Simpler, equitable, efficient tax system

MUSIC FOR TAXPAYERS A band entertains taxpayers queuing to file their income tax returns on the last day at the Bureau of Internal Revenue office in Intramuros, Manila. RICHARD A. REYES

The Philippine economy is doing very well. The World Bank says that the Philippines is a rising tiger in Asia. Yet, it also says that the country needs to do more to achieve inclusive growth.

What do you mean by this?

Karl Kendrick Chua (World Bank Philippines senior country economist): Indeed, the last 10 years have been remarkable for the Philippine economy. The economy grew faster than it did in any period in the past seven decades. Inflation is low and stable, benefiting many businesses and households. The economy is awash with over $40 billion a year in remittances and revenue from the BPO (business process outsourcing) industry. Public debts and deficits have gone down significantly, allowing the government to double social services spending in the last four years.

While millions of Filipinos are now benefiting from higher economic growth, 25 million Filipinos are still living in poverty. A Filipino is considered poor if she lives on less than P52 per day. Moreover, three-fourths of Filipino workers are informally employed with little protection when they get sick and face bleak career prospects. Around 3 in 10 Filipino workers are either without jobs or want to work more hours since they do not earn enough.

The government has done a good job in raising growth and securing macroeconomic stability in the last decade, leading to significant job creation and poverty reduction. But much more can be done to ensure that all Filipinos, especially the poor, benefit from higher growth. This is what we mean by inclusive growth.

Can you elaborate on what needs to be done?

Chua: For a poor Filipino to benefit from higher growth, she needs to be healthy first, so that she can spend more time in school and raise her chances of getting a good job. When she gets sick, she needs to have access to quality health clinics. Her children need to study in schools that have books, clean toilets and good teachers.

A poor Filipino farmer needs reliable roads, bridges and irrigation to produce better crops and connect to markets. These are essential for raising her income and bringing her out of poverty.

All of these, infrastructure, health and education will cost money. However, in the last seven decades, the government hasn’t raised enough revenues and sustained them to fund these important investments.

Even if corruption and tax evasion were eliminated, tax revenue would still be inadequate because the current system limits the amount that can be generated.

This is why we lag far behind the rest of the region. For instance, as a share of gross domestic product, Thailand spends around twice more on infrastructure, twice more on health and thrice more on education compared with the Philippines.

Countries that invested significantly in these areas were able to sustain growth for many decades, create more and better jobs, and bring the majority of their people out of poverty. For these reasons, the country needs to raise tax revenue.

So, basically you are saying that we need to raise taxes. But isn’t raising taxes going to hurt many people? Won’t it just push people into poverty?

Chua: The good news is raising tax revenue can and should be done in a manner in which the rich pay more than the poor relative to their income. This is called vertical equity. It also means that two individuals with the same income should pay the same amount of taxes. This is called horizontal equity. However, since this is not really the case today, there is room to reform our tax system.

Currently, our tax system is complex, inefficient and inequitable. Many large corporations benefit from income tax holidays or reduced tax rates when they don’t really need them. For instance, one of my friends works in a large corporation that receives tax incentives and he gets 18 months of pay a year.

On the other hand, many micro and small enterprises (MSEs), where the poor are, pay much higher taxes relative to their income. In fact, on average, firms receiving incentives pay only P1 for every P100 in revenue compared to P3 in firms not receiving incentives. This is unfair.

Taxes that are not adjusted for inflation also worsen the equity of the tax system because it means that the rich pay less and less for certain goods as their incomes rise. For example, the gasoline excise tax rate has remained at P4.35 per liter since 1996.

Yet, the income of the top 10 percent has almost tripled in the same period. Since they consume nearly 60 percent of gasoline, the relative amount of tax that they pay today has fallen drastically.

Moreover, the complexity of the tax system, in which MSEs have to file and pay a multitude of taxes almost every month, means that they spend a considerable amount of time and money falling in line and trying to comply with tax rules, instead of doing more productive things and earning more. This indirectly increases their tax burden relative to the rich.

All these need to change. First, the tax system needs to be made simpler so that Filipinos have an easier time paying taxes. Second, it should be made more equitable so that poor people pay much less taxes and rich people pay much more taxes. Finally, it should be reformed so that it promotes rather than hinders job creation.

Asking richer Filipinos to pay more taxes is not only fair and responsible. It is also in their best interest. If society cared more for the poor, by ensuring that they stay healthy, get a good education and are able to raise their incomes, everybody would benefit from higher economic growth, better quality of life and reduced crime. In short, shared prosperity sustains high growth and benefits everyone.

But why doesn’t the government just improve enforcement of existing taxes instead of raising tax rates?

Chua: Higher revenues do not necessarily mean higher tax rates. Tax enforcement can be improved substantially. For instance, in 2013, the Bureau of Internal Revenue announced a campaign to boost tax collection from the self-employed and professionals (SEPs).

The government estimated that only about 403,000 out of 1.8 million SEPs paid taxes and the average income that they declared was close to the income of a minimum wage worker. This is hard to believe. According to the government, successful implementation of this campaign could generate up to P200 billion in tax revenue without raising tax rates.

However, relying only on anticorruption efforts and tax administration reforms is not enough, given the size of our investment deficit, which has built up over many decades. They alone will not raise enough revenue to help farmers connect to markets. They will not raise enough revenue to ensure that children are healthy enough to go to school and increase their chances of getting a good job when they graduate.

To really help the poor, the country needs around P700 billion more in tax revenue. Eradicating corruption and tax evasion can reduce this gap to around P300 billion, not zero. It is for this reason that the government needs to effectively prioritize and sequence tax policy reforms.

What exactly are you recommending?

Chua: First, we need to raise tax revenue in the most equitable way. This means that the poor should not be paying relatively more than the rich and that two individuals or firms with the same income must pay the same amount of taxes.

Second, once we have raised revenue to attract investments that would make the majority better off, we can consider lowering some tax rates while further broadening the base.

Let’s be very clear on this. It will be very irresponsible and unfair to the poor if only the second part of the reform were enacted, as it would rob the poor of the opportunity to rise above poverty and this can be passed on to their children, making poverty even harder to eradicate.

For instance, this is what a two-part tax policy reform package could look like. Part I could include the following:

Rationalize the granting of tax incentives by making them more transparent, performance-based and temporary. Recipients of tax breaks must be put on a publicly accessible website. Since the country cannot afford to grant tax incentives left and right, a ceiling for these tax breaks should be considered.

These reforms can reduce systemic leakages (about P150 billion annually), level the playing field and raise revenue.

Broaden the value-added tax (VAT) base by reducing the number of VAT exemptions that have little economic rationale. Vulnerable groups can be better protected using the conditional cash transfer (CCT) program.

Centralize and increase the valuation of real properties to better reflect market prices. If needed, levy a minimal national surtax on real properties to improve the equity of the tax system as wealth and property ownership are highly correlated. To reduce the impact on taxpayers, the estate tax can be abolished and inheritance can be treated as simple transfers.

Adjust oil excise taxes (which have been frozen since 1996) for inflation. Doing so would improve the progressivity of the tax system as the richest 10 percent of households consume almost 60 percent of the total gasoline volume. Again, vulnerable groups can be protected using the CCT.

Only after revenue-enhancing measures are in place can rates be lowered.

Part II could include the following:

Reduce the corporate income tax rate from 30 to 25 percent while raising the gross income earned (GIE) tax from 5 to 7.5 percent. This would improve horizontal equity between firms receiving tax incentives and firms not receiving tax incentives.

Reduce the top tax rate for personal income from 32 to 25 percent and reduce the number of brackets to simplify the system further.

Harmonize all tax rates of passive income to reduce distortions from favoring certain types of capital.

Simplify the tax regime for MSE. This could involve harmonizing the income tax, percentage tax and the local business tax into a single tax on turnover paid only once per year.

Do you support the bill that increases the exemption threshold for the 13th month pay?

Chua: Using the 2012 Family Income and Expenditure Survey, we find that only the top 15 percent of workers will benefit and thus will erode the progressivity of the tax system. A better option would be to adjust tax brackets so that workers, who have been pushed up into higher tax rates by inflation, will see a decline in their tax payments.

What assurance do we have that the people’s hard-earned money will not be lost to corruption?

Chua: We understand that any taxpayer wants to make sure that her hard-earned money is not wasted. Thus, reforms to improve the transparency and accountability of government spending are necessary before we can expect richer Filipinos to freely contribute more.

Moreover, efforts to improve public trust in the revenue agencies as well as the quality of their service would help improve compliance.

Key reforms include:

Moving toward fully open data, including the passing of the freedom of information bill

Enhancing budget reporting, in particular allowing the public to track spending from appropriations to results on the ground

Further enhancing the integrity of revenue officials by publicly posting the net worth of the top revenue executives to send a strong signal to the public that the revenue agencies are committed to good governance.

Successful implementation of these reforms will allow the public to see more tangible improvements in governance and convince them that their taxes are being spent wisely. These crucial reforms would help make a better case for tax policy reforms.

Any last words?

Chua: The Philippines has achieved so much in the last decade. Many of us are benefiting from higher growth and macroeconomic stability.

However, close to 25 million Filipinos still live below P52 per day. Our poor countrymen need our help. They deserve much better.

It is high time to invest more in the poor. A fairer, simpler and more broad-based taxation system can help make that possible.