The tax reform program: Social and economic implications

More elaboration is coming out from the Duterte government concerning the tax reform package now in Congress. In particular, I refer to Tax Reform Package 1.

A more simple and efficient tax system. The proposals seek, first, a drastic reduction of the personal income tax by lowering the top marginal rate and increasing exemptions. In place of the loss in revenues from this action, increases in tax rates are contemplated on (1) excise taxes on oil products and (2) sales taxes on the purchase of new automobiles. Also, without changing the tax rate, the reforms include broadening the coverage of the 12 percent value-added tax (VAT).

These changes are in line with best practice adopted in other remarkable Southeast East Asian growth countries. They heavily depend on indirect taxes to finance their development and they have simpler personal income taxes.

Increased application of indirect taxes has regressive features. Hence, the government is committed to transfer some of the proceeds as lump sum subsidies for the poor and vulnerable groups. Further, social and economic public spending is designed to raise the nation’s capacity for future growth and fuel investment.

There is optimism these changes will “create a simpler, fairer, and more efficient tax system that can promote investment, job creation, and poverty reduction.”

Economic justification and vision. The tax reform program is designed to help put the country on a strong path of seven percent per year. By the end of the Duterte administration, the government envisions that the country could move toward the per capita income levels of around $4,000 per head.

By 2040, one generation later – on the basis of a sustained growth of seven percent per year and given other structural changes within the economy – the country could move toward $12,000 per capita.

If this vision carries a message of hope about the future with the commitment of political will, it is also a statement about how difficult and disciplined is the path of catching up from behind. These neighbors are succeeding in their economic journeys, and they are continually moving up their own paths.

We have to undertake economic reforms – not only tax reforms – in order to move the economy forward. The tax reform program is part of the fiscal reforms essential in strengthening or sustaining the required macroeconomic fundamentals.

The big story: income redistribution with taxation. The big story about Tax Reform Package 1 is that it is a combination of tax reductions, tax increases, and tax base broadening measures. However, there is a distributional measure that improves the possibility of “inclusive growth.” This is done through the commitments pertaining to the public expenditure program.

A big part of the net revenue increases involves the transfer of a significant chunk of the gains towards correctly assisting the poor with lump sum income transfers [through the expansion of the conditional cash transfer (CCT) program]. This is in support of the poorest of the poor and of vulnerable sectors, while the development program raises employment and incomes.

Social expenditures assisted by increased tax resources support education and health programs designed to strengthen public services. Finally, the finance of public infrastructure improves the economy’s productive capacity.

Specifically, up to 40 percent of the additional collections from oil taxes will be used to finance the targeted cash transfers to low income and vulnerable people. The balance of this would be for improving programs in education (classrooms, teachers and improving teacher-pupil ratios); in health (local hospitals, rural health centers, doctors, and local help to improve direct health services); and, of course, address the backlog and continuing need for infrastructure investments.

In the first full year of implementation of the proposals (by 2018), the government hopes to raise the tax effort by one percent of the GDP. (This would amount to a total of P174 billion of new tax revenues). The rate of between 13 percent of GDP firmly moves up to 14 percent of GDP, not yet as high as many developed countries, but sufficiently improving toward respectability, if sustained and if, in the future, raised a little further.

A fall in personal income tax collections amounting to 0.7 percent of GDP will be offset by rises in indirect taxation amounting to almost 1.8 percent of GDP. The gains in indirect taxes will come from the VAT base expansion at the same tax rate, additional excise taxes on oil, and the increase in the sales tax on automobiles.

The VAT should be made simple and more easy to administer. That makes it a revenue productive tax. The current VAT has so many exemptions and zero ratings that makes it cumbersome and half effective as a tax.

By broadening the VAT base through the removal of exemptions, the tax will produce higher revenues and make it as efficient as similar VAT measures in other countries. Some of the exemptions from the VAT can be undertaken through direct non-tax measures that help the sector.

In the case of senior citizens being exempt from the VAT, targeted measures to help poor seniors through direct cash subsidy is being suggested in lieu of exemption which benefits even rich seniors.

Net redistributional impact. Ultimately, the objective of good tax reforms is to raise the tax effort in order to finance government expenditure in a non-inflationary way. If possible, it should not worsen income distribution.

Income distribution in general is best measured objectively by a measure known as the Gini coefficient. The World Bank considers any ratio exceeding 0.40 represent cause for concern about income inequality. Yet, by its very nature, growth accentuates unequal opportunities being opened and exploited.

Typically, countries that grow at impressively good speed have high Gini ratios. This is because growth provokes sharp income rises for growing sectors.

Singapore, Malaysia, even China, have high Gini ratios, all at 0.46 or close to this. The Philippine Gini ratio is also around this level currently.

Though the Duterte tax reform program hopes to mitigate income inequality, the reduction of income inequality will not register quickly in statistical terms. With income transfer subsidies, the Gini ratio could fall.

The government projects this could move towards 0.415 under the most optimistic scenarios. The likelihood is the Gini ratio could well remain close to 0.44 or near where it is at now.

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