Sunday, July 27, 2008

Towards A New Social Contract on Taxes, Wages & Safety Nets

The recent blog entries* related to VAT and dole-outs have gotten me to thinking of a holistic package of recommendations related to both the Tax burden and Social Safety Nets.

I. Basic Principles

I believe that any such set of recommendations must be based on a set of principles by which we envision Philippine Society to operate under. The principles that i have identified (so far) are the following**:

A. Principles related to Safety Nets

A.1 No Excuse for Hunger. Given our abundance of resources, there is absolutely no reason why any Filipino (employed or unemployed) should go hungry in his own country. For starters, there is absolutely no excuse to have people resort to recycling garbage for food.***

A.2 Fair burden across sectors. In the interest of fairness and social cohesion (essential to building up social capital****), no segment of Philippine Society should be unduly burdened in sustaining the government and its social programs. In particular, the Middle Class has been feeling particularly besieged and consequently alienated. This is in no small part because they see that they are the only ones paying income taxes while the majority poor, do not.

A.3 Social Security before Taxes. A person's income should first be allocated to social security (i.e. retirement benefits, housing and medical insurance) before it is allocated to taxes. Here in Singapore, for example, the amount deducted for Social Security is higher than the amount deducted for income taxes.

B. Principles Related to Capability Building and Demand Generation

The foundation for industrial development is a healthy domestic base.

B.1 Obligation to Give-back. Every recipient of social welfare should have the responsibility to give back to Society by using his capabilities to contribute to social welfare and economic development.

B.2 Subsidies as Stimulus. In the interest of pump-priming the economy, Safety Nets should first be allocated to consumption. A study by the United State's Congressional Budget Office identified direct injections (such as unemployment or food stamps provisions) to the poor as having the biggest effect to propping up consumption which is important to avoiding a recession. In this sense, the much criticized katas ng VAT dole-outs are actually a step in the right direction in terms of its multiplier effect.

C. Principles Related to Development: Investment, Innovation and Technology

The key to economic development is to build up local capabilities to innovate and continuously improve on existing technologies.

C.1 Savings before Consumption. Tax incentives and disincentives should be structured to prioritize savings over consumption.

C.2 Culture of Entrepreneurship and not Dependence. Entrepreneurial activities should be encouraged and dependence of OFW remittances should be discouraged.

The following are the specific recommendations that are based on the above principles.

II. Specific Recommendations on Taxes, Social Security and Income Subsidies

1. Flat tax on income: For all salary and wage earners, impose a uniform income tax rate. The initial rate can be pegged at 12 percent.

Table 1: Existing***** versus New Income Taxes
Update Oct-18-2008: Just to emphasize, Exemptions not applicable on New Tax Due

As shown on the above table, given this recommendation, any salary or wage earner who receives an annual taxable income of 70,000 pesos or above will receive a tax relief, while those receiving less will have additional tax burden. (Note that in the above, the subsidies for the lower income earners haven't been factored in. The effect of subsidies is shown in Table 2 below.)

2. Equal or bigger Social Security Contributions relative to Income Taxes. Similarly, impose a uniform social security contribution (includes SSS, Pag-Ibig, Medicare and/or GSIS) rate that is equal or higher than the income tax rate, in this case, the cumulative rate could also be pegged twelve percent. This deducted amount will then go into retirement, housing and medical insurance of the employee and/or wage earner's At the same time, the pool of savings can still be made available to extend credit to the contributors or to support the government's socialized housing and health maintenance programs.

The Employer's contributions could be pegged at half of the employee's i.e. six percent. (Additionally, if we want to roughly follow the Singapore model, the total contribution of both employer and employer can be capped at Ten Thousand pesos per month each.)

The benefit of the first two recommendations has to do with principles A.2 and A.3. A flat tax covering all income levels will mean that no segment of the salary and/or wage earning population would feel that they are unduly taking a disproportionate part of the burden and help eradicate the Paano Naman Kaming Mga Middle Class sense of victimhood.

3. Replace tax exemptions with subsidies for both employed and unemployed. The Fair Burden Principle (A.2) above means that the tax base should be widened****** to cover the entire working population. If left as it is, for the lower income groups, this would clash with the No Excuse for Hunger Principle (A.1). Therefore, a survival subsidy, in the form of food stamps, initially pegged at 20 pesos per day per adult (18 to 64 years old) should be provided. Table 2 below calculates the net relief across all the income brackets illustrated in Table 1.

Table 2: Net Tax Relief (Burden)
Update Oct-18-2008: Just to emphasize, Exemptions not applicable on New Tax Due

The above table illustrates that the 20 pesos per day food stamp subsidy covers adults (18 to 64) of all income brackets, even those with zero income, i.e. the unemployed. This institutionalizes and systematizes the katas ng VAT and provides a basic layer of social safety net, one that addresses hunger to fulfill Principle A.1 while at the same time, helping sustain consumer demand that drives the economy (Principle B.2). This is also an improvement over tax exemptions on minimum wage earners because it also considers the welfare of the unemployed who outnumber the employed.

4. Eliminate the minimum wage.******* The minimum wage should be eliminated in order to give business enterprises the flexibility to compete in the world market (in support of Principle C.2). Since the problem is unemployment and chronic underemployment, the priority should be given to creating as many jobs as possible. By comparison, the task of increasing the wages of workers who are already employed is secondary. Besides, reducing unemployment is in the interest of labor because fewer people looking for jobs will ultimately mean a stronger bargaining position.

5. Retain VAT. This is in keeping with the principle of prioritizing savings over consumption (Principle C.1). Retaining VAT will also enable continued funding of food stamps (Principle A.1).

6. Tax OFW remittances. OFW Remittances should be included as part of income and taxed accordingly. This is in keeping with the principle of discouraging a culture of dependence (Principle C.2).

7. Implement a National ID. This National ID could be either the SSS/GSIS ID, the BIR's Tax Identification Number or a separate number altogether. Such an ID is needed to facilitate the distribution of subsidies as well as the collection of taxes and social security. To prevent abuse, the introduction of the National ID should be accompanied by increased safeguards on privacy.

III. Conclusion: A Foundation for Investment, Innovation and Technology Improvement

Each of the preceding recommendations will benefit certain segment of Society and impose a burden on another. It is therefore important to take a holistic approach in the spirit of give and take among the different sectors. Below is a visual summary of the complementary roles of Social Security Contributions and Taxes in achieving our objectives in the areas of Survival, Civilized Living, Capability Building and balancing Consumer Demand with Investment.

Figure 1: Taxes and Social Security Contributions as applied to Areas of Nation Building********

While we should not lose sight of the fact that our economic development ultimately depends on our home-grown ability to innovate by continuously improving existing as well as developing new technologies, not having to be preoccupied with matters of survival is an essential first step.

Notes:
*An initial formulation of my recommendations can be found in the comments section of this blog entry over at Manolo's. Blog entries on the VAT issue that i have read include:
**I'll update the list as and when i think of additional principles.
***Known as 'pagpag', a term i first heard from fellow blogger The EQualizer.
****I realize that, strictly speaking, social capital brings about social cohesion (and not the other way around) but i nevertheless believe that anything that increases social cohesion increases social capital as well.
***** Refer to the BIR Website for existing guidelines.
******See also Solita Monsod's criticism on the recent law granting tax exemptions on minimum wage earners. (Hat tip to Manolo.)
*******This does not mean that Labor Unions should be discouraged. On the contrary, strong Unions should be encouraged in order to have the workers' interests represented in a tripartite partnership between labor, management and government.
********Not all items shown on the diagram are discussed in this present blog entry. Manolo Quezon reintroduced the idea of Victory Gardens to mitigate the effects of the food crisis. I briefly described my version of a large scale implementation this concept in this comment.

31 comments:

Jego said...

Nicely done. This should be more widely discussed. May I suggest you forward a copy to our more forward-thinking representatives and interest groups. (I believe Rep. Ruffy Biazon has a blog, as well as UNO spokesman Adel Tamano.)

The abolition of the minimum wage will generate the usual knee-jerk opposition, but you have presented the case for it quite well. I just dont know how that would play politically.

I just have a minor quibble: would you be in favor of giving the citizens a choice on where to place his or her social security funds? As you are aware, the SSS, the GSIS, the AFPSLAII have always been used by those in power. We have no idea to what extent our funds in these institutions have been plundered. Personally, I think the citizen should have an option to put their investments in the hands of more capable local financial institutions.

cvj said...

Hi Jeg, thanks. I'll take up your suggestion.

I think the reason why the abolition of the minimum wage is opposed is because people see it as a capitalist vs. labor issue, where it actually is a form of competition between the employed vs. the unemployed.

Your idea of giving the employee-beneficiary a choice on which financial institution to deposit his/her contributions is a good one. I could imagine a form of Joint Account arrangement between the SSS and/or the Employee so that one party cannot withdraw without the consent of the other.

stuart-santiago said...

sounds good, cvj. fairer all around, esp. to the middle class. sana pagisipan mo na rin our debt problem, since most of our taxes go to debt servicing?

Anonymous said...

Most remittances are not enough for food and tuition CVJ, so to tax them is harsh.

We're not all computer programmers like you. A lot of us are seamen who get paid as little as 20,000 pesos a month.

And consider stay at home mothers too. They're not "lazy" and "dependent". Fathers from Saudi and such elect to have them stay at home so that they can raise their kids properly. To tax the last peso which they carefully budget is the height of ignorance and insensitivity on your part

Anonymous said...

Consider as well that the incomes of most OFW's are already being taxed at socialist rates (around 30%). OFW's don't see any benefits to these taxes as most of them don't retire in these countries and go home after a few years. And you're gonna tax them further just as a "deterrence"?

cvj said...

Thanks Angela. Regarding the debt burden, i'll think about it as well.

Hi Anonymous, if you don't mind me asking, how much of the 20,000 you earn as a seaman do you remit back to the Philippines?

Anonymous said...

I think any tax reform fantasy should take into account the big picture.

The big picture is that our government finances are built to maintain our credit rating on Moodys and Standard and Poor. If we default on our debt who's gonna lend us money to buy dollars that are needed to import rice and oil, two commodities that we can't produce enough of and we don't have respectively.

And if you discourage OFW's to remit their dollars, that would mean the government has to take out tranches from IMF to maintain our 2-months supply of dollars.

With the price of oil and rice at record levels, this means we need more dollars to import these commodities. Currently, OFW's are keeping our dollars balance of payment on the positive. Any plan to "discourage" dollar remittances is financial suicide and would further aggravate our debt position.

Anonymous said...

You're 12 percent across the board flat tax wouldn't be enough to cover our debt burden. A huge chunk of our budget is used by Congress to buy dollars from the CBP. The reason we buy dollars from our own central bank is that we can't pay our debt in pesos. Thus, when that 70% of that 600 billions pesos yearly budget is allocated to debt, the congress has already factored in the interest payment and capital reduction on that debt.

The most important thing is that we don't default (the reasons for which I've laid out on the previous post).

The progressive tax rates have also been calculated with the view that it won't be high enough that the rich (oligarchs) will move to other countries but not low enough that we won't meet our debt obligation.

The 12% figure you pulled out of your ass too low that we won't be able to make our debt obligation.

Equalizer said...

"We have our disagreements, but we are one nation with one faith. As your President, I care too much for this nation to let anyone stand in the way of the people’s well-being. I will let no one threaten our nation’s survival. "GMA SONA 2008

The DRAMA has begun!!!

Expect shortly this political game scenario on how Gloria Arroyo will extend her term beyond 2010 in spite of constitutional restrictions.

This will just be a repeat of the 2003 events when Gloria reneged on her 2002 Rizal day promise to the nation not to run in the 2004 elections.

Anonymous said...

"Hi Anonymous, if you don't mind me asking, how much of the 20,000 you earn as a seaman do you remit back to the Philippines?"

All of it.

cvj said...

Thanks for providing the info Anonymous. At 20K remittance per month, that would mean that your family receives 240K per year. Given the latest Family Income and Expenditure Survey (FIES), that would make your family better-off (in terms of income) than seventy-percent of the Philippine population. This is not to trivialize your difficulties, but i believe that convincing the rest of the Filipinos (i.e. the other seventy percent) to do their part requires that those who are relatively better-off to set an example.

anonymo us said...

anonymous: where do you get the money to spend for breakfast/lunch/dinner (and movies and cigarettes)?

Anonymous said...

This budget is an epic fail because it doesn't address our debt repayments. In fact, it totally ignores the reality of debt and makes assumptions as if the Philippines has no debt.

CVJ, are you one of the debt free coalition radicals?

You've totally ignored the salient points in Tuesday, July 29, 2008 10:30:00 AM and Tuesday, July 29, 2008 10:31:00 AM.

Anonymous said...

"anonymous: where do you get the money to spend for breakfast/lunch/dinner (and movies and cigarettes)?"

We get free board and lodge at the ship. I quit smoking and drinking and don't spend on myself. All of my money is budgeted for my two kids by my wife.

"i believe that convincing the rest of the Filipinos (i.e. the other seventy percent) to do their part requires that those who are relatively better-off to set an example"

I don't see how the government taxing my money will make the desperately poor and unemployed get jobs.

You're acting as if the job market is demand driven. It's not. It's supply driven. So whether or not my wife gives a few hundred pesos to my pitiful, parasitic relatives they will still not be able to have jobs simply because there aren't any. And what you want to do is to further institutionalize parasitism by making the government the ones to determine which poor people to feed?

Excuse me, but I'd rather that my wife decide who to feed by spending our money on deserving relatives.

cvj said...

Anonymous (at 10:41:00 AM), rest assured i haven't forgotten your concern. I'll address the issue in a future blog post.

Anonymous (at 10:50:00 AM), as i propose it, the food stamp allocations are available to everyone (even your wife). Your wife can tell your parasitic relatives to just avail of the food stamps so they won't have to starve to death. Under the New Social Contract, the rest is up to them. That's the point behind principle B.1 above.

As a Filipino, i would like to remind you that over and above your duty to your family, you also have a duty to your country (and countrymen). At your income level, you happen to be among the more better off. Tayo tayo lang ang puwedeng magtulungan.

Anonymous said...

You have a fundamental flaw in your principle, and that is that we have abundant resources to feed the poor.

No we don't. If you haven't noticed, our food production/land available for farming is reaching Malthusian levels viz-a-viz our population level. Which is why the lands of Vietnam, Pakistan and Thailand are providing for our additional rice needs.

Dayam said...

Twenty pesos? HAHAHAHA. Anung mabibili ku don? 5 pandesal?

Anonymous said...

"family receives 240K per year...that would make your family better-off (in terms of income) than seventy-percent of the Philippine population."

Yeah if I'm better off, then GMA is popular.

Those food stamps of twenty pesos X 365 days = P7,300 X 10 years = P73,000.

P73,000 in ten years. I could just spend that money on my kids college tuition.

CVJ, this is how my wife and I budget our income, down to the last pesos. As you can see, P73,000 is not enough to cover the college tuition of my kids when you factor in inflation.
Of course, you have to factor in rent and food and the cost of books.

On a monthly basis, we currently pay P7000 pesos on rent, P3000 on utilities and water, P5000 on food, P1000 on tuition, there's about P4000 left for clothes, medical, and other contingency spending.

We need every peso we can save. And I'd rather that I save that on my kids future.

cvj said...

Anonymous (at 2:51:00 PM), i know that you find it hard to believe, but the figures don't lie. At 240K per year, your wife and kids are among the more fortunate ones. BTW, thanks for providing information on the breakdown of your expenses, that's very useful.

Regarding the amount of tax to be paid, it's not 7300 per year. That's the food subsidy that your wife can receive, if she chooses to.

Your tax payment is computed as follows:

Gross Income: 240,000
Less Exemptions (as per existing law):
Married - 32,000
Children -16,000
(i'm assuming you have 2 kids @8K per child)

Taxable Income: 192,000
Income Tax Payable (@12%) 23,040
Add back Food Stamp 7,300

Net Annual Disbursement: 15,740

Your effective tax rate is therefore 6.6%.
(15,700/240,000)

On your children's college education, we should follow what Australia does where a student loan can be obtained to be paid for by the child once he/she is already working. Perhaps this can be done by allowing educational loans against SSS contributions.

I also believe that the portion of OFW remittance that is contributed to the SSS should be income tax exempt.

cvj said...

Anonymous, i need to correct the above tax computation in view of the new exemptions based on RA 9504:

Gross Income: 240,000
Less Exemptions (as per existing law):
Married - 50,000
Children -50,000
(i'm assuming you have 2 kids @25K per child)

Taxable Income: 140,000
Income Tax Payable (@12%) 16,800
Add back Food Stamp 7,300

Net Annual Disbursement: 9,500

Your effective tax rate is therefore 4%.
(9,500/240,000)

Anonymous said...

"On your children's college education, we should follow what Australia does where a student loan can be obtained to be paid for by the child once he/she is already working."

Great (sarcasm intended). So what you're telling me is, in principle, I should teach my children to rely on debt to fund their education.

I would rather that I save and pay for my kids college tuition now so that when they graduate they can get a kickstart at saving for a home/family. They won't have to worry about repaying college loans.

What will happen if every Filipino college aged person would want a college education? Can the government afford to pay for 10 million college kids for free?

What's worse is that this government funded college loan would probably subjected to means testing. Given your irrational emphasis that I'm on a high-income level, my kids won't probably be qualified for loans, as they're too rich.

To trim down the numbers of potential college kids, the government will also probably do an academic means test. That means those who don't have an NSAT score of 90 and above will probably be excluded from this program. What if my children were not that bright? Should that preclude from a college education?

Government funded college loans is just another way of government stealing from the income of one hardworking man from one generation and allocating it to the children of another generation. Granting loaned college education en masse at the present will also be funded by government debt, which means more constraint on our deficit and debt position. Where will the government get the money to pay for this program given that you've already cut the government revenue by cutting taxes? More foreign debt?

Anonymous said...

And I need to pay for my kids braces. That's 25,000 a pop. I don't want to disadvantaged my kids by them having Ai Ai De las Alas' smile when they grow up.

cvj said...

Anonymous (at 4:45:00 AM), in figure 3 of my blog entry, there is a reason why i put Universal Primary and Secondary Education on the Taxes side and College Loans on the Social Security side. This is because i believe that the primary and secondary education of the nation's young is the obligation of society as a whole, which includes government and family while tertiary education is the obligation of the individual who is being educated.

My idea is that, instead of putting the burden of university education on the parents, we should let the student pay for his or her education via the Social Security deductions on their salaries during the initial years of their working life. They are young and able bodied so they should be able to take on such a responsibility. (This is better than spending their initial salaries as single young professionals on Starbucks or gimmicks.) Besides, the realization that they are paying would likely have a focusing effect which would make them be more serious with their studies.

Of course, as parents, you can help if you want to or are able to but you are better off saving for your retirement so you won't be a financial burden to your kids later.

On the topic of 'means testing', i believe that when it comes to our State Universities, the only kind of test should be rigorous testing of acquired knowledge and intellectual ability. If your kids are not that bright (hypothetically speaking), then i don't think they should get in by virtue of their capability to pay as it would deny a poorer, but brighter kid a shot at a university education. Our Society should strive to become a Meritocracy based on the right set of criteria, and in this case, it means prioritizing intellectual capability over their parents' wealth.

cvj said...

Sorry, my reference to 'figure 3' in my first sentence above (at 4:45:00 AM) should instead be to 'figure 1'.

cvj said...

Anonymous (the seaman), please disregard my computations at August 01, 2008 12:44:00 AM. You have to pay 28,800 (240K x 12%). It turns out my suggestion will not work if the exemptions are retained. (Thanks to the other anonymous who commented at July 29, 2008 10:31:00 AM.)

leytenian said...

"I would rather that I save and pay for my kids college tuition now so that when they graduate they can get a kickstart at saving for a home/family. They won't have to worry about repaying college loans."

you sound like my brother and my cousins in the USA.. but that's very difficult to achieve in reality. Very few can save and make real return higher than inflation. If you save it on a regular bank that will provide 5% return, you will actually lose because inflation is now at double digits. Savings must provide a higher return than current inflation. The question would be, where would you invest your money to hedge against inflation?

I would suggest that your wife will study business and entrepreneurship .Lots of available opportunities, especially if you target the OFW dependents. they are the one's who can afford your business. I will not rely on savings and leaving that money in the bank.

You only need to save 6 months total of all monthly expenses or 1 year total of monthly expenses.. just in case, it will take you six months to 1 year to sail again. One year of total monthly savings is good financial stability , knowing that your job will be stable forever.

The rest of your money should go to investment ... open a new business or invest it on stocks..

I always believe that children should start learning basic finance by getting a student loan when they go to college.

Why would I finance my children's education in cash if I can use my cash and invest it to stocks or business that will provide me a return of 10% or more...

educational loan have lower interest rates.

By the time my children will graduate, the money i made on other investments will actually pay off the entire loan balance and at the same time, I will make 4%...

Just something to think about. If one don't like to risk in opening a business, then buy real estate. do not rent.. the interest payment on your mortgage is tax deductible...

thank you.

leytenain said...

correction:

i was assuming that educational loan interest is 6%..

Anonymous said...

We can save more than you suggested-we're very thrifty. My pay is basically kept in a foreign bank account linked to an online savings account (like ING) which earns 8% per year at the moment.

Don't know much about stocks and other asset investments and don't want to risk it.

My strategy is that the foreign currency I put my money in will always have a high exchange rate versus the Peso. When I pull the money out of the foreign bank, I get charged a withholding fee of 12%. I think this is better than putting my foreign currencies in Philippine banks-they may offer about the same interest rates (5 to 7%) but I'm nervous of potential bank runs, the low insurance of PDIC (only 100,000 pesos), the inflation, and the devaluation of the Philippine peso.

Anonymous said...

"I would suggest that your wife will study business and entrepreneurship"

80% of businesses fail within the first year. My kids are still young so it's better if she stays at home 'til the kids are old enough to go to school. Then she could go back to working full time.

leytenian said...

hi anonymous,

well sounds like you are a good father. also good in investing. yes I agree that when the kids are small, the mom should stay home..

thanks for sharing.

ceiling mount tv brackets said...

Nothing Comes for Free

Revamping the social contract to increase economic security will not come without a cost. Upper-middle-class earners and the well-off would be required to pay for more of their own benefits by shouldering the costs of the new savings and insurance mandates. Government programs would be scaled back for those who don’t need the help so that resources could be diverted to those who do. The elimination of many current regressive tax breaks could easily generate $200 billion a year. And another $200 billion could be saved by scaling back benefits that go to well-off citizens in programs ranging from agriculture subsidies to Social Security to Medicare.

The need to rethink the United States’ social contract provides us with the opportunity to give it a much-needed facelift. A new system consisting of a diversified economic portfolio of wage supports, mandated saving, new insurances targeted at real risk, and a strong safety net will both help to counter negative trends in income inequality and provide a new level of individual economic security. Last century’s social programs were aimed at helping retirees; this century’s should be aimed at increasing the opportunity and security of workers and their families.