.  Moreover, I stress strongly that the advantages must be clear and compelling to overcome the losses that accompany the use of the tax incentive, even the well-structured incentive.  The problems of achieving a well-structured incentive are in themselves formidable.  Even assuming that such problems as unfairness and windfalls are overcome, there are still the losses and drawbacks we have described: confusion and divided authority in the legislative and administrative processes, difficulties in maintaining budgetary control, confusion in perceiving and setting national priorities, and dangers to the tax structure itself.”

Although governments all over the world are not much different from one another and it is tempting to accept Surrey’s conclusions as applicable to us, it is important that we continue to make our study of our own tax incentive system.  But what is significant about Surrey’s analysis is that it dispenses with the animosity engendered by insensitive rhetoric.  We should proceed with the study with as much objectivity as we can, without any name calling nor condemning.  After all, one of us, I trust, is willing to cast the first stone.