So President Noynoy Aquino (PNoy), in response to proposals by some legislators, said that he is not convinced that lowering income tax rates would be beneficial to the country. He claims that: “If we lower income tax rates, revenues will be smaller while the deficit will be wider. The widening deficit will be a negative factor when credit ratings agencies rate us.” To assess this claim, let’s put aside (for now) our skepticism that the administration needs more funds in an election year to support it’s effort in perpetuating it’s hold on power. How true is PNoy’s claim that a lower income tax rate would result in smaller revenue and bigger deficit? I’m not an economist but for some reason I find PNoy’s explanation of economic cause and effect to be rather flimsy; it negates other factors that contribute to change in revenue. Besides, why is he so obsessed with credit rating when it doesn’t really necessarily give a thorough image of the rosiness of a country’s economic favorability?
So, does lowering the income tax rate necessarily result in smaller revenue? It is interesting to note that in America’s case, history seems to show that when taxes are cut, Federal receipts (revenue) has a very strong tendency to rise. When taxes are raised, government revenue has a strong tendency to fall. Besides, a quick look at the concept of Gross National Product (GNP) would suggest that how taxes affect a country’s output isn’t as simplistic as PNoy seems to pontificate. According to Investopedia.com, the aggregate demand equation shows the effect of taxes on a country’s economic output.
GNP = C + I + G + NX
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C = consumption spending by individuals
I = investment spending (business spending on machinery, etc.),
G = government purchases
NX = net exports
This, then, suggests that:
“Consumer spending typically equals two-thirds of GNP. As you would expect, lowering taxes raises disposable income, allowing the consumer to spend additional sums, thereby, increasing GNP.”
So if PNoy’s claim that lowering taxes would necessarily have a detrimental effect on the economy does not really hold water, then does credit rating status justify his refusal to lower income tax rates?
The definition of sovereign credit rating is:
“…a country’s ability to meet its financial obligations. Credit rating agencies provide these ratings and investors use this to assess the level of risk related with investing in a country. The rating may also include an evaluation of a country’s political risk.”
Let’s ask ourselves, did our country’s “improved credit rating” result in improved foreign direct investment? I don’t seem to notice foreign businesses flocking to the country to invest in the country nor invest in PNoy’s much touted Public-Private Partnership (PPP) scheme. An article by Alito Malinao reveals that the Aquino administration has very little to show in its PPP program. His article notes that:
“According to a document distributed by the Investor Relations Office (IRO), only five PPP projects would be completed when Aquino leaves office after his six-year term that expires on June 30 next year.
The five projects to be completed by middle of 2016 are not even big-ticket infrastructure projects.”
According to Business World Online, the Philippines, although having moved from 10th place to 9th place in East Asia in terms of Foreign Direct Investments (FDIs), is still dwarfed by those of its comparable Southeast Asian peers. For instance, in terms of credit rating, Vietnam has a lower credit rating (32, BB-) compared to the Philippines (54, BBB-) but Vietnam still beats us when it comes to FDIs. So isn’t it reasonable to ask: Does investment grade really matter that much as PNoy projects it? This is the danger in giving too much emphasis on credit rating. It gives us an illusion of investment (and economic) confidence when in fact there are a lot of other factors that should be considered. For instance, in Australia’s case, an article from The Guardian notes:
“The worry is that a credit rating downgrade will cause the yield on the government’s bonds to rise – meaning that it will cost more for the government to pay back its debt. As a general rule the higher your bonds are rated the lower the yield.
But there are, however, a lot of other factors that determine the interest rate the government will have to pay on its debt. For example Australia’s cash rate set by the RBA (currently at 50-year lows of 4.5%) is a major factor, so too is Australia’s expected inflation, and also very importantly is the yield of US government bonds.
In the bond market everything is connected to everything else, and everything is firstly connected to the US.
Australian government bonds generally follow the lead of US Treasury bonds. And over the past decade the yields for Australian government 10-year bonds average about 1.3 percentage points higher than those in the US.
In the past 18 months, the yields of US bonds have risen due to improved expectations about the US economy and also a belief that the US Federal Reserve will increase its interest rates. And so, as a result, the yield on Australian government bonds has also risen in that time – from around 3% to 4% for 10-year bonds.”
So at least for Australia’s case, a credit rating downgrade has very little (if any) to do with credit rating. So why is PNoy being so paranoid about this?
Now that we have seen how flimsy PNoy’s skepticism is with regards to lowering income tax rates, may I offer some reasons why lowering tax rates is a good idea?
First of all, I am not convinced that the Philippine economy is booming. Contrary to the Aquino administration’s claim that the bad road congestion condition in the country is proof that the economy is doing well, our country still needs a lot of the ingredients for a healthy economy. Forbes magazine has an interesting article that tells of what is the most important contributor to a nation’s economic growth.
“The single most important contributor to a nation’s economic growth is the number of startups that grow to a billion dollars in revenue within 20 years.”
The article further states:
“Schramm says the U.S. economy, given its large size, needs to spawn something like 75 to 125 billion-dollar babies per year to feed the country’s post World War II rate of growth. Faster growth requires even more successful startups.
This is an amazing statistic. Schramm is describing the X factor of America’s historical success.”
Have we seen a lot of start-up companies in the Philippines grow into a billion dollar revenue company within 20 years? What seems to be missing in making that happen? Infrastructure for one, perhaps? (Amongst many other needs) So how is the state of our country’s infrastructure?
Now I can grant that taxes are needed to pay for such public goods like infrastructure, national defense, and a justice system. But does this mean that the people have to give the government absolute power on how their money is used? Does anyone really think that the government uses other people’s money (i.e. taxpayer money) more efficiently than private individuals and businesses? Think about it! Has anyone really heard of a private individual or a business spend, say, Php22 on a packet of noodles when it really normally costs just Php7? So why are we not surprised to see government procurement of overpriced items such as imported rice?
Next, high taxes run counter to work and investment. Why would anyone want to work more if it means that the more effort exerted results in a bigger chunk taken out of one’s pay? In the same token, why would companies invest more of their earnings to further develop or expand their business if further development and expansion means more levies or taxes? I can see some relationship to the law of diminishing returns here. As people give more money to the government, at some point the return to the people would get smaller and smaller to the point that it even gets counter-productive. Isn’t that what we are seeing? As people’s tax burdens increase, do we see any improvements in our daily lives? How’s the traffic and the MRT condition nowadays, for instance?
Finally, if freedom loving individuals truly want to be free (which includes free of government over-reach), then lowering taxes offer a check on the expanding size and scope of government. With lower taxes, we are giving the government less of our money to play with. The fact is nobody really cares about money more than the person who actually earns it. In a free country, doesn’t the person who actually earns the money have the right to keep what they earn?
So there we have it. I do not see how PNoy’s skepticism in lowering taxes is justified. Now if we go back to the idea that we have an upcoming election and that funds are badly needed to help the administration ensure its electoral victory to extend its grip on power then perhaps that is a more believable reason.
Calling a spade, a spade…