Credit raters caution against watering down tax reforms

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By Elijah Joseph C. Tubayan

THE CURRENT FORM of the second tax reform package, as approved by a House of Representatives committee earlier this month, risks slowing momentum of progress in state revenues and infrastructure spending, senior executives of Fitch Ratings and Moody’s Investors Service warned.

“One of the drivers of the improvement in the credit rating is the government’s tax reform initiative,” Stephen Schwartz, head of sovereign ratings for Asia Pacific Fitch Ratings, said in an e-mailed response on Sunday to BusinessWorld queries.

When Fitch affirmed its “BBB” rating — a notch above minimum investment grade — with a “stable” outlook in July, it noted that revenue improvement from Republic Act No. 10963 — or the Tax Reform for Acceleration and Inclusion Act (TRAIN) that slashed personal income tax rates in order to give households more money to spend, raised or added taxes on several goods and services and removed various value added tax exemptions when the law took effect on Jan. 1 — should help preserve fiscal stability as the government ramps up spending on infrastructure.

“If the package were to result in a significant loss of revenue, rather than being revenue neutral, it could pose a partial setback to the tax reform program in our view, since the Philippines’ revenue ratio is low compared to its ‘BBB’ peer median (16.2% vs the median 32.1%),” said Mr. Schwartz.

“Higher revenues will also be needed to finance the ambitious infrastructure program.”

Both analysts, however, said it was too early to estimate the fiscal impact of the legislated reform, since it has yet to secure plenary approval in the House and in the Senate.

The second tax reform package, filed as House Bill No. 8083, or the Tax Reform for Attracting Better and High-quality Opportunities (TRABAHO), is up for second and third reading approval in the House after it hurdled Ways and Means committee deliberations on Aug. 7.

It seeks to cut the corporate income tax (CIT) rate to 20% gradually from 30% currently in order to put the regime at par with the country’s Asian rivals for investors, while removing redundant tax incentives.

The House committee, however, did not adopt the Department of Finance’s (DoF) proposal to peg gradual CIT cuts to incremental revenues from removal of select tax incentives in order to keep the measure “revenue-neutral,” meaning the package in its current form would bleed the revenue stream by P62 billion from the planned first two percentage point CIT cut in the first year of implementation in 2021 that will not be matched by an offsetting provision.

In a separate e-mail on Tuesday, Christian de Guzman, Moody’s Investor Service vice-president and senior credit officer said: “As the government had intended TRAIN 2 (as TRABAHO was initially called) to be revenue neutral, the absence of conditionality between the rationalization of fiscal incentives and the cuts in the corporate tax rates poses some risk to that revenue neutrality.”

“This is not to say that it would be impossible to achieve revenue neutrality, but it would be more difficult to do so,” he added.

“Ultimately, if corporate tax cuts were not ultimately funded by the additional revenue from lower fiscal incentives, the government may have to pare back expenditure to maintain deficits at a sustainable level,” he explained.

“We expect the main revenue gains to come from tax package 1, that went into effect at the beginning of this year, with additional gains from tax administration.”

Moody’s Investors Service late last month affirmed Philippines’ “Baa2” rating — a notch above minimum investment grade — and “stable” outlook, citing the economy’s overall strength, even as it flagged risks from rising inflation and the planned shift in government form.

State revenue collections grew 20% to P1.41 trillion last semester — exceeding a P1.30-trillion target for those six months by eight percent — from P1.18 trillion in 2017’s first half, while disbursements grew 20% to P1.60 trillion last semester — two percent more than a P1.57-trillion spending goal — from P1.33 trillion in the same period in 2017.

Infrastructure and other capital outlays surged by 41.6% to P352.7 billion last semester — 4.3% more than that period’s P338.3-billion target — from P249.1 billion recorded in 2017’s first half.

The Finance department has lined up as many as five tax reform packages cumulatively designed to shift the tax burden more to those who can afford it, while increasing collections. The government targets to raise the proportion of revenues to gross domestic product (GDP) to 17.7% by 2022, when President Rodrigo R. Duterte ends his term, from 15.6% in 2017 and share of infrastructure spending in GDP to 7.4% in 2022 from 5.6% in 2017. By doing this, it hopes to prod GDP growth to 7-8% annually until 2018 — thereby lifting more Filipinos out of poverty — from 6.3% in 2010-2016.

Other tax reform packages include a general and estate tax amnesty with eased bank secrecy law provisions and a higher motor vehicle user’s charge; higher excise taxes for alcohol and tobacco products; a bigger state share in mining revenues; a simplified, uniform property valuation scheme; and rationalized capital income taxation, among others.

Also on Tuesday, the DoF said in a statement that Finance Secretary Carlos G. Dominguez III has written lawmakers to outline his department’s proposal on real property tax reform.

House Speaker Gloria M. Macapagal-Arroyo, Albay 2nd District Rep. Jose Maria Clemente “Joey” S. Salceda and Senator Panfilo M. Lacson filed separate bills in 2016 that aim to simplify land valuation and ensure prompt updates in order to make local governments less dependent on their annual share in national taxes.

The DoF said the letters “suggested several enhancement measures to their proposals to further strengthen the country’s real property valuation and taxation system.”

“Essentially, real estate is the most valuable asset and biggest financial resource. But its contribution to government revenues — particularly for local governments — has remained dismal due to outdated Schedule of Market Values (SMV), poor collection efficiency and tax administration and lack of uniformity in the valuation of real property,” Mr. Dominguez was quoted as saying.

“Thus, the need to put in place an equitable, efficient and transparent valuation system has become even more urgent and necessary to stimulate the property market, attract investments, improve government’s resource mobilization through property taxation, and foster greater confidence in the real estate sector.”

The DoF also said that it proposed provisions that will bar local governments that fail to update on time their SMVs — with approval of the Finance chief — from getting credit financing or performance-based grants from the national government; require local assessors and other personnel involved in real property valuation to undergo training with the Philippine Tax Academy; as well as mandate automation, adoption of tax mapping technology and of a software-enabled valuation system, data cleansing and computerization of record management systems, among others.