A Comment on Raising the Ceilings on Tax-free 13th Month Bonuses

SA. Quimbo22 September 2014

Presented at a Public Hearing of the Ways and Means Committee

Senate of the Philippines

How do salary and wage earners fare in terms of horizontal equity?

• Horizontal equity: similarly situated taxpayers should pay similar taxes

• Salary and wage earners:– Shoulder 85 percent of all individual income

taxes (excluding capital gains)– Pay more taxes than the self-employed

professional and non-professional, for the same income decile• Not horizontally equitable

PROFILE OF THE PHILIPPINE LABOR FORCE(in 000)

Source: 2013 LFS

Average Income Tax Payments, by type of worker

First Decile Second Decile

Third Decile Fourth Decile Fifth Decile Sixth Decile Seventh Decile

Eight Decile Ninth Decile Tenth Decile -

5,000

10,000

15,000

20,000

25,000 Salary and wage earnerSelf-employed (non-prof)Self-employed (prof)

Source of Basic Data: 2012 LFS-2013 FIES (N=76,405 workers from 40,171 households)

Gains in horizontal (and intertemporal) equity

• Primarily, salary and wage earners gain from the the proposed increase in ceilings for tax-free 13th month pay from 30,000 pesos to 70,000 pesos

• 30,000 pesos in 1994 is equivalent to 70,633 pesos in 2014

• The effect of increasing the ceiling to 70,000 pesos is to reduce taxable income by at most 40,000 pesos (= 70,000 – 30,000) for workers with monthly pay of at least 30,000

How many workers gain?

• Using data from the 2013 Labor Force Survey, 1.99% of all salary and wage earners have a basic monthly pay of at least 30,000 pesos:

22,212,000 S&W earners x 1.99%

~ 442,000 workers

Back-of-the-envelope estimates (maximum loss)

442,000 workers (earning at least 30,000 per month)

x 40,000 pesos (assume that all workers earn at least 70,000 per month)

x 32% (highest tax rate)

________________________

5.6576 Billion Pesos

• Decompose total individual income tax collections as reported by BIR by bracket

• Use income and household characteristics from the merged 2012 FIES-2013 LFS to estimate taxable income and tax payments due Assume income underreporting 15% - 25% Limitation: maximum income is 10M only

• Use tax payments reported by BIR for the top 500 tax payers for individuals with at least 16 M pesos

• Tax payments for those with income 10M-16M are treated as a “balancing figure”

• All relevant tax rules applied to estimate taxes due (for Self-employed, we used standard deductions, not the 40% optional standard deductions)

Estimating the Revenue Effects (1)

BASE SCENARIO

Estimating the Revenue Effects (2)

• Re-computed taxable income assuming various ceilings (40,000; 50,000; 60,000; and 70,000)

• Assumed that 68% (1-proportion of professionals to all workers) of top 500 taxpayers (plus all those with income in excess of 10 million pesos) have a 13th month bonus

Simulations

Can be partially recovered from VAT

(77% of expenditures are subject to VAT)

Distribution of Income Tax Payments, by ceiling amount

30K tax-exempt bonus

40K tax-exempt bonus

50K tax-exempt bonus

60K tax-exempt bonus

70K tax-exempt bonus

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

17.23% 16.81% 16.64% 16.57% 16.52% 1000 individuals earning at least PhP10M - 16M (assumed)From TOP 500 (over 16M)ProfSelf-employedOver PhP500KOver PhP250K but not over PhP500KOver PhP140K but not over PhP250KOver PhP70K but not over PhP140KOver PhP30K but not over PhP70KOver PhP10K but not over PhP30KNot over PhP10K

A concern: will firms be strategic?Strategic behavior

makes sense only for workers earning 30,000

– 70,000 pesos per month:

These are 407,000 workers.

Assume a 20,000 peso loss in taxable income

per worker.

Estimated total loss from strategic behavior

= 20,000 x 407,000 workers x 32% =

PhP2.6048 B

Worker's Annual Basic Compensation 1,200,000

OPTION 1 (straight)

OPTION 2 (strategic)

Monthly Pay 100,000 50,000Annual Basic Pay 1,200,000 600,000 13th Month Pay 100,000 700,000 TOTAL Annual Compensation 1,300,000 1,300,000

Taxable Income 1.2 M - deductions + (100k-70k)

600k – deductions + (700k - 70K)

Assume: 100k deductions Estimated Taxable Income 1,130,000 1,130,000 Worker's Annual Basic Compensation 600,000

OPTION 1 (straight)

OPTION 2 (strategic)

Monthly Pay 50,000 20,000Annual Basic Pay 600,000 240,000 13th Month Pay 50,000 410,000 TOTAL Annual Compensation 650,000 650,000

Taxable Income 600K - deductions + 0

240k - deductions + (410K - 70K)

Assume: 100k deductions Estimated Taxable Income 500,000 480,000

Concluding Remarks• I support the proposal on grounds of horizontal equity

– Protective of salary and wage workers

• Improved equity comes at small price: 1.7 B

• Strategic behavior can be curbed with ceilings on the ratio of 13th month pay to monthly basic pay or limits on frequency of payments of the 13th month bonus (e.g., at most twice a year)– Estimated loss of 2.6B under the extreme (but unlikely) scenario that all firms

will undertake strategic behavior

• Whether back-of-the-envelope estimates or more careful estimates using population-based surveys and the roster of top taxpayers, the maximum potential loss ranges from 4.3 B (=1.7+2.6) to 5.6 B