The need to focus on tax administration in the near term

The author is the senior policy analyst and a member of the Management Collective of Action for Economic Reforms.

Two factors make tinkering with the tax code irresistible. One, the
BIR’s tax effort, contributing roughly 75% of National Government tax
revenue, has slid down to pre-CTRP (Comprehensive Tax Reform Package)
levels. After peaking at 13% in 1997, it went down to 10.9% in 2000,
lower than the 1994 BIR tax effort of 11%. Two, the revenue “crisis”
comes at a time when prospects for economic recovery are bleak, and all
sectors look to government to stimulate economic activity.

Instead of resorting to temporary measures such as an oil levy, the
present administration proposes substantive reforms in the tax system.
Most controversial of these is the plan to shift from net income to
gross income in determining taxable income for corporations and
individuals engaged in trade or business or practice of profession.

The proposed gross income tax will likely take the form of a modified
gross income tax. This is because a pure gross income tax will find
difficulty passing political and constitutional muster. Politically,
business will oppose lesser allowable deductions. Constitutionally, it
may violate the equal protection clause in the Bill of Rights, and
perhaps also the provision that taxation shall be equitable. The
modified gross income tax, in contrast, allows deductions that makes
possible a compromise with business, as well as enables it to pass the
test of constitutionality. In the bill filed by Rep. Francisco Perez II
of Batangas, several deductions are contemplated: (1) sales returns,
discounts and allowances; (2) costs of good sold; and (3) cost of
services for those engaged in sale of service. Further, the tax rate
will be reduced to 15%. Presently, the tax rate on business income is
32%.

Because it is necessarily of the modified variety, the proposal is not
radically different from the present scheme. The difference lies only
in the lesser allowable deductions. This is the proposal’s selling
point: Lesser deductions equals a simpler system plus a larger tax
base. Additionally, it appears more equitable to compensation income
earners who are not allowed to deduct expenses related with employment,
such as transportation to the workplace. To pursue the equity
objective, however, there will be a need to adjust the rates for pure
compensation earners. Under the Perez proposal, pure compensation
earners will remain subject to progressive rates, with a 32% top rate.
Compensation income earners will find it highly inequitable that a
partner in a professional partnership, for example, will be taxed at
15% while he may be taxed at 32%.

The point remains that, with proper adjustments, a case may be built to
support the shift to gross income taxation based on the standards of
fiscal adequacy, administrative feasibility and theoretical justice.

But the relevant test of the appropriateness of the measure is the
context in which it is being proposed. If the standards of a sound tax
system are the test, why stop at shifting to gross income tax? Why not
consider also measures that will address all conceivable defects of the
Tax Code? The present tax system, after all, is substantively far from
perfect. To name a few defects: the long list of exemptions that
distorts the VAT system; the distinction in donor’s tax rate if the
donee is a stranger; the code’s sentence constructions that will
challenge the comprehension of even a native English speaker. The list
goes on. It is doubtful, however, if this comprehensive approach will
capture the imagination of many who have only recently gone through
such exercise with the CTRP.

This fact makes the emphasis on the context of reform even more
compelling in prioritizing what measure to consider at this time. The
question that should be asked is whether the proposed shift to gross
income tax addresses the problems of the moment, specifically, a
sliding BIR tax effort, missed revenue targets, and the need for
greater government spending.

The answer is it does not; the timing is off.

For one, the supposed revenue impact of the measure is highly
speculative. In government’s submission to Congress, the Executive
projects an additional tax take of P4.5 billion from the measure for
2002. It argues that the shift “will make our tax system competitive
with the other countries in the region, thereby making the Philippines
another investment hub in Asia.” This is obviously unrealistic given
the present trend in foreign capital flows. As for the increase in the
tax base, the Executive has yet to present the combined effect of
reducing allowable deductions and the tax rate. Add to this the effect
of a comparable reduction in the top rate for compensation income
earners, which may be required to address equity concerns of the
present proposal.
An even more compelling argument against it is that insisting on the
measure at this time is counterproductive. It distracts the focus on
the problem now generally recognized, that is, tax administration.
Economist Rosario Manasan estimates the evasion rate in individual
income tax at 60% and that in VAT at 62% in 1999. As seen in the past,
substantive reform is not always decisive in addressing the revenue
problem. However theoretically superior the design of a tax measure is,
the good points are often lost at the point of administration.

The growing general awareness and consensus that tax administration is
key is recently being transformed to positive actions by the government
and the private sector. On the part of government, the reform program
of the new BIR commissioner has a high tax administration content. On
the part of the private sector, more organizations are seriously taking
up the issue. By putting into the picture a highly debatable measure,
the march towards forming a critical mass in support of decisive
reforms in tax administration will expectedly take a sidestep.

Thus, the way forward is clear. The Executive must put off the debate
on the shift to gross income tax for another time. Instead, it should
not miss the opportunity to clinch a critical mass for decisive reforms
in tax administration.

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