As tax base shrinks during pandemic, proposed law seeks to cut revenue sources

The Duterte government is pushing for a bill cutting the corporate income tax in exchange for strict limits to tax perks enjoyed by investors. Economists however warn against eroding the revenue base at a time of a pandemic, when funds are needed the most.

What you need to know about this story:

• A proposed law will cut income tax rates to help companies preserve jobs during the pandemic.
• The bill will also remove the special 5% gross earnings tax enjoyed in perpetuity by investors.
• The Philippines is at the bottom half of an index measuring inequality, indicating lower spending for social protection. 

It sounds counterintuitive but one of the Philippine government's strategies to address hunger, joblessness, and the economic slowdown arising from the pandemic is to reduce taxes paid by corporations.

Tax cuts are one of the salient features of the proposed Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act that President Rodrigo Duterte has already certified as urgent. 

Once it becomes law, income tax rates of small businesses and big corporations will be slashed to 25% from 30% (the highest in Asia), a move that is expected to reduce government revenues by P37 billion within six months of its passage, according to the Department of Finance (DOF).
 
The same bill also provides that every year for the next five years, one percentage point from the already reduced tax rate will be shaved off until it goes down to 20%. This will result in foregone revenues of P476.8 billion for the five-year period, the DOG said.  

The bill, which originally started out as Package 2 of the Duterte administration's Comprehensive Tax Reform Program, became the “Trabaho” (Tax Reform for Attracting Better and High-Quality Opportunities) bill, and later, the Corporate Income Tax and Incentives Rationalization Act (CITIRA).

One year and a pandemic later, the bill now known as CREATE aims to achieve three goals: one, to make the Philippines become more attractive to foreign direct investments (FDIs); two, to simplify rules covering income tax breaks; and three, to provide critical support for businesses crippled by the largest economic contraction in the country's history. 

By and large, it's a tall order. 

The corporate tax cuts are just half of the story. The bill also seeks to expand the powers of the Fiscal Incentives Review Board (FIRB), an interagency body chaired by the DOF that grants tax perks to government corporations.  

Under CREATE, the FIRB will also be authorized to grant tax incentives to private corporations, a mandate that will likely curtail the powers of 14 investment promotion agencies (IPAs) and 546 economic zones. CREATE will also replace more than 300 special laws that give tax perks and other incentives to investors. 

Most crucially, CREATE, if passed, will do away with a special tax that has allowed some businesses to pay as little as 5% on gross income earned (GIE) for decades, instead of the full 30% income tax rate paid by most companies, in lieu of all other national and local taxes. 

Leading economists from the University of the Philippines, Ateneo de Manila University and De a Salle University are skeptical of CREATE and have asked policymakers to break it up into three separate pieces of legislation.

“CREATE is both inequitable and inefficient,” said a joint statement issued in June 2020 by 24 economists, including National Scientist Raul Fabella and former National Economic and Development Authority (NEDA) Chief Dante Canlas. “It is, in fact, a mere tax relief for incorporated businesses, equivalent to a subsidy, leaving out microenterprises and unincorporated small and medium enterprises. CREATE definitely falls short in terms of distributive justice.” 

The statement added: “At this time when the economy and the tax base is shrinking, government urgently needs additional resources to cover its COVID-19 commitments, it is imprudent to shed off tax revenue.”

The economists’ proposal has so far no takers. The bill is waiting to be scheduled for plenary discussions at the Senate.

Tax savings to help preserve jobs

The logic of CREATE’s proponents goes as follows: Corporate tax cuts will mean substantial savings for businesses, big and small, which they can reinvest on operations and/or help workers keep their jobs. 

“Companies can make better use of this money than any government program in terms of retaining jobs, in terms of keeping businesses,” DOF Assistant Secretary Antonio Lambino II said in a September 2020 interview with the Philippine Center for Investigative Journalism (PCIJ). 

“About 86% of those savings are reinvested, at least in terms of the Philippine experience,” Lambino added, citing agency estimates, which used data from the 2015 edition of the Top 1000 Corporations in the Philippines, a yearly publication of BusinessWorld newspaper.

The average reinvestment rate is lower for companies receiving incentives, according to DOF findings shared with PCIJ. 

Reinvestments for 2020 may drop to roughly half or P0.43 for every P1.00 of net income generated by companies and will gradually pick up from 2021, based on rough estimates from an enterprise survey conducted by the DOF. 

Lack of data has prevented the DOF from making reinvestment estimates for micro, small, and medium enterprises (MSMEs). This sector accounts for 99.5% or 998,342 of the total 1,003,111 business establishments, according to the 2018 List of Establishments of the Philippine Statistics Authority (PSA).

Once CREATE is passed, authorities can set conditions to help ensure that tax savings of companies, big and small, will ultimately benefit workers, said Filomeno Sta. Ana III, coordinator of policy and advocacy group Action for Economic Reforms (AER).  

“During that period, companies should be disallowed from declaring dividends, buying back shares, or increasing salaries of their top executives,” he said. “As a result, gains from the tax cuts can be redirected for new investment, job preservation, or job creation.”

The CREATE bill will also impose a sunset provision on the special 5% tax on gross income that has indefinitely exempted investors in economic zones from paying the regular 30% tax on income. After a period of four to nine years, the 5% tax will be replaced with a special corporate income tax (SCIT) that will still allow investors to enjoy tax discounts of up to 74%. Tax liabilities may be reduced by as much as 48%, according to the DOF, and investors would still be exempt from paying six other types of taxes. 

In 2018, actual foregone revenues from the special tax rate reached P62.933 billion, according to latest data from the Department of Budget and Management (DBM). 

This was almost 11% higher than the P56.731 billion in foregone revenues recorded a year ago. 

Officials of the Philippine Economic Zone Authority (PEZA) warned that removing the 5% incentive under CREATE would “erode the country's competitiveness in attracting new FDIs.”

“It may even trigger the exodus of existing [economic zone] locators or re-allocation of their production quotas to other countries where they can be more viable with their export operations,” a PEZA official said. “All our ASEAN counterparts are [continuing] to enhance their incentives, and here we are trying to do the opposite.”

This sentiment was echoed by PEZA Director General Charito Plaza. 

“We shouldn’t change the export enterprises incentive package,” she said in an interview. “Our exporters have different branches all over the world. We’re not the only game in town. We’re competing with other countries that are also using ecozones and attracting investors through incentives.”

V. Bruce Tolentino, an economist and one of the private sector representatives in the Monetary Board, the Bangko Sentral ng Pilipinas’ (BSP) highest policy-making body, disagreed.

“Firms locate in the Philippines either because they can operate here efficiently or because we possess resources that they need,” Tolentino said in an email to PCIJ.

“Tax incentives are merely sweeteners, aimed primarily at producing better economic outcomes from firms already predisposed to investing in the country. This is why it is crucial to make the [tax incentives] regime performance-based. If they were predisposed to investing in the Philippines anyway, and we give them perpetual tax perks without conditions, there is no incentive to perform better,” he said.

He added: “If a company is profitable, it should not have to leave, especially since the costs of relocating may not justify whatever tax discount would be lost.”

Tolentino also pointed out that CREATE features an “enhanced deduction system” that could entitle companies to incentives higher than current levels. 

“The main difference is that those deductions correspond to actual performance (in job creation, research and development, etc.) so there is an incentive to invest more in labor, research and development...training, and other economically desirable outcomes that benefit both the company and the country,” Tolentino said.

Is a VAT exemption a tax incentive? 

Other stakeholders agreed with the country’s top economists and have also opposed the income tax cuts in CREATE, especially in light of the novel coronavirus disease (COVID-19) crisis that has claimed thousands of lives, shuttered businesses, and laid off millions in a continuing saga marked by despair and dislocation.  

“Whether or not you're happy with the quality of services the government is providing, [the government] will still need to expand the pie to be able to have meaningful public expenditures for social services,” said Alvic Padilla, a former senior economic justice advisor for the UK-based Christian Aid. Nevertheless, Padilla said he was in favor of the provision to simplify tax incentives as outlined under CREATE. 

In January 2020, Padilla led a multi-country effort to produce a study that dealt with tax incentives, titled, “The Use and Abuse of Tax Breaks.” 

Published by the Financial Transparency Coalition, the study contained a special section on the Philippines, which cited data from the finance department's study about tax incentives.  
Padilla said the estimated P301 billion foregone revenues due to tax incentives in 2015 “could have easily covered the annual national budget for health (P104.96 billion) or social security and welfare (P231.34 billion).”

The same thing could be said for 2018. 

Based on the Department of Budget and Management (DBM) data for that year, the government's investment promotion agencies granted tax incentives worth P477.168 billion in 2018. 

The amount could have easily covered the budgets of the health and the social welfare departments at P167.9 billion and P141.8 billion, respectively. 

Some officials of IPAs — which grant income tax breaks to investors anywhere from four to six years — have criticized the DOF for "over-estimating" revenues foregone due to tax incentives. 

The DOF estimates should not have included value added taxes (VAT) and Customs duties because they are not incentives, several officials of the Board of Investments (BOI) and the PEZA have said in separate interviews. 

A noted tax lawyer, whose clients included PEZA enterprises, shared the same opinion, asserting that VAT, a tax on goods and services borne by end-consumers, is covered by a separate law. 

Of the P301.2 billion foregone revenues due to tax incentives in 2015, P18.1 billion came from Customs duties, P159.8 billion from the VAT on imports, and P37.0 billion from VAT on local goods and services, based on data emailed by the DOF. 

Taken together, Customs duties and import and local VAT for 2015 was worth P214.9 billion, an amount that was almost three-quarters of the total. 

“All over the world, VAT exemptions for exporters are not counted as incentives so why does the DOF consider that as an incentive?” an official told PCIJ. 

A DOF official defended its figures, explaining that these were arrived at by a special team of 30 members that checked, examined, and encoded items from numerous documents, including 6,000 financial statements of companies that received incentives from 2015 to 2017. 

The team also examined the August 2018 cost-benefit analysis of tax incentives produced by the National Economic and Development Authority (NEDA), which, among others, said that data about tax perks were hard to come by. 

In accounting for revenues foregone due to tax incentives, the DOF team chose to include VAT and “other exemptions that were not received by regular corporations,” the DOF official said. 
AER's Sta. Ana, who supports CREATE, shared that sentiment.  

“Strictly speaking, only export goods are VAT-exempt or zero-rated. But clearly, the threshold for exemption even in the proposed reform is below 100%,” Sta. Ana said. “In that case, the VAT exemption for such firms is a tax incentive or a tax expenditure.”

He added: “It is in fact the power of the state, not just a prerogative, to impose taxes or withdraw taxes.”

Philippines in bottom half of progressive spending index 

VAT-included or not, revenues foregone due to tax incentives could have benefitted millions of Filipinos. 

Had these revenues from tax incentives not been foregone but instead have been collected, channeled, and spent properly on social protection programs, the Philippines would have improved its turnout in “progressive budget spending,” according to Mae Buenaventura, senior policy officer of the Asian Peoples' Movement for Debt and Development (APMDD).

Progressive budget spending is one of the metrics examined by the Commitment to Reducing Inequality Index (CRII) in 2018. Formulated by Development Finance International and Oxfam, the reducing inequality index ranked 157 countries based on fair taxation, public spending on health, education, and social protection, and labor regulations. 

Results of the CRII 2018 were featured in “Towards Sustainable Tax Policies in the ASEAN region: The Case of Corporate Tax Incentives,” a June 2020 study commissioned by Oxfam and undertaken by the Vietnam Institute for Economic Policy and Research, the PRAKARSA in Indonesia, and the Tax and Fiscal Justice Asia. 

Based on its CRII scores in progressive budget spending for ASEAN countries, the Philippines spent 33.66% of its total budget on education (18.31%), health (8.00%), and social protection (7.35%). 

This set of figures were a far cry from what Thailand spent on education (18.93%), health (14.20%) and social protection (33.10%), or a combined 56.3%.

As a result, the Philippines ranked 114th in the progressive budget spending metric in terms of reducing inequality, way below Thailand (56th), Vietnam (89th), Singapore (91th), Indonesia (98th) and Malaysia (99th). 

The Philippines was 15 notches above Cambodia (129th), Laos (153rd) and Myanmar (156th). 
Thailand — together with Vietnam and Singapore — “scored best on progressive budget spending in the ASEAN region,” the report said, adding that all three countries had the highest levels of universal health care in the region in 2015. 

Moreover, based on its overall rating in the index for reducing inequality, the Philippines scored 0.331 and placed fourth, among nine ASEAN countries ranked. 

Only two — Thailand and Malaysia — breached the 0.354 average for the East Asia Pacific region since both countries' scores were tied at 0.377. 

Both countries were trailed by Indonesia (0.344), Philippines, Vietnam (0.315), Cambodia (0.254), Myanmar (0.194), Singapore (0.162), and Laos (0.158). 

Thailand and Malaysia may have outclassed others in the reducing inequality index, but they're still very much in the same boat with other ASEAN-member countries as far as tax collection is concerned. 

Levels of revenue collection, measured as a proportion of GDP, remained very low for all nine nations, compared with the OECD average, according to the Oxfam-funded study. 

In wealthier OECD countries, the average budget revenue ratio stood at 39.6 in 2018, much higher than the ASEAN average of 19.1. 

While five countries breached the average — Cambodia (23.9), Thailand (21.4), Philippines (20.2), Vietnam (19.5), and Malaysia (19.4) — these ratios were still considered low, the June 2020 study said. 

These low ratios showed that “countries in the region have little budget capacity and are running public deficits,” the study said. “This gap has dramatic consequences for the quality of public services, infrastructure, and levels of good governance.”

Add a pandemic — and its ensuing effects — into the mix and it would likely result in, among others, increased demand for public services that have barely been able to cope even before COVID-19 came along. This is best exemplified by the overwhelmed health system in the Philippines, which continues to struggle with the pandemic's manifold effects.  

COVID-19 to bloat the deficit

To finance urgent spending to deal with the coronavirus outbreak, most countries were expected to spend “enormous amounts” to smoothen the transition into what advocates hope would become a “better normal.”

Singapore, the richest country in Asia, was expected to spend 13% of its GDP for COVID-19 measures. For Thailand, the figure was 9%. 

Vietnam, Indonesia and the Philippines were expected to mobilize resources estimated to be at just 3% of GDP, the Oxfam study said, citing a report from RaboResearch.  

This surge in financial outlays was expected to outpace revenue collection, which would lead to deficit spending, the study said. 

But this is nothing new for the Philippines, which ran a deficit for 17 of the last 21 years from 2000 to 2020, the Oxfam study said.
 
For this year, economic managers set the budget deficit target at 9.6% of GDP. The country has reached more than half of that ceiling, hitting 6.5% of GDP from January to June, based on latest available data. 

This turnout was already above the average 4.2% deficit-to-GDP ratio for all ASEAN nations as forecast by the study. 

This is where foregone revenues from tax perks would have made a difference.

Citing a 2019 OECD report, the Oxfam-funded study said that both the Philippines and Vietnam could decrease COVID-19 budget burdens by one third by “stopping offering corporate income tax incentives to both multinational and domestic companies.”

The estimate doesn't include the one-time P640 billion worth of revenues to be foregone once CREATE is passed. 

“It doesn't seem logical for the country to borrow funds left and right and, at the same time, allow revenues to be foregone,” said APMDD’s Buenaventura. “That proposal defies common sense.”

As of 2018, way before coronavirus became a household word, the Philippines — just like Myanmar, Laos, and Cambodia — still had “to tackle high poverty rates measured by income,” the Oxfam study said, citing the World Bank's World Development Report. 

Hundreds of billions of pesos of foregone revenue could have been spent on poverty reduction, social protection and efforts to address COVID-19, instead of helping reduce taxes of the country's top corporations while in the middle of a pandemic, critics said.

Kenneth Abante, coordinator of Covidbudget.PH, a website that tracks public funds allotted for and spent on the coronavirus response, agreed that fiscal reform should be undertaken. 

But Abante, who had worked for the DOF, pointed out that other urgent matters needed to be addressed. 

“The reform needs to happen because the incentive structure currently benefits the incumbents,” he said. “Is this the right time to push for it? Are there more important priorities? To which the answer is yes.”

Abante added: “There are more important things that we should manage like our health. If the Philippines [becomes] a COVID-19 hotspot, will investors invest?”

But BSP’s Tolentino emphasized the importance of enacting CREATE as soon as possible. 

“CREATE must be passed now, since the issues that CREATE targets have been long-standing, and further delay in reform will mean continuing to hobble the economy,” he said. “Moreover, passing CREATE now will end the wait-and-see attitude of many investors who seek more clarity in the tax regime so that they can make their financial projections. It will also provide immediate relief to struggling businesses. Delaying the passage of this measure has caused too much investor uncertainty. Passing this now will allow the business community to resume operations and start creating new jobs with new investments.”

Tax competition, a race to the bottom?

A noted tax lawyer, who belongs to one of the country’s top auditing firms, wants the corporate tax  cut to be deeper. 

Instead of only 5 percentage points as envisioned under the corporate recovery bill, the income tax rate reduction should go as deep as 7 or even 10 percentage points from the get-go to finally allow the country to be competitive with its peers, the lawyer said. 

In short, from 30%, the corporate income tax rate should be immediately reduced to 20% upon CREATE's enactment, the lawyer said.  

“My frustration with some government proposals is that it's as if we're existing in a vacuum,” the lawyer said. “It's as if we don't have competitors and we're not fighting for the same foreign direct investments.”

The Philippines, in its bid to attract job-creating investments, should brace itself for tax competition in the region, the lawyer said. 

Based on the 2019 ASEAN Investment Report, the Philippines placed fifth among 10 regional economies, attracting $9.8 billion in foreign direct investments in 2018. It trailed Singapore, which at $77.6 billion, took the top spot and received half of the region's total of $155 billion. It was followed by Indonesia, Vietnam and Thailand. 
 
“We should look at what these countries are offering and see whether we can outdo them,” the tax lawyer said. 

Data from the Oxfam study showed that average corporate income tax (CIT) rates across the region had fallen for the past 10 years, from 25.1% in 2010 to 21.7% in 2020.

However, these rate reductions and increases in tax incentives did very little to affect investment decisions, according to the study. Investors have enjoyed the special 5% tax and other perks for almost half a century, but the Philippines did not become a top destination of foreign direct investments.

“There is no evidence that tax incentives increase FDI—indeed, quite the contrary. The majority of the corporate tax incentives currently offered by ASEAN countries are not aimed at attracting long-term investments but rather are an attempt to compensate for weak governance and poor infrastructure, and they feed the short-term desire of shareholders to cut corporate tax payments to the bare minimum,” the Oxfam study said. 

The way forward is tax cooperation, and not competition, in the region, the tax study said. 
“ASEAN countries need to make sure that tax policies in the region serve the common good and provide for a stable fiscal environment,” the study said. 

The first of its three recommendations is for the region to draw up a whitelist and a blacklist of tax incentives: the former should include perks that are acceptable, investment-based tax incentives. The latter should involve putting up a plan to phase out profit-based tax incentives at a certain date. 

The second recommendation is to establish rules for good governance of tax incentives. 

Finally, the study called on countries to agree to a tax standard across the region. 

“...[C]orporate income tax incentives offered should not be set below the level of a minimum effective corporate tax rate,” the Oxfam study said. “The appropriate rate is subject to discussion, with a possible range of 12.5% to 20%.”

Although it falls at the highest end of the range, the recommended figure still falls within what is envisioned under CREATE. 

However, AER's Sta. Ana is not convinced of the study’s proposal for tax cooperation.

“The reality that we’re in an ASEAN that is engaged in tax competition,” Sta. Ana said. “In other words, we also have to make our tax rates competitive in order to get a share of those investments.”

He added: “Reforming the fiscal incentive system is critical to address investment promotion, industrial policy, tax revenue, and tax administration. While we also have to put other reforms in place, fiscal incentive rationalization is one key reform that has to be done.” –PCIJ, October 2020

Robert JA Basilio Jr. is a freelance writer based in Quezon City. He can be reached via email at [email protected].