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U.P. Academic Congress

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

Political Economy of Tax Reform

What’s the fiscal outlook?

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


Fiscal House in Disarray

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


Diokno I Economic Briefing 102709


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 2007 2008 2009 2010
Total, Debt Service 614,069 612,682 702,600 746,175
Domestic 441,237 430,425 478,588 492,716
Foreign 172,832 182,257 224,012 253,459
Distribution, %
Domestic 71.9 70.3 68.1 66.0
Foreign 28.1 29.7 31.9 34.0
In percent of GDP
Domestic 6.6 5.8 6.1 5.8
Foreign 2.6 2.5 2.9 3.0
Total 9.2 8.3 9.0 8.8
In percent of NG revenues
Domestic 38.8 35.8 42.7 42.5
Foreign 15.2 15.2 20.0 21.9
Total 54.0 50.9 62.7 64.4
In percent of Tax Revenues
Domestic 47.3 41.0 49.6 48.3
Foreign 18.5 17.4 23.2 24.9
Total 65.8 58.4 72.9 73.2

What will the

next President
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


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


Revenue Measures: Hard

Reforming fiscal incentives
Reforming excise taxes on
cigarettes and liquor (e.g.
two-part excise for

CDMIPhilippine Economic Roadmap


Revenue Measures:
 Increase VAT to 15%. Lower personal income
tax rates and the corporate income tax rate
to 25%

 Reform the tax structure of the financial

sector by making it neutral
 10% tax on all passive income
 Remove tax on insurance premium

 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);

impose presumptive national real property
tax (RPT).
CDMIPhilippine Economic Roadmap

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
 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
in economic activity Tax Elasticity Adj R2 t- value
(GDP) since it is ad
valorem in nature and VAT 1.29 0.9740 26.0
since agriculture while PIT 1.21 0.9529 20.1
VAT exempt is roughly
less than one-fifth of
the economy.
 PIT is also responsive
since wages adjust
with inflation

DioknoI VAT or Income Tax

VAT is mildly progressive
VAT paid by expenditure percentiles

Percentile Share (%) of Percentile Share (%) in

total spending total VAT
spending liable to due
Poorest 1% 0.1 44.2 0.1
1-10% 1.9 45.9 1.4
10-25% 5.2 48.4 4.1
25-50% 13.2 53.0 11.5
50-75% 22.1 58.4 21.2
75-90% 22.3 61.9 22.7
90-99 25.0 63.8 26.3
Richest 1% 10.1 75.8 12.6

DioknoI VAT or Income Tax

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.
 Managing the reform: The new President should get
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.

DioknoI VAT or Income Tax

Fiscal Picture in Recent Philippine
Social Expenditures, 4
Aquino Ramos Estrada Arroyo
Education+SBP 21,873 55,855 90,997 123,158
Dept of Health 6,187 8,586 11,835 12,952
Per capita spending
Education+SBP 362 797 1,201 1,434
Health 102 123 156 150
Per capita real spending
Education+SBP 855 1,023 1,224 1,101
Health 240 160 160 115
Sources: Government authorities, 2000=100