January 24, 2018| Ateneo de Manila University
Before anything else, let me thank the students and teachers who made this information session possible. It gives me hope that high school students are keen on understanding policies that have implications on the country’s development. I think that not enough young Filipinos concern themselves with the affairs of the nation, which is quite unfortunate.
After all, it’s you guys who will inherit the country we are trying to build. It is you who might steer its path as future leaders. Having said this, I commend your efforts in trying to bridge the information gap between the government and the general public.
The participation of young students, armed with fresh ideas and contagious enthusiasm, will only brighten the country’s development outlook.
Preliminaries on Taxation: Why We Pay Taxes
As an Economics professor, I think it’s important to establish some concepts on taxation before we go into the details of the Tax Reform for Acceleration and Inclusion (TRAIN) Law. This will give you the tools to better appreciate tax reform, now or even in the future. Think of this as a crash course on tax policy. So let’s start with a central question: why do we pay taxes?
The most obvious reason for paying taxes is to fund the provision of public goods and services. For the purposes of this discussion, let us just define “public goods and services” as goods and services that benefit the general welfare of the people.
In our case, “public goods” would include national defense, administration of justice, internal security, conduct of foreign policy, some types of infrastructure, and all sorts of programs implemented by the government. The point is without taxpayer money, the government will not be able to provide its citizens with such “public goods and services”.
Another reason for taxation, which may not be too obvious to you at this point, is to approach a more equal society. One of the ways to redistribute wealth is with tax policy. Once you start working and filing for taxes, you will find out that those who earn more also pay more taxes - this is called progressive taxation. And as discussed earlier, the revenues collected from taxation will be channeled to poverty-alleviation and development interventions.
You can see this principle applied to the TRAIN Law. As your income bracket goes up, you give up a larger share of your income as taxes. All those earning P250,000 and below pay zero income tax, while those earning more than P8 million pay as much as 35 percent. I will discuss this more in detail later.
The third reason for paying taxes is to correct for harmful behaviors that affect many people (the technical term for this is negative externalities). For instance, a strong argument can be made that factories spewing toxic chemicals should be asked to pay taxes.
These chemicals do not only pollute the environment but also pose health concerns to people around the area. Imposing taxes on such activities can correct for negative effects of some economic activities.
In short, we pay taxes to finance projects for the common welfare, to approach a fairer society, and to correct for harmful activities. Keep these things in mind as we move along.
Preliminaries on Taxation: Desirable Characteristics of a Tax System
Next, let’s outline some characteristics of a good tax system. This will explain to you why we need to reform the Philippine tax system to begin with.
The first characteristic we are looking for is a buzzword for economists - efficiency. When we say a tax system is efficient, it means that it allows resources to flow into their most productive uses.
Next, we want the tax system to be administratively simple. A tax regime that is difficult to administer will lead to loopholes and leakages on the part of government.
For taxpayers, it will also mean unnecessary costs like complicated paperwork and even wasted time. We want to reduce these complications to a minimum.
The third characteristic we look for in a tax system is flexibility. Ideally, the taxes imposed should adjust to the changing economic conditions like the prices of goods and services.
Fixed taxes have the tendency to be outdated once they no longer reflect prevailing economic conditions.
Fourth is fairness. When we say fairness, we think of equity rather than strict equality. This means that those who have a higher capacity to pay should pay more.
In the same manner, similarly-situated individuals should be treated similarly.
With these basic concepts you students now have a simple framework by which to evaluate any tax system. Our discussion on the TRAIN Law will serve as a case study of sorts given the framework we have established.
The importance and effects of TRAIN
When we speak of TRAIN, we are actually talking about a series of packages to be proposed by the Department of Finance (DOF). Ultimately, however, it is Congress that passes these laws because it is their job according to our Constitution.
Today, we will only discuss Package 1A. But keep in mind that there is a Package 1B and three (3) more tax reform packages before the term of the President ends.
The essential features of Package 1A include: (1) lowering the personal income tax rates, (2) reducing exemptions in the Value-Added Tax base, (3) increasing taxes on petroleum products and automobiles, and (4) introducing taxes for sugar-sweetened beverages.
The ultimate goal is to raise revenues to finance the government’s priorities, namely upgrading infrastructure and reducing poverty. Taking Package 1A and 1B together, about P1 trillion will be raised between 2018 and 2022. TRAIN will also enforce a simpler, fairer, and more efficient tax system. So let us dissect Package 1A with the tools I explained earlier.
First is the lowering of personal income tax rates. Prior to TRAIN, the personal income tax rates of the Philippines were last adjusted in 1997. Can you imagine that the maximum tax bracket before was just P500,000? On a monthly basis, it means that someone who earns P41,666 a month will already belong to the highest tax bracket.
Such heavy taxes squeezed the pockets of a lot of workers. Maybe the tax bracket was appropriate in 1997, but accounting for inflation over the past two decades, then this doesn’t make sense anymore.
With TRAIN, the income tax payment of 99 percent of wage earners will be lower. In contrast, those earning more than P8 million annually will pay higher taxes at 35 percent, whereas the highest tax bracket before was 32 percent. I think it’s fair enough to say that those earning almost P700,000 per month should pay higher taxes.
Another argument is that lowering taxes will incentivize people to work harder. A high tax rate is like punishing people for working – imagine a 90 percent tax rate, perhaps everyone will stop working.
Here are some sample calculations for you to better appreciate the reduced income tax rates with TRAIN. A call center agent with an annual salary of P252,000, or a monthly salary of P21,000, used to pay taxes amounting to P21,867. With TRAIN, he/she will be tax exempt as his annual taxable income falls below P250,000.
We applied the same calculations with a clerk whose annual salary is P184,416, or a monthly salary of P15,368. With TRAIN, the said clerk will save up P7,282 in reduced tax payments.
Next, TRAIN also reduces the exemptions in the Value-Added Tax (VAT) system. When you buy food or clothes or whatnot, you will notice a 12 percent VAT amount in your receipts.
For simplicity’s sake, this means that you pay about 12 percent on top of the actual price of a product you bought. Again, such revenues are collected by the government for important programs and projects.
The problem with our VAT system is that too many exemptions have been granted. Ideally, VAT exemptions should be limited to necessities like raw agricultural food, education, and healthcare.
Unfortunately, our legislators have allowed them to spillover to other sectors who otherwise should not enjoy VAT exemptions. TRAIN alleviates this situation as it repeals 54 out of 61 exemptions.
The first advantage is that it will improve efficiency in our tax system. We have a 12 percent VAT rate, yet our collections from VAT is only equal to 4 percent of Gross Domestic Product (GDP). Think of GDP as the size of the entire economy.
In comparison, Thailand has a 7 percent VAT rate but also collects VAT-revenues amounting to 4 percent of GDP.
The takeaway here is that our VAT system had too many loopholes because a higher rate should result to higher collections. With TRAIN we try to keep exemptions to a minimum like low-cost housing, purchases of senior citizens and persons with disabilities, among other things.
Here, you can see the VAT rates across different countries as well as their respective VAT collections as share of GDP. With a higher VAT rate, it should be normal that collections should also go higher. Evidently, the Philippine VAT tax base has many exemptions and loopholes.
Besides Thailand, some countries have lower VAT rates but still collect a higher share of VAT revenues as a share of GDP. An example would be Vietnam (with a 10 percent VAT), and other East Asia and Pacific countries (with an average VAT rate of 8.4 percent, yet collects revenues of 5.2 percent of GDP).
Now you understand the revenue argument: less exemptions and loopholes will result to more collections for the government. Now, let’s look at the equity argument.
A tax system is said to be fair if similarly-situated individuals are treated the same way. Do you know that boy and girl scouts used to enjoy some VAT exemptions?
Is there any good reason to exempt a boy or girl scout, but not exempt students like you? So the expanded VAT system also responds to our equity objective.
We will move on to the most controversial provisions, which are the taxes on petroleum products, automobiles, and sugar-sweetened beverages.
But before I explain, let me tell you that TRAIN should be evaluated as a package. One can always nitpick a negative feature with TRAIN, but don’t miss the big picture.
The government gave up P150 billion in 2018 alone in order to ease the income tax burden on our workers. But we have to recover this monumental loss from other sources.
This is the wisdom behind the other features of Package 1A. But it will also be foolish to say that the government recklessly imposed higher taxes on other goods and services just to raise additional funds like any monarchy in the Middle Ages. This is definitely not the case.
Let’s analyze the controversial features one step at a time.
The taxes on petroleum products, like personal income tax rates, were also last set in 1997. This has led to foregone revenues of about P140 billion a year for the government.
Obviously, the old petroleum taxes do not anymore reflect the current economic conditions and prices.
Here is the schedule of taxes for the petroleum products. First, you will notice that the taxes will be imposed gradually rather than in one swoop. Compared to their current rates, the taxes on some products have even doubled compared to their previous rates. These petroleum taxes may seem burdensome at first glance, but let me explain why it is fair.
Critics say that this reform is anti-poor because it will adversely affect jeepney drivers and poor farmers who are the heavy users of petroleum.False. In fact, official government statistics do not confirm this.
The Family and Income Expenditure Survey (FIES) in 2015 shows that the top 10 percent of households account for 51 percent of total fuel consumption. At the same time, the richest 1 percent of households consume as much fuel as the poorest 50 percent of households.
Again, the takeaway is crystal clear: it is the rich who consume more fuel with their numerous cars and so forth. This is the fairness argument.
Another point that we take for granted is that petroleum products impose a cost on the environment and to the health of people. We must take into account these costs to correct for such behaviors.
Raising taxes on petroleum products is one way of protecting the environment.
All these arguments justify the increased taxes on petroleum, such that diesel taxes will go up to P6 per liter and P10 per liter on gasoline by 2020.
The argument for higher taxes on automobiles is similar to petroleum products. It is the rich who have more cars.
The taxes for automobiles will also follow a progressive scale such that luxury cars will be taxed more than regular cars. Here you can see that cars priced P4 million and above will be taxed at 50 percent. On the other hand, cars that cost below P600,000 will be taxed at only 4 percent.
Besides revenue and redistribution gains, it will also correct for the traffic congestion costs that car-owners impose on the general public. The traffic situation in Metro Manila is so bad, but we have to acknowledge that car owners oftentimes aggravate the situation.
You may have one car for one person, which is not very space-efficient compared to say a bus or a train.
Last on the list are the taxes for sugar-sweetened beverages. It is primarily a health measure which doubles as a revenue measure. It aims to curb the consumption of sugar-sweetened beverages which contributes to the diabetes and obesity cases in the Philippines while also raising ample revenues.
Under TRAIN, an excise rate of P6 per liter will be taxed on drinks containing sweeteners, and P12 per liter on drinks containing high-fructose corn syrup.
To shield most Filipinos, 3-in-1 coffee and milk are exempt from this tax.
Now that I have explained the particular features, let me discuss the objective of the whole package. As mentioned, Package 1 will raise about P1 trillion in revenues for the next five years and improve our tax system.
Here you see the breakdown of each feature, as well as the aggregates for the entire package. It is noteworthy that the personal income tax cuts will lead to losses as much as P150 billion in 2018. And as mentioned, this will be made up by the revenue-generating features with the expansion of the VAT base, the oil excise taxes, the sugar-sweetened beverage taxes, and tax administration improvements.
The revenues generated, which equate to almost 1 percent of GDP, will be key to modernizing our public infrastructure and sustaining our social services programs.
From the revenues of TRAIN, 70 percent will go to infrastructure projects. This means roads, bridges, airports, seaports, and even school buildings and hospitals for all Filipinos.
It means spending more time with our families, rather than spending more time on the road with the horrible traffic.
It means expanding economic opportunities to the poor with improved mobility and a more comfortable public transport system.
It also means better accessibility of services, particularly schools and hospitals, for the poor.
For the next six years, it also means providing jobs, especially in construction, such that some Filipinos need not go abroad to look for work.
On the other hand, the other 30 percent of TRAIN revenues will go to social services programs. It will help fund free college education in State Universities and Colleges, the National Health Insurance Program, the Conditional Cash Transfer Program, among other poverty-alleviating interventions.
For a young and developing country like the Philippines, whose median age is 23 years old, we must prioritize developing our youth. This means giving them the best education and healthcare public money can buy.
At the end of the day, a country’s greatest resource is its people. Without TRAIN, the government will lack the funds to finance these development priorities.
Addressing the Misconception on TRAIN
Before I open the floor for questions, allow me to address the main criticism on TRAIN: that it is anti-poor. They say that TRAIN will ease the lives of the middle and upper-classes while imposing a heavy burden on the informal workers and minimum-wage earners who are tax-exempt even before TRAIN.
We, in the government, have already thought of mitigating measures to protect the poor from potential price increases.
In 2018, a cash transfer of P200 per month will be given to the poorest 50 percent of households in the Philippines, or the poorest 10 million households in the country.
In 2019 and 2020, the cash transfer will go higher at P300 per month per household.
The Bangko Sentral ng Pilipinas and other government institutions have also projected the rate of increase in prices given TRAIN. Despite the higher taxes, inflation (or the rise in prices) is still pegged to remain at 2 – 4 percent from 2018 to 2022.
Here is a sample of products and their projected price increases with TRAIN. It will be noted that such price increases are very moderate, whether in food or non-food products. The biggest price increase is really just with the petroleum products. Nevertheless, the cash transfers to be provided by the government should be more than enough to make up for the slight upward adjustment in consumer prices.
In total, the personal income tax cuts and/or the cash transfers will more than offset the costs to households with the higher prices. This is not mere speculation, but backed by formal studies by government institutions.
More so, the budget for these cash transfers is already included in the National Budget.
The appropriate way of assessing the TRAIN is to look at its “net incidence”: by looking at the additional burden on the tax side versus the additional benefit on the expenditure side.
The tax revenues to be collected will not be stashed by the government as if it was stolen from the people. Rather, it will be spent on the pressing needs of the country, which will benefit the poor the most.
After all, it’s the poor who send their children to public schools, public hospitals, and avail of government-provided services.
It’s the poor and working class who will benefit the most from an improved public transport system, and so forth.
In closing, the TRAIN Law is a reform initiative that is crucial to the poverty-reduction and economic development goals of the country.
It amends an outdated, inefficient, and unfair tax system while raising enough funds to enable the country to reach its potential.
For perspective, here are some of the things that the TRAIN Law can fund in the next five years:
- 629,120 public school classrooms, or
- 2,685,101 public school teachers, or
- 60,483 rural health units, or
- 484,326 barangay health stations, or
- 1,324 provincial hospitals, or
- 35,745 kms of paved roads, or
- 786,400 kms of temporary bridge upgrades, or
- 2,665,763 hectares of irrigated land.
Imagine being able to accomplish any of these things.
Still, tax reform is not a walk in the park. There will be winners and losers.
What is important is that the gains outweigh the losses, while simultaneously protecting the welfare of those who will be negatively affected.
Thank you and I am now ready to take your questions.