A Model for Tax Administration Reform

Maricar Paz M. Garde

The tax effort in the Philippines – the ratio of tax revenue to GDP – has steadily declined since the
onset of the Asian financial crisis. After reaching a peak of 17% in 1997, it dipped to 14.4% in 1999, and hit
an all time low of 12.3% in 2003. What is worrisome is that as the country’s economy recovers from different
shocks albeit slowly, tax collection fails to catch up. An even more serious problem is tax evasion. A study
shows that the evasion rate was 60.8% for income tax and 62.6% for VAT on domestic sales in 1999. The
decline in the tax effort and the worsening evasion problem are definitely alarming for a cash-strapped
Philippine government.

Dismal tax collection is reflective of tax administration performance. The Bureau of Internal Revenue
is beset with lack of resources, incompetent personnel, and rent-seeking behavior among its ranks. Its
reputation for sleaze has serious ramifications. Private enterprises surveyed by the Social Weather Stations
(SWS) in 2002 ranked the BIR as the second most corrupt agency (at 72%) next to the Bureau of Customs
(74%). Another SWS survey attributes 58% of corruption to tax examiners, and 38% to taxpayers. Corruption
in the Bureau does not only lead to inefficient outcomes such as lower revenue collections, but also affects
the attitude of individuals and firms toward tax payment. Distrust in tax administration lowers people’s
incentive to pay correct taxes (since payments may only go to tax collectors’ pockets) and encourages under
the table deals with auditors or tax collectors.

Weak tax collection can be addressed by: 1) reforming tax policy and 2) reforming tax administration.
Optimal policy entails few and simple taxes with a broad base. Efficient administration requires modern and
efficient tax processes and competent tax personnel. In the last two decades, the Philippines has undertaken
two comprehensive reform programs, the 1986 Tax Reform Package and the 1997 Comprehensive Tax
Reform Package (CTRP). These programs shifted income taxation from the schedular to a more global
approach, replaced the sales tax and other taxes with the VAT, and introduced several other changes in the
tax system. The government has not implemented any major administrative or managerial tax reform in
recent years.

Although far from perfect, the present tax policy adheres to the principle of simple and few taxes.
Certain changes are needed such as cutting the list of VAT exempted goods and services in order to
broaden the tax base. What policy has neglected is reforming tax administration. Most developing countries
(e.g. Peru, Chile, etc) that introduced changes in tax policy simultaneously employed tax administration
reforms. The Philippines has been remiss in doing so.

Why bother with tax administration reform? A World Bank study entitled The Nuts and Bolts of
Revenue Administration Reform by Jit B. Gill enumerates the reasons: 1) actual tax revenues depend on the
efficiency and effectiveness of tax administration, 2) the quality of tax administration determines the
investment climate and private sector development, 3) tax and customs administrations are usually known
for corruption, and 4) reform of revenue administration has to keep up with increasing sophistication of
business activity and tax evasion schemes. Given our weak fiscal situation, it is certainly time to improve on
tax collection and transform the BIR into an efficient and trustworthy public institution.

The BIR must undertake radical changes that include full automation of the tax system and major
overhaul of the tax collection unit. A major problem that troubles most tax agencies is human resource
management. The Bureau itself has admitted that it is saddled with a bloated workforce, low salaries, high
incidence of corruption in its ranks, and difficulty in hiring and retaining competent people. These HR
problems have not only resulted in inefficiency, but have also hindered major reform. For instance, the five-
year computerization program funded by a $40 million loan from the World Bank met strong employee
resistance.

An example of a good tax administration reform program is the comprehensive staff evaluation and
replacement program undertaken by Peru in the early 1990’s. The country was then under threat from two
terrorist groups and on the verge of economic collapse due to recession and hyperinflation. President Alberto
Fujimori used tax administration reform as a rallying point. The idea was to transform the Superintendencia
National de Administracion Tributaria (SUNAT) from a corrupt and inefficient office into an institution of
competence and integrity.

The employees of SUNAT were given the choice of either participating in the program or going into
early retirement. Those who agreed to go under the program went through rigorous evaluation that tested not
only competence, but moral and psychological aspects as well. Those who participated but failed were
terminated. After comprehensive evaluation was completed, SUNAT embarked on an aggressive recruitment
program in Peru’s most prestigious universities. Fresh (and presumably uncorrupted) graduates were hired.
Last, SUNAT raised wages significantly (the scale of the hike was from $50 to $1000) to retain competent
staff members and curb rent-seeking activities among employees.

The comprehensive staff evaluation and replacement program was accompanied by other reform
measures. The Peruvian government even went as far as granting semi-autonomous status to tax
administration. The results were highly satisfactory. Internal revenue which was at 5% of the GDP in 1991,
improved to 10.9% after initial changes were conducted. The figure shot up to 13% of the GDP in 1997. The
evasion index for VAT and income tax was reduced from 90% to 45%. Most importantly, a survey revealed
that 90% of large taxpayers believed that taxpayer service improved. Although the cost of SUNAT'
s staff
replacement program exceeded $2.3 million, the benefits were tremendous and long lasting.
 Can the Philippines reform its tax administration? Can it follow Peru’s example and transform the tax
agency into an efficient and trustworthy government office? The country is in fiscally weak, and the
government is under extreme pressure to raise tax revenues. New taxes can be legislated, but they would be
most effective if accompanied with structural changes in the tax administration. Legislation to reform tax
administration would also be more acceptable, if not welcome, to the people. Bold reforms are oftentimes
passed during times of crisis when radical solutions are needed. The BIR’s role in the nation’s life has never
been more crucial now that the country is in the verge of a debt crisis.

Ms. Maricar Paz Garde is a lecturer, economics department, college of business and economics, De La Salle University

These article are contributed by the CBE Faculty in the column of Business Focus of Manila Bulletin
published November 15, 2004.