Taxation Poverty and Equity Karl Kendrick T Chua

Taxation, Poverty, and Equity Karl Kendrick T. Chua Undersecretary and Chief Economist As of October 27, 2016

Contents • Theory • Evidence • Philippine tax reform o Our vision o Proposed tax reform o Impact on households o Targeted transfers o Long-term impact With much thanks to the World Bank for sharing some slides 10/27/2016 DEPARTMENT OF FINANCE 2

Theory 10/27/2016 DEPARTMENT OF FINANCE 3

The efficiency-equity trade-off • Maximizing the total of well-being (efficiency) requires paying attention to minimizing the costs (distortions) of taxing, other things equal. • Addressing the distribution of well-being (equity) requires that we pay attention to the progressivity of the tax burden. • What makes things challenging is that, with few exceptions, there is a trade-off between equity and efficiency. 10/27/2016 DEPARTMENT OF FINANCE 4

Fiscal instruments and equity • Taxation o Progressive: income tax, property tax o Regressive: consumption tax, transactions tax, lumpsum tax • Expenditure o Progressive: health, education, social protection; infrastructure? o Regressive: blind subsidies, consumption spending 10/27/2016 DEPARTMENT OF FINANCE 5

Importance of comprehensive analysis • Partial analysis, while expedient, does not give complete picture. o Excise tax on alcohol and tobacco o Excise tax on oil o VAT • Comprehensive analysis needed to capture the full effect of the net fiscal system. • Assessing the progressivity of a tax or a transfer in isolation can give the wrong answer to the question: Is the tax or the transfer equalizing? 10/27/2016 DEPARTMENT OF FINANCE 6

Evidence 10/27/2016 DEPARTMENT OF FINANCE 7

How progressive are indirect taxes? Ethiopia (2011) KAKWANI INDEX: INDIRECT TAXES Peru (2009) Mexico (2010) Sri Lanka (2010) Chile (2009) El Salvador (2011) Indonesia (2012) Brazil (2009) South Africa (2010) Guatemala (2010) Bolivia (2009) Armenia (2011) Russia (2010) Georgia (2013) -0. 25 -0. 20 -0. 15 -0. 10 -0. 05 0. 00 0. 05 0. 10 Sources: Armenia (Younger et al, 2014), Brazil (Higgins and Pereira, 2014), Bolivia (Paz Arauco et al, 2014), El Salvador (Beneke et al, 2015), Ethiopia (Woldehanna et al, 2014), Georgia (Cancho and Bondarenko, 2015), Guatemala (Cabrera et al, 2014), Indonesia (Afkar et al, 2015), Mexico (Scott, 2014), Peru (Jaramillo, 2014), Russia (Lopez Calva et al, 2015), Uruguay (Bucheli et al, 2014), South Africa (Inchauste et al, 2015), and Sri Lanka (Arunatilake et al, 2014). 10/27/2016 DEPARTMENT OF FINANCE 8

How progressive are direct transfers? KAKWANI INDEX: DIRECT TRANSFERS South Africa (2010) Peru (2009) Chile (2009) Guatemala (2010) Mexico (2010) Russia (2010) Sri Lanka (2010) Ethiopia (2011) Armenia (2011) Indonesia (2012) Georgia (2013) Brazil (2009) El Salvador (2011) Bolivia (2009) 0. 00 0. 20 0. 40 0. 60 0. 80 1. 00 1. 20 Sources: Armenia (Younger et al, 2014), Brazil (Higgins and Pereira, 2014), Bolivia (Paz Arauco et al, 2014), El Salvador (Beneke et al, 2015), Ethiopia (Woldehanna et al, 2014), Georgia (Cancho and Bondarenko, 2015), Guatemala (Cabrera et al, 2014), Indonesia (Afkar et al, 2015), Mexico (Scott, 2014), Peru (Jaramillo, 2014), Russia (Lopez Calva et al, 2015), Uruguay (Bucheli et al, 2014), South Africa (Inchauste et al, 2015), and Sri Lanka (Arunatilake et al, 2014). 10/27/2016 DEPARTMENT OF FINANCE 9

In general, direct taxes and transfers are equalizing, while indirect taxes increase inequality, but the design of the tax matters a lot. 0. 1200 Marginal Contributions from Market to Consumable Income (equalizing impact of direct and indirect taxes and transfers) 0. 1000 0. 0800 0. 0600 0. 0400 0. 0200 0. 0000 -0. 0200 ca A fri ru ss ia Redistributive Effect ut h Indirect subsidies Indirect taxes Ru Direct transfers So Direct taxes Pe In do ne sia A rm en ia Bo liv El i Sa a lv ad or Et hi op ia Sr i. L an Co ka lo m bi a G eo rg ia G ua te m al a M ex ic o Ch ile Br az il -0. 0400 Sources: Armenia (Younger et al, 2014), Bolivia (Paz Arauco et al, 2014), Brazil (Higgins and Pereira, 2014), El Salvador (Beneke et al, 2015), Ethiopia (Woldehanna et al, 2014), Georgia (Cancho and Bondarenko, 2015), Guatemala (Cabrera et al, 2014), Indonesia (Afkar et al, 2015), Mexico (Scott, 2014), Peru (Jaramillo, 2014), Russia (Lopez Calva et al, 2015), and South Africa (Inchauste et al, 2015). Note: contributory pensions treated as part of market income. 10/27/2016 DEPARTMENT OF FINANCE 10

Mexico’s 2010 Tax Reform • Proposed reform o Substantial expansion in indirect (VAT) base: new 2% uniform expenditure tax named Contribution to Fight Against Poverty (CCP), on top of existing VAT, on all goods and services to be used to finance expansion in social protection and poverty alleviation. o Increases in various income tax and duties rates. • Approved reform o Was a much reduced version of this, in particular replacing the proposed 2% uniform VAT with increase in standard rate of VAT from 15% to 16% instead and food exemptions were kept. o Part of reason proposals rejected was because it was seen as “regressive. ” Is it? 10/27/2016 DEPARTMENT OF FINANCE 11

Mexico 2010: Impact of an increase in VAT 0. 00% Distributional impact of increases in VAT and excise taxes (change as a % of expenditure) -0. 10% -0. 20% -0. 30% -0. 40% -0. 50% -0. 60% Poorest 2 3 response 4 No behavioral 5 6 7 8 9 Richest Source: Abramovsky, Atanasio, Emmerson, and Phillips. 2011. The distributional impact of reforms to direct and indirect tax in Mexico 10/27/2016 DEPARTMENT OF FINANCE 12

Taxation and Income Inequality – Tax Variables: theory generally holds PIT*Progressivity (2) -0. 094** (0. 043) (4) (5) (6) -0. 005*** (0. 001) CIT -0. 703*** (0. 109) 0. 009*** (0. 002) CIT*Globalization SSC+Payroll 0. 720*** (0. 168) GST 0. 485*** (0. 154) Excise 0. 258 (0. 195) Customs Constant Observations Number of id Sargan AR 2 (7) 30. 658*** (1. 848) 713 69 58. 41 0. 857 38. 326*** (1. 917) 834 75 66. 80 0. 727 39. 337*** (5. 696) 873 74 37. 12 0. 950 32. 397*** (3. 994) 908 78 35. 21 0. 798 35. 120*** (4. 698) 834 71 35. 74 0. 960 0. 130 (0. 178) 30. 118*** (4. 372) 871 75 39. 58 0. 992 (8) -0. 105 (0. 098) -0. 004 (0. 003) -0. 925** (0. 397) 0. 013** (0. 006) 0. 234 (0. 168) 0. 314 (0. 343) 0. 988*** (0. 301) -0. 497 (0. 393) 35. 716*** (3. 720) 634 56 37. 69 1. 153 Standard errors in parentheses, *** p<0. 01, ** p<0. 05, * p<0. 1 Source: Vazquez, Dodson, Vulovic. 2013. The Impact of Tax & Expenditure Policies on Income Distribution: Evidence from a Large Panel of Countries 10/27/2016 DEPARTMENT OF FINANCE 13

Public Expenditures and Income Inequality – Expenditure Variables: theory generally holds Social Protection (2) -0. 139*** (3) (4) (5) (0. 038) Education -0. 134** (0. 058) Health -0. 695*** (0. 030) Housing Constant Observations Number of id Sargan AR 2 33. 828*** (1. 923) 604 65 51. 23 0. 988 42. 334*** (1. 755) 643 67 55. 81 0. 746 35. 543*** (1. 525) 694 72 55. 92 0. 816 -0. 768*** (0. 068) 24. 468*** (4. 247) 503 61 48. 34 0. 650 (6) -0. 123 (0. 097) 0. 038 (0. 175) -0. 415* (0. 230) -0. 139 (0. 168) 21. 441** (9. 714) 410 54 41. 62 1. 071 Standard errors in parentheses, *** p<0. 01, ** p<0. 05, * p<0. 1 Source: Vazquez, Dodson, Vulovic. 2013. The Impact of Tax & Expenditure Policies on Income Distribution: Evidence from a Large Panel of Countries 10/27/2016 DEPARTMENT OF FINANCE 14

Economic Effects of Taxation and Public Expenditures: less of a progressive instrument means more inequality Policy Instrument -0. 09 -0. 01 -0. 70 0. 01 0. 72 0. 49 0. 26 0. 13 Increase (+)/Reduction(-) between 1990 and 2005 (percentage points) -0. 61 1. 76 0. 24 3. 84 0. 98 2. 10 -0. 09 -0. 66 -0. 14 -0. 13 -0. 70 -0. 77 1. 57 -0. 86 2. 11 -0. 78 Estimated Marginal Effect Personal Income Tax * Progressivity Corporate Income Tax * Globalization Social Security and Payroll Taxes on Goods and Services Excises Customs Duties Total Effect of Taxes Social Protection Expenditures Education Expenditures Health Expenditures Housing Expenditures Total Effect of Expenditures Resulting increase (+)/reduction(-) of income inequality (Gini), ceteris paribus (percentage points) 0. 04 -0. 13 0. 70 1. 03 -0. 02 -0. 09 1. 53 -0. 22 0. 12 -1. 46 0. 60 -0. 97 Note: All policy instruments are expressed as % of GDP Source: Vazquez, Dodson, Vulovic. 2013. The Impact of Tax & Expenditure Policies on Income Distribution: Evidence from a Large Panel of Countries 10/27/2016 DEPARTMENT OF FINANCE 15

Philippines: Better tax administration can improve equity of taxes Income Gini coefficient before and after income tax and transfers Source of basic data: FIES 2006 A = before tax and before non-taxable income B = before tax and after nontaxable income (remittance) C = after reported tax D = after computed tax using reported income E = after computed tax using adjusted income (better tax admin) Source: World Bank. 2011. Philippine public expenditure review 10/27/2016 DEPARTMENT OF FINANCE 1616

Philippines: Better tax administration can improve equity of taxes Income Gini coefficient before and after all taxes and transfers Source of basic data: FIES 2006 A = before tax and before non-taxable income B = before tax and after nontaxable income (remittance) C = after reported tax D = after computed tax using reported income E = after computed tax using adjusted income (better tax admin) Source: World Bank. 2011. Philippine public expenditure review 10/27/2016 DEPARTMENT OF FINANCE 17 17

Philippine tax reform 10/27/2016 DEPARTMENT OF FINANCE 18

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. Vision for the Philippines • By 2022 (6 years from now) o Poverty rate reduced from 26 to 17% (or some 10 million Filipinos uplifted from poverty). o Law abiding country. o Peace within the country and with our neighbors. o Achieve high middle income status, where per capita gross national income (GNI) increases from USD 3, 000 to USD 4, 100 by 2022 in today’s money (where Thailand China are today). • By 2040 (24 years or one generation from now) o Extreme poverty eradicated. o Inclusive economic and political institutions where everyone has equal opportunities. o Achieve high income status, where per capita GNI increases from USD 3, 000 to USD 12, 000 by 2040 in today’s money (where Malaysia and South Korea are today). 11/28/2020 DEPARTMENT OF FINANCE 19

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. How to achieve the vision • All these investments require additional funds of around 1 trillion pesos per year in 2016 prices on top of the current 1. 3 trillion. • This can be achieved through tax reform, which is integral to the larger goals of the administration and crucial for achieving the vision of a prosperous country. • In addition, complementary economic reforms are crucial: secure property rights, enhance competition, improve food security, and simplify regulations. 11/28/2020 DEPARTMENT OF FINANCE 20

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. Proposed tax policy package 1 Revenue eroding measures Package 1. Personal • income tax (PIT) and consumpti • on tax • 11/28/2020 Adjust brackets to correct “income creeping” Reduce PIT max rate to 25% over time, except for the highest income earners to maintain progressivity Shift to a modified gross system to simplify PIT system Offsetting measures • • • Passage Expand the VAT base by limiting exemptions to TBA raw food and other necessities (e. g. , education, health) Increase excise on all petroleum products & index to inflation (diesel and essentials from 0 to 6 pesos per liter; gasoline and non-essentials from around 4. 35 to 10 pesos per liter). Increase excise on automobiles (progressive ad valorem system). Mitigating measures • Low income consumers and businesses are already protected by the marginal threshold, which can be adjusted if needed. • Use targeted programs to protect the poor and vulnerable. Benefits will not be reduced. DEPARTMENT OF FINANCE 21

PRELIMINARY AND SUBJECT TO CHANGE. High end revenue impact by 2019 (PHP billion and % of GDP) 11/28/2020 DEPARTMENT OF FINANCE 22

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. Where to use the tax revenues • A quarter to a third of the incremental revenues from the petroleum excise tax will be allocated to fund highly targeted transfer programs in the first year of implementation. • The remaining amount will be allocated to education, health, infrastructure and other investments. 11/28/2020 DEPARTMENT OF FINANCE 23

Combined tax impact by household 11/28/2020 DEPARTMENT OF FINANCE 24

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. “The money we generate from the rich, who do not need exemptions and subsidies, will be transferred back to the poor and used to fund more and better services. ” 11/28/2020 DEPARTMENT OF FINANCE 25

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. Protecting the poor, investing in the people • • A highly targeted transfer program is more transparent, accountable, and direct way to protect the poor and vulnerable. On the other hand, tax exemptions and blind subsidies are inefficient and cause large leakages. 11/28/2020 • Conditional cash transfer like the 4 Ps to make the poor healthier and more educated to take on better jobs or livelihoods. • Transfer programs have good multiplier effects: 1. 34 to 2. 52. DEPARTMENT OF FINANCE 26

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. Proposed new programs • The unconditional cash transfer (UCT) program is a time-bound means to mitigate initial shock of the increase in petroleum excises to allow people to continue spending normally while adjusting smoothly to new price regimes. • Over time, it can be used to provide rapid emergency cash relief in times of disaster. 11/28/2020 • Persons with disabilities—lowincome PWDs will receive cash transfer benefits and better Philhealth services. DEPARTMENT OF FINANCE • Senior citizens—lowincome senior citizens will receive cash transfer benefits (socialized old age pension). 27

Proposed layered social protection program to mitigate effect of tax reform on poor and vulnerable Rapid emergency/disaster relief (when needed) PWD top up of 1000/month Senior citizen top up of 1000/month Non-CCT beneficiaries Non-CCT commuting class UCT P 500/month for 1 year UCT P 250/month for 1 year Indirect transfers to public vehicles (Pantawid Pasada) to offset increase in fares (around P 1500/year for 1 year per household) CCT beneficiaries Top up in existing benefits P 500/month 0 Covered by DSWD’s Listahanan 2015 25 50 Percentile of households 11/28/2020 No targeted transfer; already benefiting from lower personal income taxes 75 100 Amounts are indicative and depend on actual collection DEPARTMENT OF FINANCE 28

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. Transfer effect Targeted transfers will be crucial in protecting the poor from shocks and assuring progressivity of the tax reform. Combined effect (high case) Decile/ percentile Typical Filipino household Package 1 annual change in take home pay 2019 projected monthly household total income PIT VAT PETROL & TRANSPO Transfer Net of (full year) transfer Net AUTO D 1 Subsistence poor 4, 071 0 -65 -187 0 -252 6, 000 5, 748 D 2 Subsistence poor 6, 488 5 -177 -293 0 -465 6, 000 5, 535 D 3 Poor 8, 229 55 -223 -396 0 -564 6, 000 5, 436 D 4 Near poor 10, 001 281 -292 -603 0 -614 3, 600 2, 986 D 5 Near poor 12, 118 734 -369 -810 0 -444 3, 000 2, 556 D 6 Informal worker 14, 901 1, 854 -456 -1, 116 0 283 1, 500 1, 783 D 7 Minimum wage worker 18, 956 4, 209 -890 -1, 522 0 1, 796 1, 500 3, 296 D 8 Above minimum wage 25, 825 9, 365 -2, 429 -2, 164 0 4, 772 1, 500 6, 272 D 9 Professional 39, 535 21, 177 -11, 509 -2, 985 0 6, 683 D 10 Middle class 98, 674 78, 693 -19, 605 -7, 046 -21, 599 30, 443 0 30, 443 P 100 Executive 277, 011 208, 347 -42, 575 -18, 285 -176, 602 -29, 114 0 -29, 114 T 1000 CEO 563, 733 310, 308 -61, 842 -29, 979 -535, 978 -317, 492 0 -317, 492 Top taxpayer A 1, 500, 000 -457, 978 -146, 733 -54, 718 -1, 222, 292 -1, 881, 721 0 -1, 881, 721 Top taxpayer B 3, 000 -1, 237, 978 -293, 467 -142, 266 -1, 222, 292 -2, 896, 002 0 -2, 896, 002 Source: FIES-LFS 2012, DOF staff estimates Note: Each household has about 2 income earners. This analysis is with regard to fuel excise revenues converted into various transfers (doesn’t yet include emergency relief program or PWDs and senior citizens top up) 11/28/2020 DEPARTMENT OF FINANCE 29

Income inequality of tax reform package 1 46 Gini of tax reform proposals 44. 7 45 44. 1 44 42. 2 43 42 41. 5 41. 1 41 40 39 10/27/2016 Base case High case w/o transfer High case w/transfer DEPARTMENT OF FINANCE Alternate case 1 Alternate case 2 30

Change in income after tax-transfer reform 15% % increase in household income 11. 8% 10% 7. 1% 5% 5. 5% 2. 5% 1. 8% 2. 0% 1. 4% 2. 6% 1. 0% 1. 4% 0% -0. 9% -5% -4. 7% -8. 0% -10. 5% 10/27/2016 DEPARTMENT OF FINANCE er ay xp er To p ta xp ay B A 0 00 To p ta T 1 00 P 1 0 D 1 D 9 D 8 D 7 D 6 D 5 D 4 D 3 D 2 D 1 -15% 31

Consumption: The high case initially sees lower consumption due to higher consumption taxes but later on catches up well as investments make people more productive. High case: proposed tax reform Base case: no reform Low case: only PIT is passed 4 3 2 1 0 Low 11/28/2020 Base DEPARTMENT OF FINANCE 42 20 31 20 30 20 29 20 28 20 27 20 26 20 25 20 24 20 23 20 22 20 21 20 20 20 19 20 20 20 18 -1 17 As percent deviation from steady state 5 High 32

Consumption path of rich and poor: Transferring back some 25 percent of incremental revenues to the low income households improves their welfare today and in the future. 7 5 4 3 2 1 -2 11/28/2020 Non-poor 42 20 31 20 30 20 29 20 28 20 27 20 26 20 25 20 24 20 23 20 22 20 21 20 20 20 19 18 20 -1 20 17 0 20 As percent deviation from steady state 6 Poor DEPARTMENT OF FINANCE 33

Investment: Over the medium-term, public investment stimulates private investment in high case. Crowding out effect and higher interest rates reduce investments in the low case. 10 As percent deviation from steady state 8 6 4 2 0 -2 11/28/2020 DEPARTMENT OF FINANCE 42 20 31 20 30 20 29 20 28 20 27 High 20 26 20 25 Base 20 24 20 23 Low 20 22 20 21 20 20 20 19 20 18 20 20 17 -4 34

GDP: The high case shows initially lower GDP growth but it soon catches up and well exceeds the low and base case as tax revenues are invested. As percent deviation from steady state 12 10 8 6 4 2 11/28/2020 DEPARTMENT OF FINANCE 42 20 31 20 30 20 29 20 28 20 27 High 20 26 20 25 Base 20 24 20 23 Low 20 22 20 21 20 20 20 19 20 18 20 20 17 0 35

Real wages: Tax-financed public investments encourages more job-generating private investment that raises productivity and wages. 9 7 6 5 4 3 2 1 11/28/2020 DEPARTMENT OF FINANCE 42 20 31 20 30 20 29 20 28 20 27 High 20 26 20 25 Base 20 24 20 23 Low 20 22 20 21 20 20 20 19 20 18 20 17 0 20 As percent deviation from steady state 8 36

DRAFT FOR DISCUSSION. SUBJECT TO CHANGE. Let’s be partners for change! Thank you very much. 11/28/2020 DEPARTMENT OF FINANCE 37