Simplifying the tax system: The way to go

THE Philippines does not lack for a comprehensive tax system. In fact, we adopted the best from both worlds—United States and Europe, with a plethora of taxes that are all-encompassing in coverage.

The tax net covers anything that moves, figuratively speaking.

There is a tax bite when income is earned, when it is spent and when it is distributed.

Even after death, an individual’s assets accumulated during his lifetime and already taxed, is again subject to the estate tax.

The current tax system is the product of the collective and brilliant minds in both the executive and legislative departments of government spanning many administrations.

Yet, it is a fact that the system does not yield sufficient tax revenues for the government.

Collection efficiency

For over a decade since 1997, tax collection efficiency had been in the cellar between 12.5 to 14 percent of GDP. Proceeds from privatization and borrowings are used to close the yawning budget gap.

As a result, national patrimonial assets are fast depleting and debt keeps soaring. Social services are wanting and infrastructure remains woefully deficient.

The national debt was P2.166 trillion nine years ago in 2000. Since then, it had more than doubled to P4.458 trillion as of March 2010. The debt is equivalent to a large 56.6 percent of the annual gross domestic production of goods and services.

A serious rethinking of the government’s approach to taxation is necessary to extricate us from this quagmire.

A study by Ibon shows that “tax reforms in the Philippines cannot work unless they form part of a more comprehensive public sector program.”

Perhaps not, if we bring in the nuclear option, i.e., the ultimate tax reform—by drastically simplifying the system and limiting it to just two major classifications of domestic taxes—a direct final percentage tax on gross receipts or earnings, similar to a gross receipts tax (GRT), to replace the complicated and leakage-prone tax on net earnings or income tax.

The other will be an indirect tax—the consumption tax, in the form of the present value-added tax (VAT). All other taxes that clutter the tax code should be discarded and replaced by either of the two taxes. Complementing these two domestic taxes will be the tax on international trade to complete the tax lineup. These three types of taxes shall comprise the revenue generators of the government.

Simplifying the tax system

This proposed revision will simplify the tax system and vastly facilitate and improve administration while providing a no-brainer system for taxpayers to comply.

Voluntary compliance will be encouraged resulting in more tax revenues for the perennially cash-strapped government. Our experience shows that throwing new taxes or higher rates at the problem is not the solution.

Aside from its simplicity, the final GRT has the distinct and significant advantage of being able to provide the government a monthly revenue stream. Monthly tax remittances will be easier on the pocket and would appeal to taxpayers in our country. There would be no need for the taxable quarter or year to end to file the annual income tax return. The benefits of the GRT are most compelling.

The present income tax on businesses is influenced by three factors —revenue, cost of sales and cost of operations, all of which are susceptible to creative accounting. In the case of individuals, they are earnings and deductible expenses.

The final GRT will reduce these three to only one. Both tax administrators and taxpayers need only establish the gross receipts or earnings. Cost of goods sold, a tricky calculation will become irrelevant as well as operating expenses.

The focus will be singular—on revenue, which is the same under the existing input-output system of value-added taxation. In this respect, the GRT and the VAT will complement each other, which is good as it will provide a cross-checking mechanism.

Percentage GRT

Conceptually, this percentage GRT is not entirely new. It is currently employed at the national level, albeit in a limited way, as a direct and indirect tax. This proposed GRT will be a final direct tax not transferable to consumers unlike the existing GRT on banks and VAT.

Existing examples of the final direct GRTs at the national level are the 0.5 percent transaction tax on sales of shares of stock through the stock exchange and the tax on passive incomes, such as the 6-percent capital gains tax on proceeds from disposition of real property, the 10-percent tax on cash dividends and 20-percent tax on interest income.

The GRT is also employed at the local level as a business tax imposed by cities with rates that vary from 1 to 3 percent on gross receipts. It is the flagship tax of cities and is working fine so there is no reason why, at the national level, it should not.

The main challenge will be devising appropriate tax rates that will not cause dislocation of government revenue while not confiscatory of the earnings of taxpayers.

A flat tax on gross receipts with one rate applicable to all will not be equitable and will not work. Different businesses have different levels of profitability and should be taxed accordingly.

Some like commodity trading operates on slim mark-ups, while others such as manufacturing, importation of goods and provision of services have higher mark-ups and ought to be taxed at higher rates.

As with the local business tax, rates specific for each particular business sector and profession will be appropriate. Benchmarking each sector based on historical data will provide the basis to establish the rates.

One risk that will be in the minds of policymakers is the possible drastic fall in tax revenues after the proposed GRT system is instituted. This risk may be minimized or altogether eliminated by back testing the GRT against historical data of specific sectors.

Reform measures

To simplify the tax system to the hilt, radical surgery is needed with all percentage sales and excise taxes abolished and replaced with the VAT. By such time, the VAT should have been rendered more palatable with offsets, such as VAT rebates for low income earners and conditional cash transfers to the poor, in lieu of price subsidies for basic needs.

Other reform measures should include standardizing different tax treatments. For instance, the distinction between ordinary and capital assets, which at the best of times is prone to abuse, must be discarded with both given similar treatment and taxed on the gross proceeds.

“Tax system inertia” is a formidable force that could hinder change. For over half a century since the inception of our tax system, we have been inculcated and immersed in a complex system such that we have become inured to its inefficiency. To make a clean break and shift to a simple and efficient system, like the one proposed here, will be a difficult and painful process.

To lessen resistance and for prudence sake, the change may be gradually eased into the system in stages. Initially, the final GRT may be introduced to individual taxpayers and businesses with gross receipts up to a prescribed threshold, say, P100 million. All others, including startups, may remain with the net income tax and migrate to the GRT after, say, three years. The switch to the VAT from the percentage and other excise taxes may follow.

The opportune time to introduce the first stage of the GRT may be midway through the term of this new administration. By such time, this paper may have provoked enough discussion to provide better clarity on the feasibility of this proposed final GRT. By such time, also, we shall have seen how far we can go with intensified tax enforcement, and with better motivated taxpayers.

Tax returns

Significantly, the tax returns filed during the intervening period under this new dispensation may be more reflective of the results of operations and earnings of taxpayers. Accordingly, we shall have a more accurate database to determine fairly representative sectoral benchmarks as a basis to establish the sectoral GRT rates for legislation of the GRT.

We have tried the complex without success; perhaps it is time to try the simple.

(The author is a certified public accountant, member of the Management Association of the Philippines (MAP) and its National Issues Committee. This article is excerpted from his forthcoming discussion paper: The Tax Revenue Side of the National Budget in the forthcoming Volume II of Knowing the National Budget. His “The National Budget: A Broad Overview” is the lead article of Volume I. The article reflects the personal opinion of the author. For feedback, email map@globelines.com.ph.) –Eduardo H. Yap, Philippine Daily Inquirer