This paper was presented at the Forum on the Macapagal-Arroyo Tax
Reform Program organized by Action for Economic Reforms and the Human
Development Network and held on 22 October 2001. The paper asserts that
the proposed shift to gross income tax does not address the pressing
problems of the moment, specifically, a slipping BIR tax effort, missed
revenue targets, and the need for greater government spending in the
face of the economic downturn. Consequently, it appeals to the
executive to put off the debate on the shift to gross income tax for
another time. It proposes instead to grab the opportunity to clinch a
critical mass for decisive reforms in tax administration.
At least three factors make tinkering again with the country's tax code
irresistibly tempting. One, the BIR's tax effort, contributing about 70
to 80 percent of total National Government tax revenue, has
disappointingly slid down to pre-CTRP (Comprehensive Tax Reform
Package) levels. After peaking at 13% in 1997, it went down to 12.6% in
1998, 11.5% in 1999, and 10.9% in 2000. This is lower than the 1994 BIR
tax effort of 11%. Two, and related to the falling tax effort, the
national government has been missing its revenue targets, compelling it
to cut its programmed expenditures to keep to its deficit ceilings.
Finally, the revenue "crisis" comes at a time when prospects for
economic recovery turn bleaker by the day, and all sectors are looking
at the government to provide the stimulus for economic activity.
Unlike in the past when the government resorted to temporary measures
such as an oil levy to address a revenue crisis, the present
administration has instead proposed substantive reforms in the tax
system. The most controversial of these is the proposal to shift from
net income to gross income in the determination of taxable income for
corporations and individuals engaged in trade or business or practice
of profession.
We have yet to see the details of the proposed measures, but as regards
gross income tax, it will likely take the form of a modified gross
income tax. This is because a pure gross income tax will almost
certainly not pass political and constitutional muster. Politically,
the business sector will definitely oppose it as it represents lesser
allowable deductions. Constitutionally, I believe that it will be
violative of the equal protection clause in the Bill of Rights, and
perhaps also the provision that the rule of taxation shall be
equitable. The modified gross income tax, in contrast, allows
deductions that politically open the measure to a possible compromise
with the business sector, as well as enable it to pass the test of
constitutionality.
If the bill filed by Rep. Francisco Perez II of Batangas represents how
the executive intends to operationalize the proposal, then several
deductions are contemplated: (1) sales returns, discounts and
allowances; (2) costs of good sold defined differently for
manufacturing and trading or merchandising concerns; and (3) cost of
services for taxpayers engaged in sale of service. Further, the tax
rate will be reduced to 15%. At present, the tax rate on business income is 32%.
Given that the gross income tax is necessarily of the modified variety,
it is really not radically different from the present set-up. The
difference lies only in the extent of allowable deductions, with the
modified gross income tax representing less deductible items. Such
lesser allowable deductions are the selling point of the proposal:
Lesser deductions equals a simpler system plus a larger tax base. May I
also add that this is somehow more equitable for compensation income earners who are not
allowed deductions of expenses that can be argued to be related with
employment, such as transportation to and from the workplace. To pursue
the equity objective, however, there will be a need to adjust the rates
for the income tax of individuals earning pure compensation income.
Under the Perez proposal, individuals earning pure compensation income
will remain subject to progressive rates, with a 32% top rate. As a
compensation income earner myself, I find it highly inequitable that a
partner in a professional partnership earning millions will be taxed at
15% while I may be possibly be taxed at 32% if Action would care to
give me a salary increase.
The point is, with adjustments here and there, I would agree that
substantively, 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. Of course the debate is not at
all new, and there are equally reasonable challenges to such arguments.
But to me, the ultimate test of the appropriateness of the measure is
the context in which it is being proposed. If the standard of a sound
tax system is the test of the needed reforms, then why stop at shifting
to gross income tax? Why not throw in for consideration other measures
that will address all the conceivable defects of the present tax code?
The present tax system, after all, is substantively far from perfect.
To name a few of these defects: the long list of exemptions that
distorts the VAT system; the distinction in donor's tax rate if the
done is a stranger; and perhaps we should also consider revisiting the
code's sentence constructions, many provisions of which will challenge
the understanding of even a native English speaker. The list goes on.
Among us present here, I'm sure we can come up with a very long wish
list of reforms that will make the tax code meet the standards of
fiscal adequacy, administrative feasibility, and theoretical justice. I
doubt, however, if this comprehensive approach to tax reform will
capture the imagination of many of us who have only recently gone
through such exercise with the CTRP.
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This fact makes the emphasis on the context of reform even more
compelling. The prioritization of what measure to consider at any point
in time will have to be determined by the context in which the measure
is being proposed. I have outlined earlier the problems that we face,
specifically, a slipping BIR tax effort, missed revenue targets, and
the need for greater government spending in the face of the economic
downturn. Does the proposed shift to gross income tax address these
problems of the moment?
I believe it does not; the timing is off.
For one, the supposed revenue impact of the measure is highly
speculative. In the Budget of Expenditures and Sources of Financing
(BESF) for 2002 submitted to Congress, the Executive projects an
additional tax take of P4.5 billion for the measure. 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". With the picture in foreign capital flows so plain, I wonder
what time zone the executive department is in. As for the supposed
increase in the tax base, the executive has yet to present the combined
effect of the trimming down of allowable deductions and the reduction
in the tax rate. Add to this the revenue effect of a comparable
reduction in the top rate for compensation income earners, which may be
required to address equity effects of the present proposal. Thus, until
the executive shows credible basis of its estimates, the projections
remain speculative.
The more compelling argument against it, I believe, is that the
insistence on the measure at this time is counterproductive and
distracts all of us from focusing on the problem which we now all
recognize, namely, tax administration. The Manasan estimates place the
evasion rate in individual income tax at 60% and that in VAT at 62% in
1999. As a testimony to the gravity of the problem, we have all
accepted these estimates without question. We have seen in the past
that substantive reform is not always decisive in addressing the
revenue problem. However superior the design of a tax measure is in
theory, the good points are often diluted 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, we see the reform
program of the new BIR Commissioner having a high tax administration
content. On the part of the private sector, we see more organizations
seriously taking up the issue. Even the media has shown a big interest,
with the PCIJ running a series of investigate reports on corruption in
the BIR. Private funds are also now flowing to programs related to this
concern.
By putting into the picture a highly debatable measure, we can expect
the march towards forming a critical mass in support of decisive
reforms in tax administration to take a sidestep. Just to give an
example, while we in Action are united on the issue of tax
administration, we cannot say the same thing about the issue of the
shift to gross income taxation at the theoretical level. Some of us
oppose it while others show openness to the idea. What is certain is
that, when this measure is seriously tackled in Congress, we will be
compelled to intervene in the process and dissipate our resources which
ought to be directed to addressing the issue of tax administration. The
growing number of groups tackling fiscal issues will surely be affected
in the same way.
We thus appeal to the Executive to put off the debate on the shift to
gross income tax for another time. Instead, let us not miss the
opportunity to clinch a critical mass for decisive reforms in tax
administration.
This paper was presented at the Forum on the Macapagal-Arroyo Tax
Reform Program organized by Action for Economic Reforms and the Human
Development Network and held on 22 October 2001 at the Discovery
Suites, Ortigas Center, Pasig City.