Current economic policy is focused on fighting the pandemic. The Central Bank has loosened monetary policy, and the national government has hiked its expenditures by allowing a higher deficit.
The steep rise in government expenditures is meant to expand and strengthen the health care system and provide social amelioration. Money is flowing to procure medicines, testing kits, and other medical supplies and equipment; augment the healthcare workforce; transfer cash and in-kind assistance to the poor; provide wage subsidies; and lend assistance to micro, small and medium entrepreneurs.
But the immediate objective of loose monetary and fiscal policies is not to pursue economic growth but to protect health and save lives. The massive spending for health and social amelioration goes hand in hand with a deliberate policy of having a community quarantine to slow down the spread of COVID-19. This essentially locks down the economy.
Although the focus is on saving lives, even if it means trading off economic activity temporarily, the government has set in motion the actions and the reforms that have to be undertaken for the economic recovery.
We do not know exactly when the recovery will happen and how quick it will be. We still do not know much about COVID-19. We do not know when the vaccine will be introduced. Fear of getting infected by a highly contagious disease cannot be fully vanquished when our information about the virus is limited and our weaponry to quell it is incomplete. The title of the book authored by British economists John Kay and Mervyn King, says it all: we face “radical uncertainty.”
Despite this radical uncertainty, policy-makers have a grasp of the required critical reforms for economic recovery. Tax reforms are absolutely necessary in light of a deficit that is running now at 8% of Gross Domestic Product (GDP). Such a level of deficit spending has to unwind once the crisis created by the pandemic subsides. On the other hand, the new normal will require a sustained higher level of spending for health and human development, science and technology, and new types of infrastructure.
It is thus providential, in a manner of speaking, that tax reforms, embodied in TRAIN (or Tax Reform for Acceleration and Inclusion) law, were enacted before the outbreak of the pandemic. The tax reforms have given the country much wider fiscal space to spend in the time of crisis or emergency. It has made the country creditworthy as indicated by the investment grade that credit-rating agencies have given to the Philippines. Thanks to the tax reforms, The Economist has ranked the country sixth among emerging economies in terms of financial strength.
Nonetheless, the comprehensive tax reform program remains incomplete. One critical package that should have been passed much earlier is now being deliberated. This is about the rationalization and restructuring of fiscal incentives together with the reduction of corporate income tax. Formerly called CITIRA (Corporate Income Tax and Incentives Reform Act), it is now dubbed CREATE (Corporate Recovery and Tax Incentives for Enterprises Act).
This reform has long been overdue, but it has gained traction recently. Ideally, Congress should have passed it on the heels of TRAIN. But the intransigence of the Philippine Economic Zone Authority (PEZA) and the hazards of compromise obstructed the bill’s early passage.
Because of the economic crisis brought about by the pandemic, the reform on corporate income tax and fiscal incentives has to adapt to the new complexity. It has to respond to both the short term, which is about the stimulus, and the long term, which is about tax and economic restructuring.
In this context, CREATE differs from CITIRA. The main change is in terms of the speed of reducing corporate income tax. CITIRA was prudent by allowing a gradual decrease in the income tax. Concretely, CITIRA would have allowed a drop of one percentage point of the tax rate every year, currently at 30%, till it reached 25%. Thereafter, further tax decreases to settle at the rate of 20%t would be made contingent on the desired sustainable level of government deficit. This was the design and the approach to avoid huge revenue losses and make the reform revenue neutral.
But the pandemic has changed the calculus. Fiscal stimulus has become urgent. Hence the bill has been redesigned as CREATE, which will immediately and in one single stroke reduce the corporate tax from 30% to 25%t. On top of this, the proposal is to extend the application of net operating loss carryover (NOLCO) for business losses in 2020 from the current three years to five years.
In sum, the original intent of revenue neutrality has to give way to the expediency of the stimulus, resulting in a net revenue loss.
The essential features found in CITIRA are retained in CREATE. Specifically, the reform makes the incentives transparent, time-bound and performance based. The reform also introduces a governance and review board to ensure that applications for incentives meet the rigorous economic criteria.
Moreover, CREATE will move away from the “one-size-fits-all” regime that relies heavily on tax incentives towards a wider and more balanced menu of tax and non-tax incentives. This menu brings innovativeness, adaptability and sophistication that all the more requires having competent governance, which is organizationally expressed in the Fiscal Incentives Review Board.
As noted earlier, CREATE is responsive to the immediate challenges brought about by the pandemic. CREATE is both a stabilization mechanism and a longer-term reform for investment promotion and tax efficiency and equity. The short term and the long term may be independent of each other, but they are not contradictory.
The immediate and sharp reduction of corporate income tax from 30% to 25% exemplifies the short-term goal of a stimulus. But we make an important caveat on the tax cut. The lessons of previous economic recessions, as well as what the literature tells us, show that the effectiveness of a tax cut as a fiscal stimulus is limited. This is because gains from the tax cut (the beneficiaries are mainly the upper classes and corporations) are not necessarily used for consumption that increases aggregate demand. Corporations, for example, might just save the windfall as a strategy to ride out the pandemic, or for those remaining profitable, they might use the gains derived from the tax cut to reacquire stocks or give dividends to the wealthy shareholders.
On the other hand, corporate tax reduction for firms with high labor intensity can have higher social benefits.
Thus, there is room to improve the design of the tax cut to make it truly responsive to a stimulus that will ultimately benefit workers and their households. The tax cut must find a way to be translated into wages that will boost aggregate demand.
Hence, our proposal is to make the immediate corporate tax reduction from 30% to 25% contingent on job preservation or job creation. This is a social bargain. The firms will be entitled to the swift income tax reduction only if they would retain their workforce or, better, increase employment. The heart of the stimulus is found in the bill’s title: CREATE. Tying the corporate tax reduction to creating jobs is thus essential.
Filomeno S. Sta. Ana III coordinates the Action for Economic Reforms.