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The VATerred Tax

(Article published in the Jan 27,2003 issue of TODAY, Business Section)

If anything comes out very clearly as the smoke lifts from the intense heat generated by the recent debate on the collection of the Value-Added Tax (VAT) from professionals is that the tax has been so battered beyond recognition that even those who ought to know better, such as some officials, past and present from the Department of Finance defending the collection, are as oblivious of its true nature as some those who oppose it.

Before things get out of hand, it is important to get back to the basics of this conceptually simple but practically complex tax.

In the first place, it is absolutely wrong to say, as some finance officials have been quoted to have declared, that it is high time that the professionals be subjected to the VAT. Not that I disagree with the idea of asking professionals to pay some tax. What is obviously wrong is how the VAT is presented by the argument. The VAT is not, as the finance officials seem to peddle, a tax on the seller of property or the provider of services. It is in reality and in substance a tax on the ultimate consumer or user of property or services. The law itself recognizes that the economic burden of the tax may be, or is even expected to be, passed on to the buyer of property or services and therefore the VAT’s merits and demerits are to be evaluated on the premise that its ultimate payer is the ultimate consumer.

In the first version of the VAT, which I defended vigorously shoulder to shoulder with that worthy tax official, Jun Deoferio, there was no mistaking who paid the VAT because it was clear that our VAT was what public finance experts call an "invoice VAT".

The sales invoice was the primary evidence of the fact that the tax is being collected and, in the invoice itself, the amount of the value-added tax that was passed on to the buyer was separately itemized. There was no doubt about it, the seller was clearly telling his buyer that the purchase price included the VAT and the buyer knew exactly how much he was absorbing.

I saw this as a good feature of the tax because it told the consumer, everytime he made a VATable purchase, that he was supporting his government and therefore, if he wanted to get value for his tax money, he had better get involved in making sure the government does its job. Transparency in the tax, I had hoped, would translate into vigilance on the part of the taxpayer.

Itemizing the VAT with invoice, however, enticed not a few unscrupulous sellers and buyers to enter into "invoice-less" transactions, with the seller offering the buyer a ten percent (10%) discount provided he did not demand a receipt. Needless to say, under this scheme the seller was able to cheat on his income and local business taxes; the buyer went home thinking he really got a good discount. To minimize this practice, Congress decided to hide the VAT in 1994. Invoices or receipts were no longer allowed to state how much VAT was passed on to the buyer. And before long, many, except the sellers and the service providers themselves who continued as they were expected to continue with the passing game, began to mistakenly believe that the VAT was paid by the seller and services provider; the consumer was blissful in his ignorance. Apparently, their ranks are now joined by some finance officials.

Let’s face it. The VAT is a tax on the consumer. Hence, the true question today is not whether professionals should or should not now pay the VAT. The true questions is whether the consumer of the services of professionals should now be made to pay the VAT on those services.

The second error is at the opposite end of the spectrum. It is the simplistic argument that all those subject to the VAT, and therefore all the professionals who would henceforth be subjected to the VAT, would simply pass on the VAT down the food chain.

That VAT is conceptually a "pass-on-to-the-consumer tax" is true in practice only for those properties and services which the consumers have no choice but to buy. Where the additional 10 percent is sufficient to make the consumer turn away, the seller or service provider is presented with tough choices. He can either absorb the VAT outright, or seek to make up for the additional burden by reducing his costs and becoming more efficient, or simply go out of business.

In some cases, these cost reduction methods take the form of reducing benefits given to laborers and wage earners. That not all professionals may be able to pass on the VAT seemed to have escaped the authorities. But it is Congress that is here at fault and not the Bureau of Internal Revenue. They have no choice but to enforce the law and assume that most, though not all the VAT, is passed on.

The third heresy comes from those who justify the collection of the VAT from professionals by citing the alleged gap between the amount that the employed pays and the amount that the professional pays in income taxes. An economist points out that average effective tax rate on business income is 1.3 percent; on mixed business and compensation income, 5.7 percent; and on strictly wage and salary income, 26.7 percent. The emotional argument is that, if poor employees pay 26.7 percent of their income in tax and businessmen and professionals, only 1.3 percent, why shouldn’t the latter be made to pay more taxes and take their fair share of the burden? Aside from being openly divisive and contrary to the spirit of unity which the finance officials should be espousing, this argument is based on a number of false premises.

A basic mistake is to think that being employed and being in a business or profession are comparable. That simply isn’t so. For instance, ask any businessman whose daily bread is not protected by security of tenure. Congress itself, which is not famous for clear thinking, recognized this when it shifted most of individual taxation from the former global or unitary system to a scheduler system. Congress correctly recognized that employment income is radically different from business income and therefore they should be treated differently. Thus was adopted the gross compensation system of taxation for the employed and net income taxation (with deductions getting more and more restricted) for business income.

But more fundamental is the error of trying to correct a perceived inequity in income taxation by resorting to the device of value-added taxation. As pointed out above, the value-added tax is an indirect tax, and while we do know who is legally required to remit the tax to the government, namely the seller and the service provider, we are not too certain as to who, in any given situation, will be in the concrete be absorbing the economic burden of the tax. Thus, assuming the economists’ estimates of the inequity in the income tax burden are accurate (after all, economists have been known to give estimates when asked for their telephone numbers), the appropriate approach is to consider the entire tax burden, not just the income tax payments of both sectors and determine what direct imposition can best rectify the imbalance, if any. Now that might be a tall order for the economists. In an earlier column, I pointed out that just on the question of tax leakage, i.e. how much taxes should have been collected but were not, there were as many answers as economists hazarding an answer.

A couple items of enlightenment, however, did come out of the current debate and these should not be overlooked. One of the strongest points for the VAT is the fact that it mandates a paper trail of taxes collected and remitted. This was pointed out by Commissioner Guillermo Parayno when he gamely faced the opponents of the VAT on professional services in a rambunctious TV show last week.

He disclosed that, with the build-up of the Bureau of Internal Revenue’s computerized capability to track payments, his office, given enough time and adequate logistical support, would be in a position to go after the big tax evaders. That is not a empty boast. I know. I have seen the Bureau’s computer capacity grow from day one and the recent barage of collection letters from Mr. Parayno’s office is just the beginning. The end of the tax evader may not be at hand; but it is not too far away either.

The other item of light was simply accidental. During the same TV show, a member of the movie industry disclosed what had been a secret, at least to the Bureau of Internal Revenue, namely, that the producers, as a matter of practice, absorb the current 20% withholding tax on the talent fees. If I understand that correctly, it was a disclosure that, the talent fee of an actor is P100,000.00, he gets the whole P100,000 and the producer remits P20,000 to the government as withholding tax on the P100,000. If I am correct, then there is a clear underwithholding. In truth, the actor, in my example, received P120,000 and therefore what should have been remitted to the Bureau is P24,000. Now, maybe the noisy members of the movie industry should, like their idol who once espoused the "no talk, no mistake" policy, try keeping quiet and let the taxmen do their job