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Appeared in "MAPping the Future" column in the INQUIRER (September 02, 2019)

Be Warned of the Dangers of a Gross-based Taxation

By Atty. Benedicta Du-Baladad.

In the middle of a tax reform, suddenly there is this push from no less than the President and from certain sectors to go for a gross-based taxation.

They say this is simple, straightforward and removes discretion and opportunities for negotiation between taxpayers and the Bureau of Internal Revenue (BIR), and therefore, it prevents or even eliminates corruption.

Is “gross-based taxation” as simple as it appears? Will it prevent corruption? NO, Sir. Behind that appearance of simplicity is a web of complexity, inequity and inefficiency, that in the end, we will find ourselves in a far worse situation than today.

A gross-based taxation is complex when applied to an imperfect environment, thus breeding more corruption, underdeclaration and nonpayment of taxes. It is grossly inequitable when applied to taxpayers with varying gross income levels. It is inefficient as it taxes capital, it cascades and pushes the full burden of the tax to the final consumer.

Let me explain one by one.

Breeds more corruption and tax evasion

In a country like ours where smuggling is rampant and where the underground economy is estimated to be more than one-third of our economy, that much amount of goods and services are bought and sold in the market without any trace, and are not reported for taxation. As it is today, that is the biggest source of leakage in revenue.

When smuggled goods enter the market and is bought by a legitimate, registered taxpayer, a trace is created, leaving an audit trail for the government to run after the seller or importer. How? The buyer will claim a deduction for the cost of the goods purchased, request seller for a receipt and will submit to the BIR relevant information (name, TIN, etc.) on the seller.

This is the beauty of a net income taxation. There is an incentive to maintain good bookkeeping, keep receipts and invoices and comply with proper documentation, otherwise, a claim for deduction will not be allowed resulting in additional taxes by as much as 30 percent (for corporates) or 35 percent (for individuals) of the amount disallowed.

It is that claim of deduction by the purchaser and the cross-reporting to the BIR that creates fear in the minds of taxpayers to be upright in their tax payments.

This cross-matching is lost as we shift to gross taxation, erasing important audit trails leading to the tax evader. Since most transactions are still done manually, it will be difficult to establish a trace. It will be a fiesta for tax evaders and some unscrupulous BIR employees alike, as the fear of being caught will be almost nil. Taxpayers—buyers and sellers—can agree not to report at will, in exchange for a lower price.

Both income tax and VAT collections will suffer. In the end, the very reasons for favoring a gross-based taxation will be the exact reverse of what will happen.

Ladies and gentlemen, the situation we are in now is not ready for a gross-based taxation. Smuggling must first be addressed.

The underground economy is too big for a gross taxation to fail. Full computerization—e-reporting, e-invoicing, e-receipting, computerized accounting systems linked to the BIR system for real-time checking—must first be put in place. Else, we are doomed.

It is grossly inequitable

A gross-based taxation is not a tax imposed on real income. It disregards the concept of income and simply, it just becomes a turnover tax. At most, it can be justified as a presumptive income tax, but it is the worst form of presumptive income tax if applied to businesses with varying income, either gross or net income, and especially if using a single flat rate tax. Different industries and sectors have varying levels of income, either gross income (direct costs deducted) or net income (all costs deducted). Trading companies, for example, have very thin margins normally ranging from 0.5 to 2 percent. In contrast, service-oriented companies have about 20-40 percent of gross income. Others are heavy in direct cost while others are heavy in operating costs. And even businesses within the same industry have varying levels of gross
income.

Imposing a 2-percent gross tax, for example, will kill the traders but will be a big bonanza to service-oriented companies. Thus, a gross-based taxation will create distortion as it will favor one over the other. Business decisions will heavily be led by taxation.

To some extent, such inequity can be addressed by adopting varying tax rates that would mimic the gross income levels of each industry. But that is easier said than done, subjective and prone to a lot of political pressure and heavy lobbying. Again, a messy situation.

Inefficient as it taxes capital

The complete disregard of cost recovery in a gross-based taxation is, in effect, taxing capital leading to unintended inefficiencies. Such tax will cascade a tax on tax, throughout the origination, generation and distribution cycle until it reaches the final consumer, who shall then bear the final burden of all accumulated taxes. 

Likewise, it favors big companies that are capable of internally generating their own inputs.

The taxes imposed on intermediate goods, had these been externally procured, are saved or skipped. This will enable them to sell their goods cheaper than the rest. At the end of the day, the micro, small and medium enterprises we are trying to help grow will be heavily disadvantaged.

With all these, why not give Citira (Corporate Income Tax and Incentive Rationalization Act), as proposed now, a chance?