B. Policy Options for Improving Tax Policy

B. Policy Options for Improving Tax Policy

13. 
    An improved tax effort calls for improvements along both the efficiency and equity dimensions of the tax system. Tax efficiency generally requires a broad tax base and low tax rates to minimize economic distortions, encourage compliance and limit corruption. Tax equity involves two important aspects: (1) vertical equity, which dictates that lower earning taxpayers should face lower effective tax rates, and (2) horizontal equity, which means that taxpayers with similar income or profits should face similar effective tax rates – where the stress on “effectiveness” refers to both the design of the tax system, as well as to compliance in its implementation. Using these fundamental principles as a guide to reforms, and taking into account political economy and administrative considerations, the following set of short- and medium-term actions offer opportunities for raising the tax intake, while improving the efficiency and equity of the tax system. Among these policy options, the first two sets of reforms (in paragraphs 14 and 15) could be implemented in the short term to achieve an immediate impact on revenues, while the next set of reforms (in paragraphs 16 and 17) are best implemented in a more gradual manner over the medium term.
    

14. 
    The following actions are recommended for reforming the system of Excise Taxes:
    

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  Automatic indexation to inflation: all specific excise rates should be automatically adjusted to inflation, preferably semi-annually but at least annually, so as to maintain their real value.
  
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  Raise excises on petroleum products (both gasoline and diesel but not kerosene) as a priority measure.¹ An excise on petroleum is efficient (since petroleum consumption has a low demand elasticity), progressive (in itself—as shown in Figure 3, but also in comparison to most other taxes), and addresses negative externalities associated with petroleum consumption (e.g., traffic congestion, accidents, pollution). Moreover, this tax is easy to administer, and both gasoline and diesel taxation in the Philippines are low by international standards, especially for diesel (Figure 4).
  
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  Introduce a temporary automatic and asymmetric adjustment mechanism if the desired increase in specific excise taxes is deemed too large for one adjustment.
  
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  Strengthen the anti-smuggling capacity, particularly for petroleum products, in the Bureau of Customs (BOC) and the BIR.
  
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  Rationalize and increase excise taxes on tobacco and alcohol: the multi-tiered rate structure needs to be harmonized; the lowest specific rates should be adjusted upwards towards the higher rates (at a minimum to return to the real 1996 value).²
  

Source: OECD, International Energy Agency, “Energy Prices and Taxes”.

15. 
    The following actions are recommended for improving the yield from the Value Added Tax (VAT), or at least avoid further erosion in tax collection:
    

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  Protect the simple and broad-based nature of the VAT, by resisting periodic calls for new exemptions.
  
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  Consider broadening the VAT base further (beginning with a reversal of the base-eroding measures that were recently introduced, especially in electricity transmission).
  
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  Eventually, the authorities might also consider increasing the tax rate beyond 12 percent, as this is relatively low by international standards.
  

16. 
    The following measure is recommended for improving the effectiveness of the Corporate Income Tax (CIT):
    

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  Undertake a structural reform aimed at broadening the tax base, lowering the tax rate, and simplifying the tax code. It is particularly important to combine the rationalization of fiscal incentives with a review of the statutory tax rate to ensure that, at a minimum, the CIT reform is revenue neutral. Such a reform would improve tax efficiency (less waste of public and private resources in complying with the tax), eliminate tax redundancies, sharply improve horizontal equity among firms, remove distortions in capital and labor allocations, and, greatly facilitate better tax administration and governance. Increases in taxes collected from some foreign corporations due to the rationalization of tax incentives need not increase the tax burden on these companies, but simply shift the ultimate beneficiary of the tax incentives granted by the Republic of the Philippines from the foreign company’s home Treasury to the Filipino Treasury (Fletcher, 2005).³
  

17. 
    The following actions would improve the performance of the Personal Income Tax (PIT):
    

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  Significant simplification of the PIT system. This involves keeping only a limited amount of deductions and credits, and simplifying the rates (potentially to a single positive rate), while keeping a high personal exemption threshold to ensure adequate progressivity and easier administration.
  
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  Alternatively, consider introducing a simple “flat” tax designed to be, at a minimum, revenue neutral. However, considering the urgent revenue needs, very low effective tax rates and limited progressivity of the tax system as it currently operates, a revenue-increasing reform would be warranted.