Raymond S.

Pacaldo BS Accountancy 2
Cleopha Mae T. Pacaldo Managerial Economics
Rayleigh Andrew T. Pacaldo Raymond S. Pacaldo, CPA, MSA

Reforms to Offset Foregone Taxes–DOF

By: Ben O. de Vera - @inquirer.net Philippine Daily Inquirer / 12:58 AM October 28, 2016

Summary

In the tax policy reform program, the Department of Finance wants to correct inefficiencies and
inequities in the tax system by making it a simple, fair, and efficient one. The present system considered
the Philippines as one of the highest tax rates in Asia but still low in revenue collections. The country is
losing P105 billion revenues; P5 billion attributed to the abuse and ineffective use of VAT exemptions to
senior citizens and P100 billion in tax holidays and incentive to investors.
In removing these leakages, the plan is to trim down VAT exemptions and convert it to lower
personal income tax rates and expanded tax base. The exemptions provided for social protection and
provision of the needs of marginal people will be converted to increased cash transfers to the poor and
higher pensions. Also, tax incentives thru tax holidays and special rates of investors and large firms will
be removed since it is not time-bounded leading to severe inequity.

Analysis
The government is trying to stimulate aggregate expenditure(output) by effecting expansionary
fiscal policy. Using the concept of aggregate demand and supply, the reduction in income taxes will affect
the behavior of households in the level of their consumption and firms with regards to their investment.
Dividing the analysis into these two sectors will illustrate the impact of the fiscal policy to GDP.

Consumption
Generally, an income earned in an economy will either be consumed or saved. With the intervention of
the Government, the income to consume or save will be reduced by income taxes and increased by the
government transfers. The income left is called the disposable income which can be represented by this
equation, 𝑌𝑑 = 𝑌 − 𝑇. A decrease in taxes would increase household’s after-tax or disposable income (𝑌𝑑 )
which will lead to increase in consumption. Using the GDP equation 𝑌(𝐴𝐸) = 𝐶 + 𝐼 + 𝐺 (close economy),
assuming I and G constant, if consumption increases then planned aggregate expenditure (AE) will
increase. An increase in AE will create a rise in output to offset having lower inventories than planned. A
rise in output will need more workers and more income to be generated which will cause ripples of more
consumption. The ripples created by the reduction in income tax is the multiplier effect of income taxes
to GDP. Figure 1.1 illustrate the simplified effect in the goods and services market a decrease in income
taxes that will increase consumption and will ultimately increase planned aggregate expenditure (output).

Investment
The impact of the expansionary fiscal policy to investment will be analyze through the money
market. As previously presented in the goods and services market, the reduction in income taxes will
increase aggregate output (income). With regards to the money market, an increase in income (Y)
increases the demand for money 𝑀𝑑 (assuming quantity of money supplied 𝑀𝑠 constant.) The resulting
disequilibrium, with the quantity of money demanded greater than the quantity of money supplied,
causes the interest rate to rise. Fig 1.2 shows the impact of increase in income to the demand of money.
 Planned Expenditure and Aggregate Output
The decrease in T increases both Y and r. The increase in r will have a negative effect on
Investment and ultimately on Y is called the crowding-out effect. The higher interest rate reduces planned
investment spending. Since sources of money for business expansion will be costly, firms will reduce
investment which causes reduction in planned expenditure and fall of aggregate output. Fig. 1.3 shows
the crowding-out effect of the reduced taxes to planned expenditure and aggregate output. After the
reduction of taxes which created an increase in consumption, the Y curve will shift upwards causing the
aggregate output (Y) increase from 𝑌 0 to 𝑌1 . Since increase in Y will cause increases in interest rate (r)
and planned investment spending will be reduced, the Y curve will shift downward reducing the aggregate
output from 𝑌1 to 𝑌 ∗ . In effect, the full potential of increasing GDP by reducing income taxes will not be
realize since it will adversely affect firm’s planned investment spending. Yet, the result of opposing effects
on GDP will depend how much will be multiplier effect of taxes and sensitivity of planned investment to
changes in interest rate. Since the government are going to implement this kind of expansionary fiscal
policy, they might have in mind already that the tax multiplier will be greater than the investment
sensitivity.

Price Level
It is also important to consider how this fiscal policy affect the price level in the demand economy.
Since it affects both goods and services and money market, it will ultimately affect the aggregate demand
of the country. A decrease in income taxes (T) will shift the aggregate demand to the right causing an

increase in aggregate output (Y). The policy is silent as to how it will affect aggregate supply, so it will stay
as is. Philippines is considered a developing country so currently we are operating at the flat part of the
aggregate supply-short run (AS). The increase in output will also increase the price-level (P). Since the shift
of AD is along the flat-part of AS, the increase in output is significantly higher than the increase in price-
level. Therefore, the expansionary fiscal policy of reducing income tax may address in increasing GDP
without significantly increasing the inflation-level in the country.
References:

de Vera, B., Bank Deposits Reach P7.6T At End-Aug. Retrieved from

https://business.inquirer.net/217398/bank-deposits-reach-p7-6t-end-aug

Annex:
Reforms to offset foregone taxes–DOF
By: Ben O. de Vera - @inquirerdotnetPhilippine Daily Inquirer / 12:58 AM October 28, 2016

The tax policy reform program being pitched by the Department of Finance is expected to plug
the estimated P105 billion in foregone revenues yearly from tax perks that investors enjoy as well as a
long list of value-added tax (VAT) exemptions.
“Among the primary goals of the DOF’s proposed comprehensive tax reform program is to plug
these leakages and correct inequitable fiscal incentives by making the current tax system simpler, fairer
and more efficient,” Finance Undersecretary Antonette Tionko said in a statement.
“The DOF-proposed reforms also aims to correct the anomaly of the Philippines imposing one of
the highest tax rates in Asia, yet having among the lowest revenue collections,” added Tionko, who heads
the agency’s revenue operations group.
According to Tionko, “the government plans to increase revenues by correcting inefficiencies and
inequities in the system and by expanding the narrow tax base,” citing that the tax take from the Bureau
of Internal Revenue’s (BIR) 2,300 biggest taxpayers already account for half of the country’s entire
revenue base.
The first package of the proposed tax policy reform program will bring down personal income tax
rates but will also trim the number of VAT exemptions, which the DOF deemed “prone to abuse,” to
compensate for lower income taxes.
 “We estimate that we lose about P5 billion on leakages from the exemptions granted to senior
citizens,” Tionko said.
“Instead of using an inefficient and leakage-prone VAT system to address the needs of the poor
and the vulnerable, we’re thinking that it would be more prudent to increase the coverage of social
protection, perhaps through targeted cash transfers or higher pensions,” according to Tionko.
Also, Tionko said the government loses about P100 billion annually from the fiscal incentives given
away to investors.
“Foregone revenues are estimated at almost P50 billion pesos per year on income tax holidays,
and another P50 billion pesos in the special rate regime among large firms,” Tionko said, blaming these
on “a fiscal incentive system that is not time-bound, which, in turn, has led to severe inequity.”