COLUMN: IS THE ECONOMY OVERTAXED?
MANILA, December 1, 2004 (STAR) By Eduardo H. Yap - This is a jolting question. Given the government’s chronic fiscal deficit and reports of a critically low national "tax effort", anybody would be foolhardy to say the economy is overtaxed. To say so would go against prevailing conventional wisdom that the economy is "undertaxed", there was massive tax "leakage", "evasion" and "gross collection inefficiency". The Department of Finance’s 12.5 percent of GDP tax effort rate in 2003, which is the lowest in the region, created these impressions. But, an analysis of the latest data on fiscal incentives released by the DOF shows otherwise. In fact, the tax effort in 2003 pertaining to the taxed sector of the economy may have likely bordered on the excessive.
P340 billion in foregone revenues
The DOF report indicated P340 billion in fiscal incentives, representing a third of potential tax revenues in 2003, were granted by the government to entities operating under various tax exempting laws. This P340 billion in foregone revenue taxes consisted of P227.4 billion in exempted VAT payments, P56 billion in exempted import duties and a further P88.5 billion in exemptions granted under the internal revenue code. P340 billion was equivalent to a massive 7.9 percent of 2003’s GDP and 170 percent of the P200-billion budget deficit. Apparently, this is a level that is beyond the government’s affordability.
The fiscal indicator called ‘tax effort’
The government uses an indicator called "tax effort" as a measure of the tax revenue generated from the economy and its collection efficiency. This tax effort is the ratio of tax revenues to the tax base. It is derived by dividing the total taxes collected by the tax base, which is the value of all goods and services produced during the year, or GDP. This effort rate is a very important fiscal indicator and is closely monitored as it indicates the tax burden and the efficiency of tax administrators. In 1997, when the budget was in surplus position, the tax effort rate was 17 percent of GDP. This was close to that of other countries in the region. In subsequent years, the tax effort dropped precipitously until it reached a critically low 12.5 percent in both 2002 and 2003.
Significance of latest DOF data
What is the significance of this latest DOF data? An analysis would indicate that the structure of our economy had, after the institution of the new trade globalization policy, been transformed into two large sectors, a very significant outperforming tax-exempt sector and the underperforming traditional taxed sector. While the economy grew, there was no commensurate increase in tax revenues giving rise to a tax-less growth phenomenon. The large amount of foregone taxes indicates the GDP of this tax-exempt sector may have been as large as 40 percent of 2003’s total economy, with the balance of 60 percent being the taxed sector. That the economy had a potential tax revenue aggregating P871.5 billion in 2003, which was equivalent to a high 20.4 percent of GDP. This, we now know, is broken down into 12.5 percent pertaining to the taxed sector corresponding to the P531.5 billion collected from it. The other 7.9 percent pertains to the tax-exempt sector. To attain a balanced budget in 2003, the government needed an additional 4.5 percent of GDP in taxes. If this was taken from the tax-exempt sector, it may mean that based on 2003’s structure of the economy we can afford no more than 3.4 percent of GDP in tax exemptions instead of the 7.9 percent that was granted. Stated differently, an excess of 4.5 percent of GDP in fiscal incentives was granted in 2003.
Disproportionate share of tax burden
The P531.5 billion paid by the taxed sector may have been equivalent to 20 percent based on its estimated 60-percent share of the economy. This translates to a very high tax effort of 20 percent of the taxed sector’s GDP, which means that the government got a very large P0.20 from the top of every P1 in goods and services produced by this sector. Considering further that a tax effort of only 17 percent of GDP was needed to attain a balanced budget in 2003, the tax burden of the taxed sector may have been excessive. In effect, the taxed sector is carrying a disproportionately large share of the country’s tax burden. The estimated excess tax effort of this sector is three percent of GDP.
A flawed measure of tax collection efficiency
Of the P871.5-billion potential tax revenue, only P531.5 billion pertaining to the taxed sector, in duties and taxes was collected. On the other hand, the P340 billion pertaining to the tax-exempt sector was waived. The DOF, in calculating the national tax effort, did not include the P340 billion as revenues. However, in the divisor of the equation, it included the tax-exempt GDP corresponding to this foregone revenue in the tax base. Thus, the tax base was bloated by the inclusion, which is meaningless, as far as measuring collection efficiency is concerned, as no direct taxes accrued from the same. This mismatched equation resulted in a diluted tax effort showing only 12.5 percent of the entire economy, consisting of both the taxed and untaxed sectors. This tax effort rate, as computed, is a misleading indicator of tax collection efficiency and should not be used as such.
Affordable level of fiscal incentives
This finding should serve as a caveat to policy makers in the exercise of the state’s tax power. Excessive taxation is harmful to an economy. On the other hand, excessive tax exemption is equally harmful as it deprives government of sorely needed revenues and results in chronic fiscal deficits as we have been experiencing after 1997. It appears that government can afford to grant exemptions equivalent to no more than 3.4 percent of GDP to attain a balanced budget instead of the 7.9 percent that was granted, if the 2003 structure of the economy will be maintained. Alternatively, the economy must be restructured to attain a growth-mix with the currently underperforming taxed sector attaining a much bigger share of the total economy. Thereby, the larger taxed sector will translate to a larger tax base, which in turn will result in higher tax revenues and the same P340 billion in fiscal incentives may be rendered affordable, assuming no cut is warranted.
Revamp the tax effort calculation
It is critical that government re-examines the way it calculates tax burden and collection efficiency to eliminate the distortion owing to the inclusion of the GDP contribution of tax-exempt sectors in the GDP tax base. By doing so, the resulting rate will be a more accurate gauge for the purpose of measuring tax collection efficiency and tax burden. This will however, require NEDA to quantity the GDP contribution of the tax-exempt sector, data which is currently not available. Without this data, an alternative method, albeit a less desirable one, is to tack-in the foregone taxes, now a known factor, with the taxes actually collected to constitute the dividend in the tax effort equation. The divisor, or tax base, shall be the entire GDP, consisting of both taxed and tax-exempt production.
(The study, "Tax-less Economic Growth", was presented to the National Issues Committee of the Management Association of the Philippines (MAP) on Nov. 23, 2004. It is part of the larger study "Understanding the Fiscal Crisis" presented at the meeting of the Rotary Club of Makati, Oct. 2, 2004, Manila Peninsula Hotel. Previous study: The 1997 Asian Financial Crisis, presented on Nov. 4, 1998 at the forum on "Who’s afraid of capital controls?’ hosted by The Human Development Network, Solita Collas-Monsod, President.)
(* Past president and chairman of the Subdivision and Housing Developers Association (SHDA). Past chairman of the Council of Rotary Past Presidents, R.I. Dist. 3810, then inclusive of Manila, Makati, Pasay, southern Manila suburbs, Mindoro and Palawan.)
Reported by: Sol Jose Vanzi
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