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How about cash flow income tax?

When I was teaching Taxation at the Ateneo Law School, those glorious days when no one but no one became a senior without having to suffer the torture of having to pass Tax I and II under my growling glare, I took particular delight in posing to my captive audience—among them Undersecretary of Finance Antonio Bernardo and Commissioner of Internal Revenue Rene Banez, both excellent pupils—various propositions that forced them to "think-out-of-box". In those days, I was told, their feeling was more like jumping out the window.

I would like to do a bit of that now—the "thinking-out-of-the-box", not the jumping out of the window, though some former students even now think that is not such a bad idea for me to do—and, submit for discussion, the suggestion of converting our income tax system to what is known as the Cash Flow Income Tax. Our revenue authorities, newspapers say, seem to have become ambivalent, despite the President’s policy pronouncement, about gross income taxation. So maybe its time to talk about a different, although not a totally opposite, idea.

The Cash Flow Income Tax, as the name suggests, considers the flow of cash as the determinative element. Its tax base is cash receipts less cash savings. Cash savings are not taxed until it is consumed, or transferred to others by gifts or bequests and inheritance. Cash receipts include wages, salaries, rent, interest, profits, dividends and similar payments. Cash savings are placements in savings accounts, time deposits, and all other financial instruments and investments. They will be taxed only when withdrawals and perterminations and conversions are made, as well as when the properties are donated or given by way of inheritance.

One can immediately see some beneficial results of the system. There can be expected an increase in savings rate, because, unlike the present system that ignores whether a taxpayer consumes his money or saves it, the Cash Flow Income Tax postpones the tax on the cash that is saved or placed in investments and collects it only when the savings is withdrawn for consumption or transfer to another person.

All purchases of depreciable assets are immediately and fully deductible. Depreciation is merely a method of recovering capital. Since the cost of capital is immediately recovered, there is no need to amortize it over the lifetime of the asset. This makes the life of accountants easier and results in less items for bar examinees to memorize.

The unfairness borne of the inconsistency between the concept of income and the realization requirement (see my column last Aug. 24) disappears since accrued gains add equally to receipts and savings. If A and B both buy a painting for P100,000, both A and B could claim savings of the same amount. If after a year the painting doubles in price, and A decides to sell, he includes in his cash receipts the entire selling price of P200,000. B, if he decides to hold on until he dies, assuming no further appreciation, the tax is paid on both the cost and appreciation upon his death. Since there is no convoluted rule distinguishing a long term asset from a short term asset, the tax is the same on the same amount of accrued gain.

To cover the same level of consumption needed to sustain one’s life, which is the justification for the current levels of personal and additional exemptions, similar exclusions can be made from the tax base. A simple rule is to exclude from the taxation so much of the tax base that is necessary to live just above a yearly determined poverty threshold.

The Cash Flow Income Tax requires no special adjustment in one’s method of paying taxes. To arrive at Cash Receipts, all one has to do is report, just like he has to under the present system, all sources of cash into his pocket. To deduct savings, he will be permitted to claim only those savings and investments duly recorded by financial institutions or recorded in a public registry. The difference is the tax base. This simplifies tax compliance, and, will certainly attract more tax filers and payers.

Of course, every tax system has its own set of technical problems, and hard to solve issues. But these are hard times requiring hard choices. We cannot reject an idea simply because it is not what we are used to. If our ancestors permitted that attitude to prevail, then we would still think today that the sun revolved around the earth.