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

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 Theory

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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.

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 Fiscal instruments and equity
• Taxation
o Progressive: income tax, property tax
o Regressive: consumption tax, transactions tax,
lump-sum tax

• Expenditure
o Progressive: health, education, social protection;
infrastructure?
o Regressive: blind subsidies, consumption spending

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 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?

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 Evidence

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 How progressive are indirect
taxes? K A K WAN I I N D E X : I N D I R E CT TA X E S

Ethiopia (2011)
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).
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 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).
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 In general, direct taxes and transfers are
equalizing, while indirect taxes increase
inequality, but the design of the tax matters a lot.
Marginal Contributions from Market to Consumable Income
(equalizing impact of direct and indirect taxes and transfers)
0.1200
0.1000
0.0800
0.0600
0.0400
0.0200
0.0000
-0.0200
-0.0400

Direct taxes Direct transfers Indirect taxes Indirect subsidies Redistributive Effect
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.
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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?

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Mexico 2010: Impact of an increase in
VAT
Distributional impact of increases in VAT and excise taxes
(change as a % of expenditure)
0.00%

-0.10%

-0.20%

-0.30%

-0.40%

-0.50%

-0.60%
Poorest 2 3 4 5 6 7 8 9 Richest
No behavioral response
Source: Abramovsky, Atanasio, Emmerson, and Phillips. 2011. The distributional impact of reforms to direct and indirect tax in Mexico

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 Taxation and Income Inequality – Tax Variables: theory generally holds
(2) (3) (4) (5) (6) (7) (8)
PIT -0.094** -0.105
(0.043) (0.098)
PIT*Progressivity -0.005*** -0.004
(0.001) (0.003)
CIT -0.703*** -0.925**
(0.109) (0.397)
CIT*Globalization 0.009*** 0.013**
(0.002) (0.006)
SSC+Payroll 0.720*** 0.234
(0.168) (0.168)
GST 0.485*** 0.314
(0.154) (0.343)
Excise 0.258 0.988***
(0.195) (0.301)
Customs 0.130 -0.497
(0.178) (0.393)
Constant 30.658*** 38.326*** 39.337*** 32.397*** 35.120*** 30.118*** 35.716***
(1.848) (1.917) (5.696) (3.994) (4.698) (4.372) (3.720)
Observations 713 834 873 908 834 871 634
Number of id 69 75 74 78 71 75 56
Sargan 58.41 66.80 37.12 35.21 35.74 39.58 37.69
AR2 0.857 0.727 0.950 0.798 0.960 0.992 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

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 Public Expenditures and Income Inequality –
Expenditure Variables: theory generally holds

(2) (3) (4) (5) (6)

Social Protection -0.139*** -0.123
(0.038) (0.097)
Education -0.134** 0.038
(0.058) (0.175)
Health -0.695*** -0.415*
(0.030) (0.230)
Housing -0.768*** -0.139
(0.068) (0.168)
Constant 33.828*** 42.334*** 35.543*** 24.468*** 21.441**
(1.923) (1.755) (1.525) (4.247) (9.714)
Observations 604 643 694 503 410
Number of id 65 67 72 61 54
Sargan 51.23 55.81 55.92 48.34 41.62
AR2 0.988 0.746 0.816 0.650 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

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 Economic Effects of Taxation and Public Expenditures:
less of a progressive instrument means more inequality
Increase
Resulting increase
Estimated (+)/Reduction(-)
(+)/reduction(-) of income
Policy Instrument Marginal between 1990 and
inequality (Gini), ceteris
Effect 2005 (percentage
paribus (percentage points)
points)
Personal Income Tax -0.09 -0.61
0.04
Personal Income Tax * Progressivity -0.01 1.76
Corporate Income Tax -0.70 0.24
-0.13
Corporate Income Tax * Globalization 0.01 3.84
Social Security and Payroll Taxes 0.72 0.98 0.70
Taxes on Goods and Services 0.49 2.10 1.03
Excises 0.26 -0.09 -0.02
Customs Duties 0.13 -0.66 -0.09
Total Effect of Taxes 1.53

Social Protection Expenditures -0.14 1.57 -0.22

Education Expenditures -0.13 -0.86 0.12
Health Expenditures -0.70 2.11 -1.46
Housing Expenditures -0.77 -0.78 0.60
Total Effect of Expenditures -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

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 Philippines: Better tax
administration can improve equity of taxes
Income Gini coefficient before and after income tax and transfers
53.0 Source of basic data: FIES
52.0 52.2
2006
51.0
50.0 50.0 A = before tax and before
49.7
49.0 non-taxable income
48.8
48.0 B = before tax and after
47.0
non-taxable income
46.0 46.3 (remittance)
C = after reported tax
45.0
D = after computed tax
using reported income
44.0
43.0
E = after computed tax using
adjusted income (better tax
A B C D E

admin)
Source: World Bank. 2011. Philippine public expenditure review
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 Philippines: Better tax
administration can improve equity of taxes
Income Gini coefficient before and after all taxes and transfers

Source of basic data: FIES

55.0
2006
52.3
A = before tax and before
50.0 50.0 non-taxable income
B = before tax and after
47.7
47.0 non-taxable income
45.0
46.0
(remittance)
C = after reported tax
D = after computed tax
using reported income
40.0 E = after computed tax using
A B C D E
adjusted income (better tax
admin)
Source: World Bank. 2011. Philippine public expenditure review
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17
 Philippine
tax reform

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 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 and 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).

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 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.
Current and additional investment needed per year (billions of pesos)
2016 expected Additional
Investment category Total
spending per year
Infrastructure 621 330 951
Education 454 454 907
Health 128 128 257
Social protection 60 60 120
Training 6 25 31
Other investments (e.g., R&D) 4 20 24
Total 1,272 1,016 2,289

• 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.

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 DRAFT FOR DISCUSSION. SUBJECT TO CHANGE.

Proposed tax policy package 1

Revenue eroding
Package Offsetting measures Passage
measures
1. Personal • Adjust brackets to • Expand the VAT base by limiting exemptions to TBA
income correct “income raw food and other necessities (e.g., education,
tax (PIT) creeping” health)
and • Reduce PIT max • Increase excise on all petroleum products & index
consumpti rate to 25% over to inflation (diesel and essentials from 0 to 6
on tax time, except for pesos per liter; gasoline and non-essentials from
the highest around 4.35 to 10 pesos per liter).
income earners to • Increase excise on automobiles (progressive ad
maintain valorem system).
progressivity
• Shift to a Mitigating measures
modified gross • Low income consumers and businesses are
system to simplify already protected by the marginal threshold,
PIT system which can be adjusted if needed.
• Use targeted programs to protect the poor and
vulnerable. Benefits will not be reduced.

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 PRELIMINARY AND SUBJECT TO CHANGE.

High end revenue impact by 2019

(PHP billion and % of GDP)
Tax package Loss Gain Net
Package 1: PIT and consumption -180.3 377.3 197.0
Lower personal income tax rate -180.3
VAT base expansion 108.4
Automobile excise 69.3
Excise tax on oil 199.6

Tax package Loss Gain Net

Package 1: PIT and consumption -1.0 2.0 1.0
Lower personal income tax rate -1.0
VAT base expansion 0.6
Automobile excise 0.4
Excise tax on oil 1.1

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 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.

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Combined tax impact by household

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 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.”

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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.
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DRAFT FOR DISCUSSION. SUBJECT TO CHANGE.
• Conditional cash transfer like the
4Ps 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.
26
 DRAFT FOR DISCUSSION. SUBJECT TO CHANGE.

Proposed new programs

• The unconditional cash • Persons with • Senior citizens—

transfer (UCT) program disabilities—low- low-income senior
is a time-bound means to income PWDs will citizens will receive
mitigate initial shock of receive cash transfer cash transfer benefits
the increase in petroleum benefits and better (socialized old age
excises to allow people to Philhealth services. pension).
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.

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 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 Non-CCT Non-CCT No targeted
beneficiaries beneficiaries commuting class transfer; already
UCT P500/month UCT P250/month Indirect transfers to benefiting from
for 1 year for 1 year public vehicles lower personal
(Pantawid Pasada) income taxes
CCT beneficiaries to offset increase in
fares (around
Top up in existing P1500/year for 1
benefits year per
P500/month household)
Covered by DSWD’s Listahanan 2015
0 25 50 75 100
Percentile of households Amounts are indicative and depend on actual collection
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 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) Package 1 annual change in take home pay

2019 projected
Decile/ monthly PETROL & Transfer Net of
Typical Filipino household PIT VAT AUTO Net
percentile household total TRANSPO (full year) transfer
income

D1 Subsistence poor 4,071 0 -65 -187 0 -252 6,000 5,748

D2 Subsistence poor 6,488 5 -177 -293 0 -465 6,000 5,535
D3 Poor 8,229 55 -223 -396 0 -564 6,000 5,436
D4 Near poor 10,001 281 -292 -603 0 -614 3,600 2,986
D5 Near poor 12,118 734 -369 -810 0 -444 3,000 2,556
D6 Informal worker 14,901 1,854 -456 -1,116 0 283 1,500 1,783
D7 Minimum wage worker 18,956 4,209 -890 -1,522 0 1,796 1,500 3,296
D8 Above minimum wage 25,825 9,365 -2,429 -2,164 0 4,772 1,500 6,272
D9 Professional 39,535 21,177 -11,509 -2,985 0 6,683 0 6,683
D10 Middle class 98,674 78,693 -19,605 -7,046 -21,599 30,443 0 30,443
P100 Executive 277,011 208,347 -42,575 -18,285 -176,602 -29,114 0 -29,114
T1000 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 3,000,000 -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)
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 Income inequality of
tax reform package 1
Gini of tax reform proposals
46

45 44.7
44.1
44

43
42.2
42 41.5
41.1
41

40

39
Base case High case w/o High case Alternate case 1 Alternate case 2
transfer w/transfer

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 Change in income
after tax-transfer reform
% increase in household income
15%
11.8%
10% 7.1%
5.5%
5% 2.5% 1.8% 2.6%
1.0% 1.4% 2.0% 1.4%
0%
-0.9%
-5%
-4.7%
-10% -8.0%
-10.5%
-15%

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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.
5

High case: proposed tax reform

Base case: no reform
As percent deviation from steady state

Low case: only PIT is passed

3

-1

Low Base High

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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

6
As percent deviation from steady state

-1

-2

Non-poor Poor

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 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

8
As percent deviation from steady state

-2

-4

Low Base High

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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.
12
As percent deviation from steady state

10

Low Base High

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 Real wages: Tax-financed public investments
encourages more job-generating private investment that
raises productivity and wages.
9

7
As percent deviation from steady state

Low Base High

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 DRAFT FOR DISCUSSION. SUBJECT TO CHANGE.

Let’s be partners for change!

Thank you very much.

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