A. Key Features of the Philippine Tax System

A. Key Features of the Philippine Tax System

5. 
   The value-added tax (VAT), corporate income tax (CIT) and personal income tax (PIT) account for over two-thirds of the entire tax intake in the Philippines.¹ The statutory rates applied on each of these tax categories tend to be somewhat higher than those applied on average elsewhere in the region or in countries with similar levels of development (Table 2). However, the revenues generated by these taxes as a share of GDP are not proportionately higher. That is, the Philippines exhibits a comparatively low tax efficiency relative to its neighbors or other countries with similar levels of development. This may be signaling the presence of significant tax loopholes and weak tax administration. In 2008, World Bank staff estimated that if tax administration were strengthened and leakages in tax collection were plugged, the Bureau of Internal Revenue (BIR) would collect 60 percent more in income taxes and VAT – which would have amounted to 4 percent of GDP on average in 2000-2006.² Important features of the tax system that contribute to tax leakage and evasion in the Philippines are summarized next.
   

6. 
   Value-Added Tax. The VAT is a well designed tax, though its efficiency and yield could be improved. Introduced in 1988, it has a relatively broad base, a single and low (positive) tax rate, and a reasonable exemption threshold. These features facilitate both the administration and compliance with the tax. It is estimated that the VAT is neutral to broadly progressive since it contains standard VAT exemptions for products that are heavily consumed by the poor (e.g., basic consumption staples). The VAT base was broadened in 1994 with the inclusion of services and again in 2005 with the inclusion of petroleum products and electricity. Each round of VAT base broadening noticeably increased the efficiency of the VAT (Figure 1). However, these efficiency gains did not prove sustainable over time. For example, 70 percent of the efficiency gains achieved from the 2005 VAT reforms were lost by 2009. This efficiency erosion is due to a mix of weak tax and customs administration and tax policy measures that reversed the initial broadening of the VAT base (such as the replacement of the VAT on electricity transmission in 2009 by a lower yielding and less efficient franchise tax).
   

Figure Philippines: Evolution of VAT Efficiency; 1997-2009	Figure Philippines: Progressivity of the PIT; 2000 vs. 2006
Source: BIR, BOC, and World Bank staff calculations. 1/ Ratio of VAT revenues to GDP divided by the statutory VAT rate. 2/ Ratio of VAT revenues to consumption divided by the statutory VAT rate.	Source: FIES 2000 and 2006 and World Bank staff calculations

7. 
   Corporate Income Tax. The CIT is overly complex and characterized by an extensive regime of tax exemptions or “incentives”. Widespread tax incentives—mostly in the form of tax holidays—significantly distort economic activity by discriminating between different types of businesses, reduce the tax base, and impose high effective tax rates (by regional standards) on companies that are not eligible to receive them. High effective rates, in turn, generate profound inequity among taxpayers, both horizontally (as companies with the same reported profit pay vastly different taxes)³ and vertically (as taxpayers with high profitability could be paying less tax than those with much lower profits). Large inequities of this sort, alongside a complex and non-transparent system, promote the perception of ‘unfairness’, and are known to noticeably reduce voluntary tax compliance and increase corruption opportunities. Tax incentives also tend to generate tax redundancies (i.e., subsidizing firms that would have invested anyway).
   
8. 
   Personal Income Tax. Compliance with the PIT is very low so that actual progressivity is minimal and falling over time. Much of this problem is due to poor tax administration, as the top marginal tax rate is fairly high by regional standards. The bulk of the problem arises with self employed professionals (SEPs): a weak capacity in detecting and enforcing tax liabilities, particularly of SEPs, has had the result that income tax payments accounted for only 4.7 percent of the total spending of the 1 percent richest households of the country in 2000 (and far less as a ratio of their income). This compares to an average tax rate of over 20 percent (using the maximum standard deductions). By 2006, the same top 1 percent of households was devoting an even smaller share (3.1 percent) of its total spending on income tax payments. Figure 2 shows the drop in effective income tax progressivity between 2000 and 2006.
   

9. 
   Excise Taxes. The revenue yield from excises has declined drastically since 1997 due to the erosion of the real value of excise rates. From 1997 to 2009, excise collection as a share of GDP fell by 70 percent, or by 1.8 percentage points of GDP (Table 1). The annual losses in excise collection since 1997 add up to a staggering 18.2 percentage points of GDP once interest costs are included.⁴ Maintaining the 1997 excise effort level would have resulted in a much lower public debt (at present exceeding 60 percent of GDP), freeing up fiscal resources that are currently needed to service the debt for much needed public spending in priority areas.
   

10. 
    Most of the decline in excise tax revenues is accounted for by petroleum excises. Considering that petroleum excises are broadly as progressive as personal income taxes in the Philippines and more progressive than the VAT (Figure 3), the decline of this tax has noticeably eroded the overall progressivity of the tax system. In contrast to petroleum excises, tobacco and alcohol excises are regressive. The tobacco excise tax rates and burden in the Philippines are among the lowest in South East Asia.⁵ A major downside of this policy stance is that the country has become the largest consumer of cigarettes among ASEAN countries (and 15^th worldwide), where almost one fifth of Filipinos begin smoking before the age of 10 and prevalence is increasing.
    

11. 
    Tax Administration. The preceding discussion noted that tax efficiency has tended to be somewhat lower in the Philippines than in other countries in the region. Table 3 presents some operational statistics on the internal revenues agency in the Philippines compared to agencies elsewhere. The Philippines’ BIR stands out in this comparison by having a very low ratio of BIR staff to the overall population; only about 0.13 staff members for every 1000 inhabitants, while the regional average is almost four times greater. Also, the last row in Table 3 shows the Philippines with the highest ratio of individual taxpayers to administrative personnel among all the comparators (609 versus the East Asian average of 579). From this it would appear that the BIR is operating very efficiently. When taking into account the relatively poor tax efficiency performance indicated earlier in Table 2, however, these figures suggest that the BIR is simply not making a strong enough tax effort. This could account in part for the comparatively low cost of administration as percent of the revenues collected (first row in Table 3). Another indication of low tax effort is the low percentage of taxpayers in the Philippines: there are only 79 taxpayers registered in BIR for every 1000 inhabitants, while the East Asian and Pacific average is 284 taxpayers per 1000 inhabitants.⁶ That is, the BIR’s capacity or willingness to draw in potential taxpayers appears to be limited.
    

12. 
    Tax evasion in the Philippines is estimated to be high and weaknesses in tax administration are systemic, including shortcomings in overall management and integrity. Despite this, previous tax administration reform efforts in the BIR have been partial rather than systemic, and ongoing efforts have been focusing on the pursuit of short-term revenue targets and the technical strengthening of specific functions or units, rather than on overall institutional reform. The short-term focus on revenue targets reflects the Executive’s need to compensate for an increasingly weak and distorted tax system, largely due to a series of tax-eroding measures passed by Congress.⁷ However, this does not appear to be the most promising way to increase tax collections. Only a more systemic institutional reform can deliver on this objective. The main shortcomings in tax administration that need to be addressed in this regard encompass the registration, audit, enforcement and collection processes, and can be summarized as follows:
    

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  Registration. The taxpayer registration system is outdated, containing many old and invalid entries, and excluding a large number of eligible taxpayers.
  
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  Large taxpayers’ service (LTS). The LTS roster is not up-to-date and the process of selection/de-selection into the unit is not automatic, but depends on the Commissioner.
  
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  Audit. The audit system is weak and the frequency of audits is low. Contributing to this weakness are (i) the absence of an audit plan, (ii) understaffing of the audit unit of the BIR and, especially, of the LTS, and (iii) weak supervision of audits as the national office receives limited feedback on audit outcomes from the regional offices. As a result, many taxpayers perceive the audit system as non-transparent, biased and abusive.
  
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  Enforcement. Tax enforcement is limited as identified tax evaders are rarely prosecuted. Instead, they are often granted amnesties or able to secure an abatement and case dismissals.
  
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  Collection. Collection is poor because the BIR has little information on the actual amounts of receivables and tax arrears, and no explicit collection strategy.