CAN anything good come out of a tax? We know that taxes are a fact of life and, like death, are a certainty in an otherwise uncertain world.
Some say a government can use tax systems to reduce inequality, aware of the fact that the same government may have promoted economic systems that created conditions for widespread income inequalities among its constituents in the first place.
In a webinar at the Asian Development (ADB) last week, Janet Stotsky, former senior staff at the International Monetary Fund, said that while many Asia-Pacific countries have achieved economic progress, many challenges remain, especially those exacerbated by the Covid pandemic. She added that "there is a growing inequality of income and wealth, a typical byproduct of robust growth in market-oriented economies. Social safety nets and social insurance systems are developing in the region but are insufficient to prevent the rising levels of poverty that we have seen recently."
The webinar was a presentation of ADB's newly published governance brief, titled "Taxation and Social Protection," written by Dr. Stotsky (PhD in economics from Stanford University). The publication is one of many knowledge products which the ADB makes available for its developing member countries on a wide range of development issues, from governance and public sector management to poverty and climate change adaptation, among many other topics.
She was joined in the webinar by Ms. Wendy Walker, the chief of ADB's sustainable development thematic group, and Dr. Michael Samson, the research director of the Economic Policy Research Institute.
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Walker, in her opening remarks, said that tax theory has traditionally focused on the trade-off between the efficiency and equity objectives. This focus "has led to greater emphasis on efficiency. However, inequality and recent increases in poverty caused by the pandemic and world events challenge the region's economies to reassess the trade-off between economic growth and equity."
She pointed out that as "policymakers continue to emphasize the traditional growth and efficiency arguments, [they] must also place greater emphasis on social protection and redistribution. Social protection is necessary for strong and sustained and equitable growth," suggesting that one can help the poor in two equivalent ways. First, by reducing their tax burden and, second, through public spending on goods and services targeted at the poor.
Dr. Stotsky explained that the basic features of an equitable tax system recognize what are called both horizontal equity — how tax systems treat different taxpayers with equivalent income (or wealth) — and vertical equity — how people at different levels of income or wealth are treated. Relatively new equity concepts that demand fresh and more spaces for discussion include generational equity, gender equity and climate equity.
One of her findings shows that most countries in the Asia-Pacific region rely heavily on taxes on goods and services. Value-added tax (VAT), which is generally regressive, is the single largest component of that taxes on goods and services (widely considered as the revenue workhorse of the tax system). Other key findings include:
– Revenue productivity from the various taxes varies considerably across the region. Corporate tax productivity tends to be low, reflecting several factors including extensive tax preferences and poor taxpayer compliance.
– Corporate income tax productivity in the region is not high. There's considerable variation in the VAT "C" efficiency; even if you have a tax with the same rate, there are differences in revenue as a share of GDP from that tax across countries. (A graph shows that based on 2018 data, the Philippines had the lowest VAT C efficiency among 18 Asian countries.)
– Developing countries usually have less progressive tax systems than advanced countries. The difference reflects several factors: variation in preferences, overall weakness of revenues, administrative difficulties in capturing income.
On fiscal redistribution, she presented a set of recommendations for tax administrators. For example, on improving personal income and payroll taxes:
– Set an appropriate threshold below which the taxpayer pays no tax on income, either through a general exemption or zero-bracket amount or a general tax deduction or tax credit.
– Tax different forms of capital income in a manner like labor income to avoid distorting markets and creating economic inefficiency and inequalities.
– As financial markets develop in a country, it is important to have good monitoring so that you have taxpayers paying tax on this component.
– On corporate income tax, it is important to try to avoid eroding your base, although political economy issues that undermine the corporate income tax are often contentious. Other challenges include administrative complications associated with transfer pricing and thin capitalization. Countries need capacity to deal with complex issues that multinationals exploit to essentially transfer their tax liability to lower tax jurisdictions.
On improving indirect taxes (something for which the Philippines has a robust legal framework):
– Set an appropriate VAT turnover threshold below which firms do not have to pay tax. Establish simplified regimes for small enterprises.
– Minimize exempted sectors and products. Judiciously use exemptions or reduced rates of tax on some basic foodstuff, education, schooling and other items.
– Tax alcohol, tobacco and unhealthy foods with excises because they serve to discourage consumption, even if they tend to be regressive. Tax fuel and carbon to discourage use and offset any regressive effects with transfers or increased progressivity of other fiscal instruments. Use excises on some services and goods that are predominantly used or bought by higher income taxpayers.
– In the move toward low and even international trade tariffs, continue to selectively use higher tariffs on luxury goods and services. You can offset the revenue loss by adjusting your other components of indirect taxes.
On improving gender equity: taxation can be inequitable in a gender sense. There can be explicit discrimination against women in the personal income tax where it is an individualized tax and where there might be different rate structures or different deductions available only to male taxpayers. It is better to have an individualized personal income tax rather than one that makes use of joint filing. This is generally more efficient and equitable than joint taxation.
Beyond tax administration, governments can promote social equity by spending money collected from taxes on public goods and services that directly benefit the poor segments of the population. Related expenditures include investments on social protection, social insurance and social assistance programs, such as conditional cash transfers, employment guarantees or public works employment, subsidies, etc.
For his part, Dr. Samson believes that a range of tax initiatives and reforms can directly improve equity. By integrating social protection benefits more effectively with taxes, tax instruments can be both efficient and equitable. He argues that with integrated benefits, we can improve both vertical and horizontal equity of the combined system better than if we just focus on the tax policy itself, or we just focus on the social protection policy by itself.
He added that social protection is necessary for strong and sustained growth. It expands the tax base and further improves domestic resource mobilization and in the long term, social protection builds human capital. It can serve as an effective fiscal stimulus and support local economy multipliers. As it generates economic growth, enabling the tax revenue to expand through two effects: one, by expanding the tax base and improving revenue collection, and two, as countries' income grows, they tend to increase their tax-to-GDP ratios.
Beyond tax-benefit integration, Dr. Samson proposes that "as integration supports a virtuous circle for equity and growth, we can go one step further by suggesting how it can broadly support climate and development strategies... The power of the fiscal system can be harnessed to reform unsustainable tax and subsidy policies. Some of the most inefficient and inequitable instruments are general price subsidies. In Indonesia, where the government was providing energy subsidies that became increasingly unaffordable, as well as other generalized price subsidies for food, the government implemented an unconditional cash transfer program that helped overcome the opposition to reducing these fuel subsidies. This was not driven by a concern for climate change; that was driven more by concerns about fiscal unsustainability. But as we look to the future, and we see the kinds of reforms that address climate change, there is an even bigger policy challenge."