Last week, outgoing Secretary Cesar Purisima shared with the public the DOF's comprehensive tax reform proposal, which he hopes to pass-on to the incoming DOF team under President-elect Rodrigo Duterte.
Many could not help but wonder -- WHY ONLY NOW?
After two (2) years of discussing tax reform proposals in the halls of Congress, it is unfortunate that the DOF decided to release its own version of proposals with just a little more than 30 days before the new administration steps in. While they may say that the best time to pursue tax reform is at the start of a new President's term, I would say that the DOF lost a rare opportunity to initiate and lead discussions on tax reforms, which would help consolidate the position of various stakeholders in preparation for the next administration. At this point, the new leadership team under incoming DOF Secretary Carlos Dominguez can just take these recently released proposals (which seem to be overly generous compared with the previous hard stance of the DOF) with a grain of salt and embark on preparing its own set of proposals.
In any case, is there anything within the DOF comprehensive tax reform package, that will help address the concerns of individual taxpayers, like you and me?
The following are the proposed major changes in the tax system under the DOF package, which we need to know as individual taxpayers:
REDUCED INCOME TAX RATE OF 25%
Both individual and corporate taxpayers will be subject to a maximum tax rate of 25%. HOWEVER, this is pre-conditioned on the DOF achieving certain tax-to-GDP ratios (i.e., 14% to 16.5%) over 6 years.
As of November 2015, tax-to-GDP ratio stood at 13.72%. With this, the DOF's proposed reduction of income tax rate to 25% is NOT guaranteed. It will all depend on the BIR's collection efficiency, together with taxpayers doing their fair share in paying the right taxes on time.
P1M TAX EXEMPTION FOR WAGE EARNERS
This proposed generous amount of tax exemption was a big, big surprise, especially coming from the DOF's hard stance during the Congress hearings. Note that this is way above the Tax Management Association of the Philippines' (TMAP's) proposal at P300,000 and that of Bayan Muna Party-list at P396,000, which was based on the family living wage.
While this all-in tax-exemption is definitely most welcome, it is disconcerting to know that this proposal might NOT immediately address the long-standing issue of bracket creep. Since this generous proposal is part of a comprehensive tax reform package, which will definitely take some amount of time to be approved by Congress, wage earners will continue to be unjustly taxed with high tax rates based on the current tax brackets, which have not been indexed to inflation for the past 20 years, at the very least.
FIXED TAX RATE FOR SELF-EMPLOYED AND PROFESSIONALS (SEPs)
Under the proposal, wage earners and SEPs will be subject to different and separate tax systems. Similar with corporations, SEPs will be subject to fixed income tax rate, which will be reduced to 25% from the current maximum rate of 32%, subject to the same tax-to-GDP conditions mentioned above.
This seems to be a good move to help simplify taxation for this sector, which has failed to contribute significantly to BIR collections. However, to make this work for SEPs, the same corporate income tax provisions on Optional Standard Deduction (OSD) and Minimum Corporate Income Tax (MCIT) should be applied.
The only downside in having a fixed tax rate for SEPs is that it makes the tax system regressive since those earning a little will be taxed at the same rate as those earning a lot.
INCREASE IN VAT RATE FROM 12% to 14%
To help offset the resulting revenue losses from its proposals, the DOF proposes to increase the VAT rate by 2%. This means that the DOF will impose higher taxes based on consumption, rather than on income. Conceptually, this appears to be fair since the more one consumes, the more one has to pay taxes.
However, one major concern with this proposal is that the country's VAT effort ratio is still quite low at only 2.2% of the GDP. This means that there is still much room for improvement in terms of VAT administration and collection efficiency. Simply increasing the VAT effort by an additional 1% of GDP will translate to additional revenues of P126B, which is way above the P82B that the DOF hopes to collect by a 2% increase in VAT rate.
Also, it is important to note that, while the reduction in income tax rate is pre-conditioned on achieving certain tax-to-GDP ratios, the increase in VAT rate is automatic under the tax reform package. Thus, once enacted, we, consumers, will immediately feel the impact of the 2% VAT rate increase while we all wait for the conditional gradual reduction of income tax rates over 6 years or more.
REMOVAL OF VAT EXEMPTIONS FOR SENIORS AND PWDS
To expand the VAT base, the DOF proposes to remove or minimize the grant of VAT exemptions, including those granted to senior citizens and persons with disabilities (PWDs). While this may sound politically dangerous, this is actually a sound tax proposal.
For the VAT system to effectively work, there must be as little or no exemption at all so that exchanges of goods and services can be properly monitored. Meanwhile, giving such preferential VAT exemptions makes tax compliance difficult for sellers subject to VAT. Most importantly, providing VAT exemption to certain sectors of society benefits only those in the middle and high-income families since they have the ability to consume more compared with their indigent counterparts.
Thus, in the case of senior citizens and PWDs, it would be best if direct subsidies and targeted financial support (e.g., higher pension benefits, medical allowances, etc.) will be given to them (more especially to those from the poor families), rather than merely providing general support by way of VAT exemption.
They say it's better late than never.
The DOF comprehensive tax reform package is a welcome addition to the ongoing public discussion on tax reform. It is just unfortunate that the outgoing DOF leadership chose to forego its chance to chart the course of tax reform in this country at the time that it can garner support from various stakeholders. It is now up to the incoming DOF leadership team to make history and implement much-needed reforms in our outdated and unfair tax system.
I just hope that real change will indeed come to the DOF this time.
