By Yasuyuki Sawada

ADEQUATE government revenues are critical for a country’s development,

and the Philippines is no exception. Improving infrastructure, reducing poverty
and inequality, and investing in health and education — all require strong
public finances. The Asian Development Bank estimates that the Philippines
will need to invest about 7% of GDP annually in infrastructure alone to support
the country’s rapid growth. The Duterte administration is targeting reaching
that level of infrastructure investment by 2022, more than doubling it from less
than 3% of GDP on average over the past two decades.

At present, the Philippine government’s revenues are just under 20% of GDP,
well below the 25% of GDP average for developing Asia and the 36% of GDP
average for advanced economies. Ensuring adequate revenues — one of the
key features of a good tax system — is one of the primary motivations behind
the government’s five-part tax reform program. The tax reform and
improvements in tax administration aim to raise up to 3% of GDP annually in
additional revenues, with 70% of this earmarked for infrastructure and 30% for
social spending.

Just as important as mobilizing revenue, however, is ensuring that the tax

system works well. There are several other features of a good tax system
beyond revenue adequacy. These are equity, efficiency, competitiveness,
stability and predictability, ease of administration and compliance, and the
need to ground policies in evidence. Let’s see how the tax reforms, and
particularly the second legislative package known as TRAIN 2, fare along
these seven dimensions.

Oftentimes when people think of equity in taxation, they focus on “vertical

equity,” or how the tax system treats people with different incomes. Most tax
systems aim for progressivity, where the rich pay a higher share of their
income in taxes than the poor. The first phase of the tax reforms addressed
this issue and succeeded in reducing personal income taxes for the bottom
99% of the population.

But another important element is “horizontal equity,” or how the tax system
treats similar entities. The guiding principle is fairness — the playing field must
be level, so that similar entities face similar tax rates. If we look at the current
system, the incentives that some firms get but others don’t works against
horizontal equity. Firms that manage to get tax incentives face much lower
effective tax rates of 6-14%, whereas firms that don’t face a 30% rate. TRAIN
2 aims to improve horizontal equity by rationalizing fiscal incentives for
businesses.

By rationalizing existing fiscal incentives, TRAIN 2 will allow for a reduction in

the 30% corporate income tax rate, and this will help with the third and fourth
features of a good tax system — efficiency and competitiveness. One of the
principles in public finance is that distortions, or the decline in society’s well-
being due to a tax, rise disproportionately with the tax rate. For this reason, it
is more efficient to have a broader tax base and a lower rate, and that is what
TRAIN 2 is trying to do for corporate taxation. A lower corporate tax rate will
make the Philippines’ tax system more competitive, as it currently has the
highest corporate tax rates in ASEAN.

One argument often leveled against TRAIN 2 and the tax reform program
more broadly is that by changing things, the government is reducing the
stability and predictability of the tax system — the fifth feature of a good tax
system. But one cannot and should not keep a tax system fixed — especially
a flawed one — simply for the sake of “stability.” The Philippines’ tax system is
in dire need of fixing, and this is the first major tax reform in the Philippines in
two decades. If we allow it to be done right, and done quickly, the Philippines
will not need tax reform for another two decades.

When it comes to the sixth feature of a good tax system, ease of

administration and compliance, two elements are very important — simplicity
and transparency. TRAIN 2 aims to help by replacing the 123 special laws
that govern tax incentives with a single law, and bring the 14 different
investment promotion agencies under a single body, the Fiscal Incentives
Review Board. One lesson from history is that the government should not be
in the job of “picking winners” — the track record of countries around the world
in doing this is not good, and it often stimulates lobbying for personal gain.
Rather, incentives should be based on firms’ documented ability to deliver,
whether it be creating more jobs, raising incomes, or increasing exports.

Which brings us to the final feature of a good tax system and of good policy
more generally — that it be supported by solid evidence. The proliferation of
large amounts of useful data have led to a “credibility revolution” in evidence-
based policy making.

Thanks to the Tax Incentives Management and Transparency Act, it is now

possible to analyze whether tax incentives — which reduced government
revenues by P301 billion in 2015 — have delivered the employment, income,
and export growth it promised. This lines up well with the objective of TRAIN 2
to make tax incentives more performance-based.

In sum, TRAIN 2 and the broader tax package are critical to strengthening the
Philippines’ tax system. Passage of this important legislation will demonstrate
the commitment of Congress, and the country more broadly, to the reforms
that are needed to spur growth, reduce poverty and inequality, and achieve
upper middle-income status. It will also set the foundations for stronger and
more inclusive growth for the next generation of Filipinos.

Yasuyuki Sawada is the Chief Economist of the Asian Development Bank.