EQUITY AND EFFICIENCY TRADEOFFS IN PHILIPPINE TAX POLICY ANALYSIS: A GENERAL EQUILIBRIUM APPROACH (CGE MODEL)

This study was prompted by a perceived lack of a practical operational approach to making tax policy choices on the basis of their equity and efficiency impacts, and more particularly, the lack of a general equilibrium framework for assessing Philippine tax policies. A multisectoral computable general equilibrium (CGE) model of the Philippine economy is constructed to permit simulation of alternative tax policies, wth emphasis on indirect taxation. This follows from the observation that most developing countries are constrained to rely more heavily on indirect taxes for raising government revenues, despite their general tendency to be regressive. Hence it becomes desirable to determine the exact nature of the equity-efficiency tradeoffs that are usually associated with indirect taxation. Using a CGE model with 18 goods and 11 income groups, an equity-efficiency locus defining a "frontier" for a fixed level of real government revenues is derived, representing alternative sales tax structures of varying degrees of progressivity/regressivity. The derivation of such a tradeoff frontier can make the tax policymaker's task more straightforward, requiring only a choice among a menu of tax structures as opposed to the usual theoretical approaches which require prior determination of appropriate parameters of the perceived social welfare function. This framework is used to assess major tax reforms undertaken in the Philippines in recent years. The general findings are (1) sales tax reforms have worsened the economy's position relative to the equity-efficiency frontier; (2) the proposed supplemental value-added taxes would be preferable to a simple increase in existing sales tax rates if more government revenue is required; and (3) the recent shift to gross income taxation has increased income tax revenues with apparently little change in equity and efficiency impacts of the tax system.