DOF passes its comprehensive tax reform study
on to the incoming administration
The Department of Finance has long believed reforming the tax system will re-engineer a more dynamic and equitable economy, augmenting the surge of investments the past 6 years has delivered for our people. In the past few years, the DOF engaged in a series of studies and consultations with academic experts as well as multilateral and bilateral institutions on our commitment to genuine tax reform–one done in a holistic manner and ideally at a time when electoral pressures do not threaten our long-term needs for short-term gains.
As we transition towards a new administration, we pass on the elements of this study for the new leadership to consider taking forward. We hope the various areas covered by our initial work sparks public discourse on financing our future. We invite our partners in media, civil society, business leaders, and citizens to join us in taking the long view as we explore the opportunities presented by tax reform.
The DOF believes the following general goals and principles animate the challenge at hand:
1. A genuine tax reform package must be comprehensive, not piecemeal.
2. A genuine tax reform package must be revenue-positive to correct historical underinvestment in our people. Eroding revenue without making up for lost ground in fiscal space is unsustainable, threatening our ability to deliver public goods and services in pursuit of inclusive growth.
3. A genuine tax reform package must empower our revenue generating agencies and streamline tax compliance for our people, making it easier for our people to pay taxes and for our tax agencies to administer the tax system, and
4. A genuine tax reform package must be competitive and progressive in light of ASEAN integration.
We should not mistake our gains for the finish line
While wider fiscal space in the six years has allowed us to grow our education budget by 125%, health by 336%, infrastructure by 360%, and social services by 166%, we still spend less on these critical sectors relative to our ASEAN neighbors. While we have improved our tax-to-GDP ratio from 12.1% in 2010 to 13.7% in 2015 we still have a lot of lost time to make up owing to the decades-long underinvestment our people have suffered. To fully harness the potential of our people, achieving a tax-to-GDP ratio of at least 16% is a major priority.
Fiscal sustainability has been an essential pillar in building our country’s resiliency to external shocks and our stronger macroeconomic fundamentals. With President Aquino’s strong sense of fiscal responsibility and political will, we have managed to improve our credit ratings, lower interest rates, grow our economy, build confidence, and move our country out of a vicious cycle into a virtuous cycle. And this has a concrete impact on the money the hold: we estimate that from lower interest rates we have saved companies P52 to P157 billion in interest payments from corporate loans from 2009 to 2014, we have saved consumers P23 to P68 billion in interest payments from consumer loans from 2006 to 2014, and we have freed up government’s fiscal space by at least P118 billion from 2011 to 2014.
We cannot reverse these hard fought gains in the fiscal sector. While we were able to pass the Sin Tax Reform Act in 2012, which has allowed us to collect around P50 billion per year from 2013-2015 for the country’s universal health care program, these policy and administrative gains are threatened by pending congressional bills that have potential revenue impact and budgetary requirements that can cost government P370 billion to P488 billion, or 2.4% to 3.2% of GDP. While it is easier to pass popular spending bills without paying for them, fiscal responsibility means making tough calls to protect our future.
The following are some viable elements that have emerged from our studies and consultations:
1. An income tax reform that will exempt 11 million wage earners from paying taxes, lower personal and corporate income tax rates (-P158 to -P222 billion) and rationalize fiscal incentives (+ at least P5 billion)
To start the reform process, we recognize the need to reform our income tax system to benefit the Filipino worker: we think granting an all-in income tax exemption of P1 million to all wage earners will not only give relief to a majority of Filipinos–it is above all, feasible from a tax administration standpoint. This move will exempt 11 million out of 12 million wage earners from paying taxes, leaving only 4% of wage earners to the BIR for better administrative focus.
Lowering the top personal income tax rate for wage earners from 32% to 25% within six years may make our economy more competitive in light of ASEAN integration. This can be coupled with the lowering of the top tax rate for self-employed and professionals from 32% to 25% within five years, while removing other personal and additional deductions and harmonizing treatment with corporate taxpayers. A decrease of the corporate income tax rate from 30% to 25% within five years is feasible if twinned with the rationalization of 224 laws that make up our overly generous regime for fiscal incentives. To safeguard our fiscal position, the staggered lowering can be based on a tax-to-GDP safety mechanism. The mechanism triggers the lowering of tax rates if the tax-to-GDP ratio reaches 14% in year 1, 14.5% in year 2, 15% in year 3, 15.5% in year 4, 16% in year 5, and 16.5% in year 6. If the tax-to-GDP does not hit the level specified, the lowering of tax rates may be postponed to the year when the level is reached.
This income tax reform will cost us P158 to P222 billion in the first year of implementation, while the rationalization of fiscal incentives will generate at least P5 billion.
2. Expanding the VAT base by removing exemptions, replacing exemptions with direct subsidies, and increasing the VAT rate from 12% to 14% to pay for income tax reform (+P80 billion and +P82 billion)
To pay for the foregone revenues, the next administration may consider increasing the VAT rate from 12% to 14% and expanding the VAT base by removing all VAT exemptions except for those in agriculture, health, banks, and education. For sectors that are affected, removed VAT exemptions may be replaced by a direct subsidy mechanism that will pass through the budget process, so that relief is given to those who need them, and expenditures made more directed and transparent. For example, VAT exemptions for senior citizens or persons with disabilities can be transformed into budgetary support or subsidies such as conditional cash transfer programs, where the impact of programs is more targeted and direct. Removing all zero-rating for VAT except direct exports is also ideal. This VAT reform will generate P162 billion: expanding the VAT base by removing exemptions will generate P80 billion, while increasing the VAT rate will generate P82 billion.
3. Indexing oil excise taxes, which have not been adjusted since 1997, to inflation (+P132 billion)
To take advantage of the low oil price environment, it is appealing to explore indexing oil excise taxes to inflation, whose rates have not been adjusted since 1997: regular gasoline can be taxed at P10 per liter while diesel be taxed at P6 per liter, while increasing rates by 4% every year moving forward. This oil tax reform may also cover coal and other petroleum products to internalize the economic costs of climate change. This oil excise reform will generate P132 billion.
4. Bank Secrecy and Anti-Money Laundering Reform (+P87.5 to +P210 billion) as the Cornerstone to Reforming Tax Administration
While we have improved our tax administration capacity and laid down the institutional groundwork for easier tax payments by improving electronic filing compliance from 8% in 2013 to at least 55% of 22 million total tax returns filed in 2015, one of the large challenges our tax administration faces is that our tax base remains very narrow. Only 2,287 companies make up around one-half of all government revenues.
While the World Bank estimates that the administrative tax gap has narrowed substantially–the personal income tax gap has narrowed from 2.9% of GDP in 2003 to 1.9% in 2012, and the VAT gap narrowed from 4.7% in 2006 to 2.8% in 2013–and while we have improved our enforcement capacity by filing more than 420 tax evasion cases and 200 smuggling cases worth P100 billion in duties and taxes over the past six years, our revenue generating agencies’ institutional capacity is severely limited by laws that weaken their effectiveness to collect and ability to prosecute criminals.
We believe the cornerstone of any genuine tax reform package is to remove bank secrecy for tax evaders and make tax evasion a predict crime to money laundering. We are likewise convinced that a one-time tax amnesty program is warranted to generate widespread support, except for those tax cases pending in court. Today, we are one of only three countries in the entire world where our tax administration cannot access the bank transactions of tax evaders. We are one of only two countries in the entire world where tax evasion is not a predicate crime to money laundering. The current anti-money laundering act even has an explicit provision that prohibits the Anti-Money Laundering Council (AMLC) from intervene in BIR operations. This is a scenario that ties both hands behind our backs as we race to plug revenue leakages draining resources away from our people.
5. Improving the organizational capacity of BIR and BOC
The organizational capacity of the Bureau of Internal Revenue and the Bureau of Customs to collect must also be improved dramatically. To promote fiscal autonomy and reverse the historical underinvestment in our tax administration systems, we think it ideal if both the BIR and BOC be allowed to retain 1% of the revenues they collect to serve as their operational budget. The combined budget of the BIR and BOC as a percentage of what they collect is just at 0.6%, even if their collection performance justified a larger investment in their systems. While our revenue performance has almost doubled the past six years, we are still spending less than one cent for every peso that our revenue generating agencies collect. This investment in tax and customs administration is also low compared to international standards.
To attract staff with competence and integrity and to discourage corrupt practices, we are convinced that the BIR and BOC must be removed from salary standardization law, as a key learning from the successful organizational reform of the Bangko Sentral ng Pilipinas, which has emerged as a world-class organization. Both revenue agencies must also be reorganized and removed from civil service protection to provide greater flexibility to manage or reward staff performance.
The next administration may also choose to pursue administrative measures that do not require legislation: tripling the number of companies in the Large Taxpayers Service (LTS) to further stabilize the revenue base, including BOC top importers in the said segment, creating a High Net Worth Individuals Unit (HNWI), and continuing to simplify tax forms, and automate the tax payment system for ease of compliance, given that 97% of total BIR collections come from voluntary compliance.
With these revenue-positive reforms and organizational reforms to the revenue generating agencies, we expect this tax reform package to generate P164.5 billion to P351 billion in additional revenues in the first year of implementation. We believe these measures as a package will improve our chances of investing and harnessing the potential of the Filipino people.
A game-changing package of this scale will capture the imagination of our people, who are ready to take the next step in our nation’s development. Nation building is a dream best lived out together; we invite policymakers and citizens alike to collaborate and engage in this monumental task of transformation.