U.P.

Academic Congress
Benjamin E. Diokno, Professor, School of Economics, U. of the Phlippines (Diliman)

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Political Economy of Tax Reform

What’s the fiscal outlook?

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Weaker, low-yielding tax system
Tax-to-GDP ratio risks reverting to low levels seen during the Marcos final years

Diokno I Economic Briefing 102709

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Fiscal House in Disarray
GMA run large deficits from 2001-04; huge deficits have reemerged in recent years

Fis

Diokno I Economic Briefing 102709

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High and Rising Public Debt
As the world economy recovers, interest rates would rise, leading to higher debt service

Diokno I Economic Briefing 102709

Statistics on Nat’l Gov’t Debt Service
Total, Debt Service Domestic Foreign Distribution, % Domestic Foreign In percent of GDP Domestic Foreign Total In percent of NG revenues Domestic Foreign Total In percent of Tax Revenues Domestic Foreign Total 2007 614,069 441,237 172,832 2008 612,682 430,425 182,257 2009 702,600 478,588 224,012 71.9 28.1 6.6 2.6 9.2 38.8 15.2 54.0 47.3 18.5 65.8 70.3 29.7 5.8 2.5 8.3 35.8 15.2 50.9 41.0 17.4 58.4 68.1 31.9 6.1 2.9 9.0 42.7 20.0 62.7 49.6 23.2 72.9

2010 746,175 492,716 253,459 66.0 34.0 5.8 3.0 8.8 42.5 21.9 64.4 48.3 24.9 73.2

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What will the next President inherit?
A huge public debt and narrow fiscal space. Fiscal flexibility, defined as recurrent revenues less personal services, interest payments, internal revenue allotment (IRA) and net lending would disappear in 2010 But what if the next administration needs a second fiscal stimulus program?

Diokno I Economic Briefing 102709

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Basic Goals of the Tax Reform
 Broaden the tax base and generate

more revenue to reduce the budget deficit and finance public goods and social protection programs
 Reduce the tax burden of corporations

and fixed-income earners
 Simplify and make more neutral and

efficient the tax structure of the financial sector
CDMIPhilippine Economic Roadmap

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Revenue Measures: Hard Choices
Reforming fiscal incentives Reforming excise taxes on

cigarettes and liquor (e.g. two-part excise for tobacco)

CDMIPhilippine Economic Roadmap

Revenue Measures: Harder  Increase VAT to 15%. Lower personal income
tax rates and the corporate income tax rate to 25% sector by making it neutral
 Reform the tax structure of the financial
 10% tax on all passive income  Remove tax on insurance premium

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 Adopt variable tax rates on fuel products
 Earmark revenue for improving the transport

system (e.g. for mass transit)

 Fix the Internal Revenue Allotment (IRA);
CDMIPhilippine Economic Roadmap

impose presumptive national real property tax (RPT).

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National Real Property Taxes Collected Through LGUs
 National government to piggyback on real

property tax (RPT) imposed by local government units (LGUs)
 Administratively, LGUs don’t have to remit

the presumptive RPT to the national treasury. Instead, the national government will deduct the said amount from each LGU’s IRA (whether or not the additional RPT is actually imposed by the LGU)

CDMIPhilippine Economic Roadmap

Arguments for raising the VAT rate
 Based on the experience in Europe and other countries, there

is still room for raising the VAT rate. In the EU community, the unweighted average VAT rate is 19.3%
 It is more efficient (in terms of lower deadweight loss) than the

personal income tax or other forms of taxes.
 VAT is highly responsive to changes in economic activity since

it is ad valorem in nature. Occasional tinkering is not needed.
 The VAT is mildly progressive.

DioknoI VAT or Income

VAT is slightly more responsive than PIT
 VAT has been more

responsive to changes Tax in economic activity (GDP) since it is ad valorem in nature and VAT since agriculture while PIT VAT exempt is roughly less than one-fifth of the economy.
 PIT is also responsive

Elasticity (1998-2008)
1.29 1.21

Adj R2
0.9740 0.9529

t- value
26.0 20.1

since wages adjust with inflation
DioknoI VAT or Income Tax

VAT is mildly progressive
VAT paid by expenditure percentiles Percentile Share (%) of Percentile total spending spending liable to VAT(%) 0.1 1.9 5.2 13.2 22.1 22.3 25.0 10.1 44.2 45.9 48.4 53.0 58.4 61.9 63.8 75.8 1-10% 10-25% 25-50% 50-75% 75-90% 90-99 Richest 1%
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Share (%) in total VAT due 0.1 1.4 4.1 11.5 21.2 22.7 26.3 12.6

Poorest 1%

Some concluding remarks
 With a looming fiscal crisis, increasing the VAT rate

from 12 to 15 percent appears to be warranted. The current rate is low by international standard. While the VAT is responsive to changes in economic activity, its productivity may be further enhanced by improvement in its administration.
 Given the seriousness of its fiscal problems, any

proposed cut in the personal income tax rates may have to be reviewed, especially in the face of the personal income tax’s most recent reform (e.g. exemption of minimum wage earners and increasing deductible deductions; PERA)

DioknoI VAT or Income Tax

Concluding remarks
 But with a bold, reform-oriented new administration,

personal income taxation may be further simplified and rates reduced sharply – say to a flat rate of 18 percent. However, it may require raising the VAT rate from 12 to 18 percent. the authority from Congress to shift from direct taxation to value added taxation within the first 100 days of his Presidency. But the implementation should be calibrated with the speed of economic recovery. Postponing the tax reform to a latter date is tantamount to status quo –then fiscal collapse becomes inevitable.

 Managing the reform: The new President should get

DioknoI VAT or Income Tax

Fiscal Picture in Recent Philippine History

Social Expenditures, 4 Presidents
Aquino Education+SBP Dept of Health Per capita spending Education+SBP Health Per capita real spending Education+SBP Health 855 240 1,023 160 1,224 160 1,101 115 362 102 797 123 1,201 156 1,434 150 21,873 6,187 Ramos 55,855 8,586 Estrada 90,997 11,835 Arroyo 123,158 12,952

Sources: Government authorities, 2000=100

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