Philippine Institute for Development Studies Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas
Policy Notes ISSN 1656-5266
No. 2008-07 (December 2008)
Are recent gains in BIR tax effort sustainable? Rosario G. Manasan
I
n a previous Policy Notes,1 this author outlined the trend in the national government’s fiscal position from 1996 to 2006. From a small surplus of 0.3 percent of gross domestic product (GDP) in 1996, the situation deteriorated sharply to a deficit of 5.6 percent of GDP in 2002 after a severe decline in tax effort was experienced within this period. Some fiscal consolidation took place in 2003– 2006 when three major laws were passed by the Philippine Congress beginning in 2004. These included Republic Act (RA) 9334 (amending the excise tax on so-called sin products) and RA 9335 (or the Lateral Attrition Law), both passed in late 2004, and RA 9337 which was an additional amendment to the National Internal Revenue Code (NIRC), passed in April 2005. RA 9334 provides for discrete increases in the tax rate on cigarettes (15–80%) and alcoholic
products (22%) beginning 2005 and every other year thereafter until 2011.2 RA 9335, on the other hand, provides for the creation of a reward and incentives fund at the Bureau of Internal Revenue (BIR) and Bureau of Customs (BOC) equal to at least 15 percent of the difference between their actual collection and revenue targets, proceeds of which will be apportioned to the various units, officials, and employees relative to their contribution to the “excess” collection. Said RA also provides that officials and employees of these bureaus may be removed from the service if ______________ 1
Manasan, R. 2007. Risks and opportunities in securing increased resources for MDGs at the national level. PIDS PN No. 2007-08 (December, pp 3–4). Makati City: Philippine Institute for Development Studies. 2 Under the amendment, the tax rate on cigarettes in 2011 will be 34–143 percent higher than that in 2003 while the tax rate on alcoholic products in 2011 will be 122 percent higher than that in 2003.
PIDS Policy Notes are observations/analyses written by PIDS researchers on certain policy issues. The treatise is holistic in approach and aims to provide useful inputs for decisionmaking. The author is Senior Research Fellow at the Institute. The views expressed are those of the author and do not necessarily reflect those of PIDS or any of the study’s sponsors.
2
their revenue collection performance falls short of the target by at least 7.5 percent. Meanwhile, the third law (RA 9337) or better known as the reformed value added tax (VAT) law, among others, expands the coverage of the VAT; converts the Philippine VAT system from a “consumption-type” VAT (where producers are allowed to get credit for taxes paid on their inputs including capital goods purchases) to an “income-type” VAT (where producers are allowed to get credit for taxes paid on all their inputs but the credit on capital goods purchases is limited only to the depreciated part of capital); and limits the input VAT credit to 70 percent of the output VAT. It also authorized the increase of the VAT rate by the President from 10 to 12 percent in January 2006. Following the amendments to the NIRC, total revenues of the central government rose from 14.5 percent of GDP in 2004 to 15.0 percent in 2005, 16.2 percent in 2006, and 17.1 percent in 2007 (Table 1). The turnaround in
the revenue effort in 2005 and 2006 was primarily due to the improvement in the tax effort of the two major collection agencies: the BIR and BOC. The BIR taxes which contributed significantly to the improved tax-toGDP ratio in 2006 included the corporate income tax, value added tax, and gross receipts tax on banks and other financial institutions. Surprisingly, though, despite the passage of RA 9334, the excise tax-to-GDP ratio continued to decline in 2005–2007 (Table 2). In 2007, the improvement in revenue effort was attributable to increased privatization proceeds rather than increased tax effort per se. In fact, the tax revenue-to-GDP ratio of both the BIR and BOC even declined by 0.1 percentage point each in 2007. What accounted for these performances? What really contributed to the gains in revenue effort in the period 2005–2007? And what implications can be drawn from them—can said gains be sustained in the near to medium term?
Table 1. National government fiscal position (cash basis) as a percent of GDP, 1996–2007
Total revenues of which: Tax revenues Privatization proceeds Total expenditures of which: Interest payments Surplus (deficit) Total expenditures net of debt service PN 2008-07
Policy Notes
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
18.9
19.4
17.4
16.1
15.3
15.5
14.6
14.6
14.5
15.0
16.2
17.1
16.9 0.3 18.6
17.0 0.4 19.4
15.6 0.1 19.2
14.5 0.1 19.8
13.7 0.1 19.3
13.5 0.0 19.6
12.8 0.0 20.2
12.5 0.0 19.2
12.4 0.2 18.3
13.0 0.2 17.7
14.3 0.2 17.3
14.0 1.4 17.3
3.5 0.3
3.2 0.1
3.7 -1.9
3.6 -3.8
4.2 -4.0
4.8 -4.0
4.8 -5.6
5.2 -4.6
5.4 -3.8
5.5 -2.7
5.1 -1.1
4.0 -0.2
15.1
16.2
15.5
16.3
15.1
14.8
15.5
13.9
13.0
12.2
12.2
13.3
3
This Policy Notes examines in greater detail the gains specifically in the BIR3 tax collection during this period. It decomposes the changes in BIR tax effort as due to: (1) change in tax policy such as the implementation of new tax measures, (2) change in economic structure such as economic growth being led by more heavily taxed sectors of the economy, and (3) change in collection efficiency or tax leakage. It then draws out the implications of the analysis on the sustainability of the recent improvement in BIR tax effort. How the major taxes fared As shown in Table 3, the aggregate BIR tax-to-GDP ratio actually went up by 0.2 percentage point of GDP in 2005 and by 1.2 and 1.1 percent-
Table 2. BIR and BOC collections as percent of GDP
All BIR Taxes I. Taxes on net income and profit A. Company, corporate enterprise B. Individual of which: Withholding on wages Individual tax on self-employed C. Others 1. Bank deposits 2. Treasury bills II. Excise tax of which: 1. Alcohol products 2. Tobacco products 3. Petroleum products III. Value added tax IV. Other percentage taxes of which: 1. Banks/Financial institution 4. Other percentage V. Others of which: 2. Documentary stamp tax All BOC Collections I. Import duties II. VAT and excise taxes on imports
CY 2003
CY 2004
CY 2005
CY 2006
2007
9.87 5.66 2.60 2.12
9.61 5.71 2.69 2.07
9.84 5.94 2.84 2.15
10.82 6.25 3.24 2.16
10.73 6.42 3.63 2.13
1.78 0.25 0.94 0.29 0.65 1.32
1.73 0.25 0.95 0.29 0.66 1.22
1.73 0.34 0.94 0.29 0.65 1.14
1.76 0.33 0.85 0.31 0.54 0.97
1.80 0.26 0.67 0.24 0.43 0.84
0.32 0.46 0.49 1.91 0.44
0.33 0.47 0.37 1.65 0.57
0.31 0.44 0.34 1.61 0.63
0.27 0.44 0.21 2.34 0.63
0.29 0.35 0.15 2.18 0.62
0.07 0.30 0.54
0.21 0.31 0.46
0.23 0.33 0.51
0.28 0.28 0.64
0.27 0.31 0.68
0.42
0.37
0.41
0.50
0.53
2.73 1.23 1.50
2.61 1.05 1.56
2.84 1.31 1.53
3.28 1.14 2.15
3.15 1.03 2.12
______________ 3 The analysis in this Notes is limited only to BIR tax revenue performance. 4 The change in tax-to-GDP ratio for each tax type for each year in 2005–2007 is always measured relative to the tax-to-GDP ratio in 2004. For each of the major tax type shown in Table 3, the contribution of the change in economic structure to the observed change in tax effort was derived by estimating the amount of tax revenue that would have been collected if there were no changes in the composition of the economy relative to 2004 (i.e., if the tax-base-to-GDP ratio was kept at the 2004 level). On the other hand, the contribution of the change in tax policy to the deterioration of tax effort was computed by estimating the amount of tax revenue that would have been collected if the effective tax rates that were prevailing in 2004 were applied to the current year’s tax base. Meanwhile, the contribution of change in collection efficiency was derived as a residual. That is, what cannot be explained by the first two factors was attributed to improvement/deterioration in collection efficiency.
age points of GDP in 2006 and 2007, respectively, following the enactment of new tax measures in 2004 and 2005.4 But what is perhaps more interesting is the fact that the overall BIR tax-to-GDP ratio would have been higher than it actually was during the period under study if collection efficiency had been maintained at its 2004 level. This finding stands in stark contrast to the great expectations generated by the passage of the Lateral Attrition Law in 2004. It should be noted, however, that said law was not implemented until 2007. PN 2008-07
Policy Notes
4
Table 3. Decomposing change in BIR tax effort, 2004–20071 2005 Tax policy Economic Tax Structure Leakage
% of GDP Value added tax Excise tax on tobacco products Excise tax on alcoholic products Excise tax on petroleum products Individual income tax Corporate income tax Tax on interest income from bank deposits Tax on interest income from T-bills Tax on banks Other taxes Total BIR taxes
Total
2006 Tax policy Economic Tax Structure Leakage
Total
2007 Tax policy Economic Tax Structure Leakage
Total
0.06 0.10
0.05 -0.06
-0.14 -0.08
-0.03 -0.04
0.69 0.10
0.02 -0.09
-0.02 -0.03
0.69 -0.03
0.71 0.13
0.19 -0.15
-0.36 -0.10
0.53 -0.12
0.07
-0.02
-0.06
-0.02
0.06
-0.02
-0.10
-0.06
0.14
0.00
-0.18
-0.04
-0.02
0.03
-0.04
-0.03
-0.13
0.02
-0.04
-0.16
-0.12
-0.01
-0.09
-0.22
0.04
-0.08 0.81 0.01
0.17 -0.70 0.00
0.08 0.15 0.00
0.25
0.00 0.50 0.01
0.10 -0.20 0.02
0.10 0.55 0.02
0.25
0.20 0.50 -0.04
-0.12 0.18 -0.01
0.08 0.93 -0.05
0.00
-0.01
-0.01
-0.04
-0.08
-0.12
-0.21
-0.01
-0.23
0.01
0.00
0.02 0.40
0.07 0.22 1.21
0.00
1.03
-0.01 0.16 -0.22
0.05
0.75
0.02 0.11 0.23
0.06
0.26
0.00 0.09 -0.78
1.16
0.48
0.00 0.18 -0.51
0.05 0.24 1.12
change in tax effort measured relative to 2004 - negative number implies increase in tax leakage relative to 2004 1
The deterioration in the collection efficiency was quite significant (estimated at 0.8 percentage point of GDP) in 2005. BIR collection efficiency registered some recovery in 2006 but the improvement was not enough to result in a complete turnaround. Furthermore, the gains were not sustained in 2007. This story is repeated with respect to most of the major taxes as shown below. Excise tax on sin products. As indicated earlier, RA 9334 provides for discrete increases in the tax rate on cigarettes and alcoholic products in 2005 and every other year thereafter until 2011. Contrary to expectations, though, excise on tobacco products declined from 0.47 percent of GDP in 2004 to 0.35 percent of GDP in 2007. A large part of this reduction was due to the decline in the volume of production of tobacco products as proxied by PN 2008-07
Policy Notes
the gross value added (GVA) of tobacco products in real terms.5 In 2006, the drop in the production of cigarettes and other tobacco products almost completely wiped out the expected increase in tax revenues due to the higher tax rates. In 2007, the fall in tax revenues due to the decline in the volume of production was even greater than the projected increase in tax revenues as a result of the amended tax rates. However, it is also notable that the revenue impact of the lower production volume was further exacerbated by the higher tax leakage (as measured relative to the 2004 level) during the period under study, particularly in 2005 and 2007. ______________ 5 The significant drop in volume of production of tobacco products observed in 2005–2007 is surprising given the low own-price elasticity of demand for cigarettes (-0.042) that is estimated for the Philippines (Selvanathan S. and E. Selvanathan).
5
On the other hand, excise tax on alcoholic products dipped from 0.33 perpcent of GDP in 2004 to 0.29 percent of GDP in 2007. Unlike that of the tax-to-GDP ratio of tobacco products, the decline in the tax-to-GDP ratio of alcoholic products in 2005–2007 is largely attributable to the higher tax leakage during those years. The expected revenue gains from the higher tax rates imposed under RA 9334 were completely obliterated by the higher tax leakage in 2006 and 2007. Although the volume of production of alcoholic products (as proxied by the GVA of beverages in real terms) fell in 2005 and 2006 (as compared to 2004), a complete recovery was evident in 2007. Value added tax. As indicated earlier, the reformed VAT law which expanded the coverage of the value added tax was passed in early 2005 but took effect in November 2005. In 2006, President Gloria Arroyo subsequently raised the VAT rate from 10 to 12 percent. The VAT-to-GDP ratio rose from 1.65 percent of GDP in 2004 to 2.18 percent in 2007. This improvement is primarily attributable to the increase in the VAT rate that took effect in early 2006. The analysis also shows that the changing composition of nominal GDP likewise had a positive impact on tax collections. However, the VAT-to-GDP ratio could have been higher had the tax leakage not increased during the period under study relative to the 2004 level. Corporate income tax. RA 9337 not only expanded the coverage of the value added tax but it also increased the corporate income tax
rate from 32 to 35 percent from November 2005 to December 31, 2008. Corporate income tax effort went up from 2.7 percent of GDP in 2004 to 3.6 percent of GDP in 2007. Improvement in tax-to-GDP ratio in 2005–2006 was due to the combined effect of the change in the tax rate policy and the change in economic structure. These two factors more than countered the increase in tax leakage in those years. The improvement, however, in collection efficiency in 2007 is noteworthy. Gross receipts tax on banks. RA 9337 also increased the gross receipts tax on banks and other financial institutions. Largely as a result of this policy change, tax effort went up from 0.21 percent of GDP in 2004 to 0.28 percent in 2006 and 0.27 percent in 2007. Excise tax on petroleum products. As part of the so-called mitigating provisions of RA 9337, excise tax on selected petroleum products (e.g., diesel and bunker fuel oil) was reduced. Following this, the excise tax revenues from petroleum products went down from 0.37 percent of GDP in 2004 to 0.15 percent in 2007. The decline in the tax-toGDP ratio may be attributable to the combined effect of lower tax rate and increased tax leakage. In 2005–2006, decline in tax effort could have been worse if not for the compensating change in economic structure. Individual income tax. The individual income tax effort improved from 2.07 percent of GDP in 2004 to 2.13 percent of GDP in 2007. While the tax leakage appears to have decreased in PN 2008-07
Policy Notes
6
2005 and 2006 relative to 2004, it appears to have worsened in 2007. Prospects for sustainability of tax effort improvements As seen in the detailed performance of BIR taxes, the gains in BIR tax-to-GDP ratio observed in 2005–2007 do not appear to be sustainable in the medium term. First, the gains in BIR tax effort during this period are largely due to change in tax policy rather than improvement in collection efficiency. The record of the BIR and BOC in meeting their revenue goals has been erratic and frequent changes in leadership have not helped any. There are also indications that the very intense focus of the tax collection agencies and the Department of Finance (DOF) in meeting revenue targets may have had adverse effects on collection effort in periods other than the very near term. Said focus may have also distracted efforts to institutionalize systematic reforms in systems and procedures. Second, the positive revenue impact of the excise tax amendment and the reformed VAT law is expected to wane in the next three For further information, please contact The Research Information Staff Philippine Institute for Development Studies NEDA sa Makati Building, 106 Amorsolo Street, Legaspi Village, 1229 Makati City Telephone Nos: (63-2) 894-2584 and 893-5705 Fax Nos: (63-2) 893-9589 and 816-1091 E-mail: rmanasan@pids.gov.ph; jliguton@pids.gov.ph The Policy Notes series is available online at http://www.pids.gov.ph. Reentered as second class mail at the Business Mail Service Office under Permit No. PS570-04 NCR. Valid until December 31, 2008.
PN 2008-07
Policy Notes
years as both measures have built-in sunset provisions.6 The reformed VAT law temporarily raised the corporate tax rate to 35 percent but this rate is scheduled to be reduced to 30 percent in 2009. As a result, the corporate income tax take is expected to decline by 0.5 percentage point of GDP, other things being equal. On the other hand, after the mandated adjustment in excise tax rates on sin products takes place in 2011, they will remain fixed at that level in nominal peso terms unless Congress passes a new law mandating otherwise. Third, RA 9504 was passed in early 2008 in order to give some (tax) relief to minimum wage earners. However, it did so by increasing the amount of so-called personal exemptions for all income taxpayers. The revenue loss arising from this provision is estimated at PhP55 billion (or 0.8 percentage points of GDP) if the new personal exemption levels are applied for the full year. Finally, new tax measures aimed at generating additional revenues (e.g., rationalization of fiscal incentives and further amendment of the excise tax on sin products aimed at applying uniform rate to minimize evasion) will face rough sailing in Congress in the near to the medium term, precisely because of the deterioration in collection efficiency in 2005– 2007. ______________ 6 The thinking at the time these laws were debated in Congress was that the increase in tax rates will not, in general, be permanent but are necessary to increase the overall tax take in the interim while the collection agencies put in measures to improve tax administration.