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.