“Reduce personal income tax, broaden VAT and raise gas taxes”

The main elements of Package I of the comprehensive tax reform program deals with personal income taxation, the value-added tax (VAT) and gasoline taxes.

Taxation of personal income and of expenditures. The taxation of personal income can be done through direct taxes on income earned, known more generally as the personal or individual income tax, and on indirect taxes.

The latter are taxes imposed mainly on the expenditures of households. In general, they are sales taxes on goods and services.

The VAT is an improved form of sales taxation which removes raw material inputs from the tax base. Excise taxes are on special classes of commodities that are singled out for their special revenue-producing features.

One new form of excise tax being considered in this tax package is the adoption of a tax on sugary products.

Reducing personal income taxes. The tax program proposes to cut personal income taxes drastically. In part, it aims to relieve the heavy burden of the personal income tax that has hit the middle income earners as a result of creeping inflation.

The personal income tax is progressive in structure: as personal income rises, the rate of tax also increases. In this way, the richer the income earner, the higher the tax burden. In a more equitable society, this is as it should be.

When prices rise, the real income falls for the same money income. The gradual creep of inflation through the years — at an annual average of three to four percent per year in the course of two decades — has moved the progressivity features of the tax to hit middle income earners more heavily.

Families whose monetary incomes have not risen as much as the inflation rate in the economy now feel the personal income tax burden is higher on middle income earners and has made them bear a higher tax burden.

To correct this “creep” of the tax burden on the middle income class, the income classes subject to tax have to be adjusted upward to address the effects of inflation. The adjustment of the personal income tax is to correct for the effects of inflation.

In practical terms, this means a fall in tax collections for the national government.

The reform of personal income taxes is a very popular measure, for it means a reduction of taxes. In the version suggested by the government, personal income tax collections will fall by P159 billion. Several bills in Congress and in the Senate have been filed and have been under some consideration actively in the past Congress.

Now that the government is aggressively pursuing this tax change, the features of the personal income tax reduction is likely to be adopted.

To broaden the VAT and raise gasoline tax. The room for increasing taxes from consumption and other sales taxes in the economy are many.

The indirect taxes in general leave much room for improvement, both in broadening the tax base and in raising rates of tax.

The direction of these changes tend to move toward more reliance on indirect taxes rather than on direct taxes. Within developing Asia, the bulk of revenues are still quite dependent on indirect taxes. The Philippines is not any different in this context.

The VAT. The last major reform affecting the VAT happened under the presidency of Gloria Macapagal Arroyo when the rate of tax was raised to 12 percent. This significantly increased government revenues.

However, the Philippine VAT has big defects. Large leakages from revenue collections reduce its ability to produce more revenues. The reason is that there are too many exemptions and also many zero-rate provisions.

Ideally, total VAT collections should bring in revenues close to, although below, 12 percent of GDP.  But the Philippine VAT collects only about 4.2 percent of GDP in revenue yield.

In Thailand, the seven percent VAT produces revenues equal to that of the Philippine 12 percent VAT. In Vietnam, the 10 percent VAT yields revenues equal to 6.1 percent of GDP.

The efficiency of tax (defined as the tax yield in percent GDP divided by the tax rate) is low in general for Philippine taxes. For the Philippine 12 percent VAT, tax efficiency is only 35 percent compared to 60 percent for both Thailand and Vietnam.

To attain a revenue yield of 6.1 percent of GDP which is the level of actual revenue yields for Thailand or Vietnam, the VAT efficiency of the Philippine VAT needs to rise from 35 percent to 50 percent.

This means drastic efforts to reduce the number of exemptions and zero-rates as well as improve the administration of the VAT. Exemptions produce large leakages in collections. For zero-rated tax sales, the usual system is first to apply the tax, but a system of refunds has to be in place. That, however, produces a massive administrative cost.

Among the major exemptions from the VAT are those given to senior citizens regardless of income status. Alternative remedies, if blanket removal is not feasible, is to grant the poorest seniors a straight cash subsidy, like the Pantawid 4Ps. It is cheaper and is more targeted to the poorest elderly citizens.

Gasoline and diesel tax.  The excise taxes for gasoline and diesel have much room for an increase in rate, if we judge from the experience in other ASEAN countries.

With the drop in crude prices from more than $100 per barrel to today’s level, at the $40 per barrel, there has been a huge wiggle room for a tax increase to finance government needs if exploited.

Philippine excise taxes on gasoline and diesel have been low. Also, they have remained the same in money terms, not adjusted for inflation. Our excise taxes per liter of gasoline are notoriously low by ASEAN comparison. Thailand’s are four times higher; Malaysia, 3.4 times, and Singapore, the highest, at 4.8 times.

The Finance department calculates that raising the excise tax on gasoline to P10 per liter and diesel to P6 per liter would yield an additional P100 billion in revenues.  This would mean simply indexing them by an annual inflation factor of 2.37 percent (the average inflation rate from 1997-2014).

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