The inequity in the tax system on individual taxpayers needs reforms

The concern over bridging the gap between the rich and the poor has always been in the development agenda of every Philippine Government since poverty incidence in the country is one of the highest in Asia. One of the areas in which structural reforms may be initiated to achieve social equality is taxation. The government has focused on legislating tax incentives to promote development of certain industries to increase employment opportunities and on creating new taxes to raise the budget for social services. However, it has overlooked the inequity between the compensation income earners, composed of the lowest earners, and the individual businessmen and professionals that has long existed at the root of Philippine tax structure.

In the 2009 Annual Report of the Bureau of Internal Revenue, it is glaring that compensation income earners bear disproportionate burden of taxation as compared to professionals and self-employed individuals. The compensation earners accounted for 87 percent of total individual income tax payments, while the businessmen and professionals only contributed a 13 percent share. According to the study of the National Tax Research Center (NTRC), 27 percent of the annual tax leakage comes from compensation earners while 73 percent is from businessmen and professionals. These facts seriously call for reform in this basic area of Philippine taxation. Under the existing tax structure, all individual taxpayers are subject to the same graduated tax rate. The compensation earners only claim fixed deductions of P50,000 and additional P25,000 for each dependent child, up to a maximum of four, and their tax liabilities are collected through withholding by employers. However, businessmen and professionals are allowed to deduct business expenses in addition to the deductions allowed to compensation earners. They have the opportunity to avoid and evade taxes because they file their own tax returns, under the voluntary assessment method.

Despite the apparent progressivity of the graduated tax rate applied to individual taxpayers, an analysis of the disparity in the level of income received by the compensation earners and self-employed individuals vis-à-vis the proportion of their tax contributions to Philippine Government reveal an effective regressivity of this current structure. The immense tax leakage from professionals and self-employed individuals results in lopsided tax burden in favor of individuals in higher income bracket, which runs counter to the intent of the Constitution to have progressive gaps in the effective tax rates reflect horizontal inequity or the unequal treatment of families belonging to the same income class.

Considering the foregoing, it may be high time for the Philippines to adopt a dual tax system for individual taxpayers. There is no problem with the existing tax structure for compensation income earners due to the effective tax collection mechanism (withholding) in place and its faithfulness to the intended progressive system. However, a different tax treatment should be crafted for the professionals and self-employed individuals to address the inequity and the resulting regressiveness. An adoption of a new schedule of graduated tax rates exclusively applicable to professionals and self-employed taxpayers could be the option closest to the present structure. The existing allowable deductions given to this class of taxpayers should be limited to direct business costs to diminish the tax leakage. The income brackets and the rates of such new schedule should be carefully studied so as not defeat the objective of having an overall progressive taxation on individual taxpayers.

In responding to the same issue, another option could be to implement a modified flat-rate tax on professional and self-employed taxpayers. A fixed percentage of the gross income of this class of taxpayers may be legislated. The balance after the standard deduction shall be the taxable income upon which the flat-rate tax is to be applied. This option will reduce the high leakage as it will minimize the opportunities for tax evasion, and increase tax compliance since it is simple and the computation is straight forward. This simplified structure will also reduce government enforcement cost and address corruption issues as there is no need for BIR personnel to audit claimed deductions.

It may be contended that these options will desecrate the constitutional requirement that taxation shall be uniform and equitable for taxing self-employed individuals and professionals differently from that imposed on the rest of individual taxpayers. However, uniformity merely requires that all subjects of taxation, similarly situated, are to be treated alike both in privileges and liabilities. The Supreme Court has long established that uniformity does not prescribe classification as long as the standards that are used are substantial and not arbitrary, the categorization is germane to achieve the legislative purpose, the law applies to present and future conditions, and the classification applies equally well to all those belonging to the same class. What may instead be perceived from this suggested reform is the pursuit of the constitutional mandate to evolve a progressive, uniform and equitable taxation, while widening the tax base to aid the perennially deficient national budget.

Rather than focusing on legislation of new tax laws to respond to the social inequity, it is important to give priority to reforms of core areas of Philippine taxation for no matter how brilliant the new laws are, the tax burden of each common Filipino will still be determined by the basic income taxation. The individual income tax system is only one of the basic areas of taxation that necessitates reforms as there are many others, including the value-added tax and capital gains tax, that are often overlooked by Philippine legislators.- Lawyer HARDY B. AQUENDE, CPA