Emerging tax reform

High up in the Duterte administration’s 10-point economic agenda is tax reform, second to “continuing and maintaining current macroeconomic (fiscal, monetary, and trade) policies.” Here, the intent is to “institute progressive tax reform and more effective tax collection, indexing taxes to inflation.” What exactly do these mean? What do these imply for the ordinary Filipino?

“Progressive,” in the context of taxation, means that the higher one’s income, the larger the percentage of that income that is paid in taxes. This is based on the notion of vertical equity: Those with higher capacity to pay must pay more, in both absolute and proportionate terms. In reality, the opposite has long been the case in our country. For the longest time, the Philippine tax system has on balance been regressive—i.e., favoring the rich more than the poor. Due to both our tax laws and the way they are enforced, rich Filipinos have ended up paying a lower percentage of their total income in various taxes than those with lower incomes do. This is an injustice the government hopes to change.

More effective tax collection means that our revenue agencies, most prominently the Bureau of Internal Revenue and the Bureau of Customs, ought to collect as much of what is due the government as our tax laws provide. Tax compliance must increase, or equivalently, tax evasion and tax avoidance must be curbed. More than 10 years ago, it was estimated that the government was losing P250 billion in uncollected taxes annually. The number is likely to be much higher now.

Indexing taxes to inflation has two elements to it. On one hand, the income tax burden has become unjustly onerous to middle- and lower-income taxpayers due to so-called “bracket creep” resulting from inflation. The top income bracket taxed at the highest rate of 32 percent starts at an annual income of P500,000, considered high in 1997 when the rates and brackets were last set. But because of inflation over the years, that income at today’s prices would be that of a middle-income earner, certainly far from being among the richest in society deserving of the highest tax rate. Unless income tax brackets are periodically pegged or indexed to inflation, an ordinary income earner is penalized with higher tax rates as monetary income goes up with inflation, even if actual purchasing power remains the same, or even declines. In fact, the lowest income brackets paying 10-15 percent in income taxes correspond to monthly incomes of P800-P5,800, well below the poverty threshold of P9,000 monthly family income—contrary to the intent of exempting the poor from income tax.

The other aspect to inflation indexing is in the way certain taxes, fees and charges, particularly those set at an absolute value rather than as a percentage, have become unrealistically low due to inflation over the years. The foremost example is the excise tax on petroleum products, ranging from P3.67 (aviation fuel) to P5.35 (leaded premium gasoline) per liter since 1997. With petroleum price increases over the years, these should have more than doubled by now to catch up with inflation. As a result, the real value of government revenues from petroleum taxes has been substantially eroded over time. Similar adjustments for inflation would be in order for fixed fees paid for passports, driver’s licenses, airport landing fees, and many more.

At the Senate last week, Finance Secretary Carlos Dominguez unveiled several tax packages that will be introduced as separate legislative measures over the next few years. The first package to be submitted in September will address the bracket creep in personal income taxes by adjusting the tax brackets to realistic levels, and lowering the tax rate to 25 percent for annual incomes beyond P800,000 up to P2 million. However, for the rich earning P5 million and above, the top rate will be raised to 35 percent, while those earning P2-5 million will see their rate reduced to 30 percent. Meanwhile, those earning the minimum wage up to about P20,000 a month will pay only a “token” P500. There will also be a shift to a modified gross income tax to simplify tax administration and avoid the complexities of reckoning with various types of deductions. To offset the projected revenue loss of P159 billion from this income tax reduction, the package also includes limiting exemptions from the value-added tax, a proposed tax on sugary products, and an increase in the outdated petroleum excise taxes. Included under the package is relaxation of bank secrecy for fraud and tax evasion cases. All together, a net revenue increase of P200 billion is expected from the package.

To be pushed next year is reduction of the corporate income tax rate to 25 percent and simplifying other corporate income tax provisions, aimed at improving tax compliance. While this is projected to lead to a loss of P34.8 billion in revenues, the government expects to offset this with P33.8 billion gained from rationalizing fiscal incentives currently given to various corporations. Further packages will centralize and update valuation of properties for the purpose of the real property tax; reduce estate and donor taxes, which will help unlock the land market and encourage more efficient land use; and harmonize taxes on capital income that includes interest earnings on deposits and other financial instruments.

There will be much discussion in the months and years ahead on new tax directions the government is taking. It is welcome that such a comprehensive review of our tax system is now being undertaken. It’s been almost 20 years since we last did it.

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