The game changing tax reform facing the nation

The tax reform package of the Duterte administration recently passed the lower house of Congress by a resounding vote of 246 in favor, with only nine against and one abstention.

The original version of the tax reform bill (House Bill 4774) was consolidated with many tax reform measures proposed in Congress. This became House Bill 5636, which is titled “Tax Reform and Acceleration and Inclusion Act,” or TRAIN.

The Senate faces a major task. The House has done its job. Now, the ball is literally in the Senate’s court.

The Senate will have to adopt its version of the tax reform to help complete the legislative process. The question is whether the Senate will be able to complete its work to permit passage of the law this year. (If that happens, then such milestone legislation would be in time for the second Duterte state of the nation address in July, within two months.)

But the more important question is whether the resulting tax reform law will usher in game-changing conditions we need to carry us forward in economic and social development. This is likely to happen if the full extent of the tax reform components are realized.

When the tax reform program was endorsed to the two houses of Congress, President Duterte emphasized the need to sustain the growth momentum and to accelerate poverty reduction.

The proceeds of such a program would help finance the government’s promised investments in infrastructure, human capital and social protection for the poor and vulnerable sectors.

The challenge for the Senate is whether it will enhance the tax reform program as envisioned in the government’s vision or whittle it down further.

Positive anticipations of the outcome have already started discussions of a sovereign credit upgrade by credit rating agencies. This could be good news.

Problems of the House-approved version. The House-approved bill could still be immensely improved. Through its various amendments, the House-approved bill has reduced the expected total revenue generation potential of the tax reform.

So far, I am not aware of estimates of this reduction in potential revenues, although the outcome appears to be acceptable to the government.

The House accepted the far-reaching recommendations to reduce the personal income tax rates. As designed, the reduction in personal income taxes will reduce the income tax burden of middle income earners, raise the tax on the very rich and make the personal income tax rates more competitive in the region. As a result, income tax relief will also benefit many low income earners.

The reduction in revenues from the income tax is to be made up for by increases in indirect taxes on goods. These are easier to impose and they are more revenue productive. They also conform to the tax framework of countries in our stage of development.

The regressive effect of taxes in general shall be countered through the various programs of expenditures directed for the benefit of the poor and middle income families through the budgetary expenditures on education, health, human capital development, and on infrastructure investments.

The House, however, modified the tax rates by lowering them and staggered the effectiveness of the tax increases for specific products (mainly energy products, gas and diesel fuels). In addition, part of the increases in fuel taxes were earmarked. The total tax revenues from these changes would therefore reduce total tax income and would introduce inflexibilities due to earmarkings.

It is not commonly realized that the rates of taxes on most items of sales in the Philippines are much lower than in other progressive economies with which our country is often compared.

Specific tax rates on energy products have not been changed since about 20 years ago. Other countries adjust their specific taxes periodically to account for inflation. At the rate of the inflation of many years, the government estimates that around P145 billion of revenues from oil and gas products have been collected.

By the same token, the tax rates on motor vehicles have not been adjusted since 13 years ago despite inflation. The gains from lower taxes have accrued to those who could afford to pay the tax.

Moreover, the House version still retains some of the tax exemptions in the VAT, which makes it produce less revenues than it should. A little elaboration on the VAT is important.

Because of continuing large exemptions from the VAT, the Philippine VAT continues to be less effective as a revenue source. The task of the Senate, if I might suggest, would be to take a long term view of this problem and make the VAT move toward simplicity and more revenue yield.

In addition to improved revenue generation, its administration would become less complicated. Simplicity adds revenues and further reduces the costs of administration. But add exemptions and revenues fall and administrative costs rise.

The Philippine VAT rate is the highest among Southeast Asian countries, at 12 percent. Thailand’s VAT rate is only seven percent, yet it contributes relatively as much as a percentage of GDP compared to the Philippine VAT.

The opportunity for a better tax reform. The Senate could determine the final shape of the tax reform program.

It is worth noting, however, that the Senate is a place where serious potential rivals for the presidency reside. Also, because senators are fewer in number, each senator is much more powerful in shaping the legislative vote than a member in the House.

Such factors might produce different dynamics of legislative action. Hopefully, it would be recognized that producing a sound tax reform program improves future governance immensely.

Whoever succeeds to the highest position of the land would reap benefits from a tax reform that produces a non-inflationary source of funding the government budget and facilitating future economic growth.

Best practice reform: simplicity, administrative feasibility and revenue efficiency. The current tax reform program provides the unique opportunity to adopt more revenue productive taxes, simplify the tax system, and at the same time correct some problems that render the country less competitive.

Many of the changes suggested have come from best practice examples applicable to the current Philippine situation from other countries. Furthe motivations for reforms are also the problems that we encounter in administering the tax system and the efforts to solve them.

My email is: [email protected]. Visit this site for more information, and commentary: http://econ.upd.edu.ph/gpsicat/