## _wp07153

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---

### VAT Reform and Fiscal Impact
- VAT base extended in November 2005 to energy products and selected professional services.
- VAT rate increased from 10 to 12 percent in February 2006.
- Revenue collection (net of mitigating tax measures) is estimated to have increased by about 1.3 percentage points of GDP in 2006.
- Fiscal allocation assumptions:
  - Authorities announced that at least 30 percent of the additional revenue proceeds will be set aside for infrastructure and social spending.
  - Analysis assumes 60 percent of the additional expenditure is devoted to social spending and 40 percent to infrastructure.
  - Social spending is assumed split equally between education and health.
- Table 5 selected yields (Fund staff estimates):
  - Widening the base: 37.1 (Billions of pesos); 0.6 (percent of GDP, full year basis).
  - Of which: crude oil and petroleum products: 30.7 (Billions of pesos); 0.5 (percent of GDP).
  - Raising the rate from 10 to 12 percent: 33.4 (Billions of pesos); 0.6 (percent of GDP).
  - Raising the CIT rate: 17.2 (Billions of pesos); 0.3 (percent of GDP).
  - Changing refund procedures: 17.6 (Billions of pesos); 0.3 (percent of GDP).
  - Mitigating measures (includes reduction in oil import tariff from 5 to 3 percent): -26.9 (Billions of pesos); -0.4 (percent of GDP).
  - Net impact: 78.4 (Billions of pesos); 1.3 (percent of GDP).

### Poverty Profile (Box 1: Poverty in the Philippines)
- Poverty incidence: 30 percent in 2003, down from 33 percent in 2000 (based on the 2003 Family Income and Expenditure Survey (FIES) as reported by the National Statistical Coordination Board (NSCB)).
- Over 4 million families (or 23.8 million individuals) lived below the poverty line in 2003.
- Income gap declined from 29.1 to 28.7 percent between 2000 and 2003.
- Poverty threshold used: annual per capita income of 12,309 pesos.
- World Bank–identified determinants of poverty:
  - Educational attainment: three-quarters of poor households have heads with no secondary education, while only half of all households do nationally.
  - Sector of employment: two-thirds of the poor are employed in agriculture, compared with 40 percent of households nationally.
  - Highest poverty incidence recorded among the self-employed and the wage earners employed in the agriculture sector.

### Scope of Reform and Modeling Assumptions
- Components of the simulated reform:
  - VAT rate increase from 10 to 12 percent.
  - Broadening of the VAT base to petroleum products, electricity, and professional services.
  - Reduction in fuel excises.
  - Removal of the franchise taxes.
  - Reduction in the oil tariff from 5 to 3 percent.
  - Devotion of a portion of additional VAT revenue to increased education and health spending.
- Modeling assumptions:
  - First-order price effects only; household and firm demand held fixed (estimates are upper bounds on income effects).
  - Firms assumed to pass all cost increases to customers.
  - Indirect effects estimated using a simple input-output model based on the 2000 input-output table for the Philippines.
  - Household consumption data from the 2003 FIES used to compute budget shares and aggregate impacts.
  - Additional social spending modeled as transfers to existing users of education and health facilities.
- Methodology highlights:
  - Direct impact measure: percent change in final prices due to tax changes.
  - Indirect impact: changes in after-tax prices of intermediate goods passed to final goods using input-output linkages.
  - Incidence calculation: budget share of each consumption item × corresponding price increase, summed to estimate percentage decline in household real income; averaged by income quintile.
  - Welfare measure: income per capita from the 2003 FIES (sensitivity analysis shows robustness to using consumption per capita).
- Caveats noted:
  - Model likely overstates income loss by about 30 percent compared with estimated revenue gain.
  - Assumed universal tax compliance may overstate total household income loss; distributional implications unaffected if noncompliance is uniform across groups.
  - Modeling of additional social spending likely overstates benefits (efficiency losses, valuation by users) and understates benefits from infrastructure.

### Distributional Impact — Key Findings
- Average gross reduction in household consumption due to VAT reform (without mitigation): 2.5 percent.
  - Bottom quintile: 2.4 percent reduction in real consumption.
  - Top quintile: 2.7 percent reduction in real consumption.
- Progressivity drivers:
  - Poor households disproportionately consume unprocessed agricultural products exempt from VAT.
  - Petroleum products (except kerosene) are largely consumed by wealthier households.
- Modeled mitigating package effect:
  - Package reduces the average income loss from 2.5 percent to 1.9 percent of income (about a 25 percent reduction in income loss).
  - Mitigating measures are progressive in percent-of-income terms: calculated to give back 1.2 percent of consumption to the bottom decile, but only 0.4 percent to the top quintile.
- Targeting and absolute benefit distribution:
  - In peso terms, wealthier households receive a large share of benefits due to higher consumption.
  - Bottom quintile receives about 15 percent of the benefit from the overall package; top quintile receives about 30 percent of the benefit.
  - Reductions in energy and franchise taxes account for over 40 percent of the mitigating package and are poorly targeted:
    - Bottom quintile receives only 7 percent of the total benefit from these tax cuts.
    - Top quintile receives 43 percent of the total benefit from these tax cuts.
  - Assumed social spending measures would be relatively better targeted: almost 28 percent of the social spending benefit would accrue to the bottom quintile.
- Fuel tax cuts:
  - Substantial leakages to better-off households associated with fuel tax cuts; diesel and gasoline reductions especially favor wealthier consumers directly and indirectly via lower prices across the economy.
  - Kerosene reduction is best targeted to the poor but constitutes a negligible share of the total mitigating package.

### Social Spending Options — Targeting and Coverage Insights
- Five alternative social spending forms evaluated: improving public health facilities, expanding access to health facilities, expanding health insurance uniformly, improving existing educational facilities, and expanding school access.
- Coverage and targeting summary (selected figures):
  - Improving public health facilities: coverage for Bottom Decile = 57.0 percent; targeting (percent of beneficiaries in Bottom Decile) = 13 percent.
  - Expanding access to health facilities: coverage for Bottom Decile = 90.6 percent; targeting = 14.3 percent.
  - Expanding insurance: coverage for Bottom Decile = 95.1 percent; targeting = 13.5 percent.
  - Improving school facilities: coverage for Bottom Decile = 28.1 percent; targeting = 15.9 percent.
  - Expanding school access: coverage for Bottom Decile = 4.8 percent; targeting = 34.1 percent.
- Trade-offs emphasized:
  - Programs that expand access tend to have higher targeting to the poor but may cover fewer households in absolute terms.
  - Improving existing facilities benefits fewer poor households in absolute numbers than expanding access would, because utilization is already concentrated among less-poor households.
- Measurement caveat:
  - Use of measured per capita income likely understates the true targeting performance of programs that expand access and overstates targeting performance of programs that improve existing services.

### Alternative Compensation Schemes (comparative numbers)
- Mitigating package average income effect: 1.2 percent of measured consumption (all households).
- Tax measures alone average income effect: 0.3 percent.
- Social spending measures average income effect: 0.9 percent.
- Examples of transfer schemes (average transfer per household, pesos per month):
  - Mitigating measures: 503 pesos per month (All).
  - Proxy means transfer: 200 pesos per household per month (All), coverage 30.0 percent, share of benefit to Bottom Decile = 29.5 percent.
- Per capita income by quintile (from survey):
  - Bottom Decile: 6,123 pesos.
  - 2nd Decile: 9,532 pesos.
  - 2nd Quintile: 14,073 pesos.
  - 3rd Quintile: 22,053 pesos.
  - 4th Quintile: 36,155 pesos.
  - Top Quintile: 97,791 pesos.
  - All: 35,579 pesos.

### Targeting of Social Programs versus Fuel Tax Cuts
- 4.8 percent of the children in the bottom decile and 3.3 percent of the second decile do not attend school.
- All forms of social spending considered are better targeted than fuel tax cuts, but only expanding access to schools delivers a high percentage of benefits to the poor.
- Of the programs considered, improving existing school facilities combines appealing coverage and targeting because poor households tend to have more children and school attendance is high nationally.
- Except for expanding access to education, the five social spending programs considered provide only marginally bigger benefit to the poor than uniform untargeted transfers.
- Report suggests investigating alternative compensation approaches for poor households, including direct targeted transfers.

### Four Alternative Targeted Transfer Schemes (design and cost parity)
- Each transfer scheme is designed to cost as much as the existing mitigating measures; transfer amounts vary by program according to coverage.
- Scheme 1: Target the poorest municipalities (NSCB poverty map) to cover 30 percent of all households. Each participating household receives P2,300 per month.
- Scheme 2: Target households living in the municipalities currently benefiting from the KALAHI-CIDSS program. KALAHI operates in 177 municipalities from the poorest 42 provinces. Six percent of households lived in KALAHI municipalities; the simulated scheme granted each residing household a P11,700 per month transfer.
- Scheme 3: Proxy means test targeting with a threshold at the 30 percentile of the score distribution. Transfers to eligible households amount to P2,300 per month.
- Scheme 4: Target households in poor barangays ranked by average proxy means score, covering 30 percent of households with a monthly transfer per household of P2,300.
- Targeting performance and coverage:
  - All four transfer schemes are more progressive and better target the poor than the existing mitigating measures.
  - KALAHI and proxy means schemes are slightly better targeted than transfers to poor municipalities or barangays.
  - KALAHI program coverage: 6 percent of all households.
  - Proxy means transfer:
    - Covers over 88.5 percent of households in the lowest decile.
    - Covers only 0.6 percent of households in the top quintile.
    - Total coverage: 30 percent (by design).
    - Under proxy means, households in the first two deciles receive over half of the benefits.
  - Comparative shares of benefits to the first two deciles:
    - Proxy means: over half of benefits.
    - KALAHI: about 47 percent.
    - Poor municipality and barangay schemes: less than 43 percent.
    - Current compensation program: 15.1 percent.
- Cost-efficiency example:
  - Fully compensating the bottom quintile for adverse VAT reform effects using transfers to poor municipalities rather than the existing mitigating package requires 72 percent fewer pesos.
- Caveats on transfers:
  - Transfers are not perfectly targeted; not all households in the bottom decile would receive compensation—compensation is on average across the decile.
  - Analysis does not account for administrative costs or implementation inefficiencies and leakages.
  - Cash transfers considered amount to 5 percent of consumption for the poorest decile (example magnitude).
  - Reference: Mexico’s Progresa program delivered transfers equal to 20 percent of consumption and had a negligible effect on incentives to work (Skoufias and Maro, 2006).

### Policy-Relevant Implications and Recommendations
- The VAT reform as modeled is slightly progressive in percent-of-income terms but imposes a measurable average real consumption loss of 2.5 percent absent mitigation.
- Mitigating tax reductions (notably on fuels) are poorly targeted in absolute terms and deliver a disproportionate share of benefits to wealthier households.
- Redirecting a larger share of mitigating resources toward well-designed, targeted social spending or transfers (e.g., proxy means tests, transfers to poor municipalities, targeted expansions of access) can increase benefits to the poorest quintiles at lower fiscal cost, subject to implementation capacity and administrative costs.
- Choice among social spending options involves trade-offs between coverage (number of beneficiaries) and targeting (share of benefits accruing to the poor); expanding access often achieves better targeting, while improving existing facilities may benefit fewer poor households.
- Effective implementation of social spending measures requires proper selection, design, costing, and execution of projects, as well as efficient use of administrative budget.
- A well-designed social safety net can enhance fiscal policy conduct and flexibility and reduce reliance on ad hoc mitigating measures that undermine revenues and introduce price distortions.
- Existing successful programs (e.g., KALAHI-CIDSS) can be extended and refined to deliver social assistance more effectively.

### Box 4. Philippines: Main Features of the VAT Reform
- VAT rate change: Standard VAT rate increased from 10 to 12 percent on February 1, 2006.
- Previously exempt goods and services that became subject to the VAT include coal, natural gas, and other indigenous fuels; petroleum products and their raw materials; power; electric cooperatives; domestic transport of passengers by air and sea; medical services; legal services; cotton and cotton seeds; non-food agricultural products; works or art, literary works, musical composition.
- Goods and services that became zero-rated include transport of passenger or cargo by air or sea to a foreign country; services rendered to aircrafts and vessels engaged in international transport; sale of goods, supplies, and fuel to aircrafts and vessels engaged in international transit.
- Other changes to VAT treatment and administration:
  - The staggering of input VAT on capital equipment over a 5-year period;
  - An input VAT credit cap at 70 percent of output VAT in a given quarter;
  - Removal of 1.5 percent presumptive input VAT on public works contractors;
  - A 5 percent sales tax on government purchases of goods and services and public works contracts in lieu of VAT.
- Mitigating measures adopted alongside the VAT reform:
  - Reduction of excise tax on kerosene, diesel, bunker fuel oil, and regular gasoline;
  - Removal of a 2 percent franchise tax on gross receipts of power distribution utilities;
  - Removal of a 3 percent franchise tax on gross receipts of domestic airlines and common carriers tax on domestic shipping;
  - Increase in the presumptive input VAT of agro-processors from 1.5 to 4 percent of gross value of agro-input purchases;
  - Increase in the marginal threshold from P 550 thousand to P 1.5 million per annum; rental threshold from P 8,000 to P 10, 000 per month; and real property threshold from P 1 to P 2.5 million.
- Non-VAT reform fiscal measures included in the reform package:
  - Increase in the corporate income tax rate from 32 to 35 percent, with automatic reduction to 30 percent envisaged in 2009.
  - Increase in the gross receipts tax from 5 to 7 percent on royalties, rentals of property, real or personal, profits from exchange and all other items treated as gross income, of banks and non-bank financial intermediaries.
  - Removal of Philippine Amusement and Gaming Corporation (PAGCOR) income tax exemption.
- Incremental revenue earmarking from VAT reform receipts:
  - 50 percent of local government units’ share in incremental VAT collections was earmarked for public elementary and secondary education; health premiums of enrolled indigents; environmental conservation; agricultural modernization to finance construction of farm-to-market roads and irrigation facilities.
- Fiscal cost of mitigating measures (annual estimates):
  - Total: 39.1 billion pesos; 0.6 percent of GDP.
  - Reduction in fuel excises: 14.2 peso bln.; 0.2 percent of GDP.
    - Of which: reduction in diesel excise: 12.1 peso bln.; 0.2 percent of GDP.
  - Removal of franchise taxes: 3.3 peso bln.; 0.1 percent of GDP.
  - Reduction in the oil tariff from 5 to 3 percent: 8.5 peso bln.; 0.1 percent of GDP.
  - Other: 1.0 peso bln.; 0.0 percent of GDP.

*Source: _wp07153 (IMF staff analysis and Appendix I as provided in the source document).*

### 1. Household Expenditure Shares and Average Expenditure ....................................................7

### 1. Household Expenditure Shares and Average Expenditure ....................................................7

### VAT Reform and Fiscal Impact
- VAT base extended in November 2005 to energy products and selected professional services.
- VAT rate increased from 10 to 12 percent in February 2006.
- Revenue collection (net of mitigating tax measures) is estimated to have increased by about 1.3 percentage points of GDP in 2006.

### Mitigating Measures and Spending Plans
- Government introduced a package of mitigating tax measures that included a reduction in selected petroleum excises.
- Authorities announced plans to spend 30 percent of the incremental revenue receipts from the VAT reform on infrastructure and social services.

### Poverty Profile (Box 1: Poverty in the Philippines)
- Poverty incidence: 30 percent in 2003, down from 33 percent in 2000 (based on the 2003 Family Income and Expenditure Survey (FIES) as reported by the National Statistical Coordination Board (NSCB)).
- Over 4 million families (or 23.8 million individuals) lived below the poverty line in 2003.
- Income gap (average income shortfall of families below the poverty threshold, expressed in proportion to the poverty line) declined from 29.1 to 28.7 percent between 2000 and 2003.
- Poverty threshold used: annual per capita income of 12,309 pesos.
- World Bank–identified determinants of poverty:
  - Educational attainment: three-quarters of poor households have heads with no secondary education, while only half of all households do nationally.
  - Sector of employment: two-thirds of the poor are employed in agriculture, compared with 40 percent of households nationally.
  - Highest poverty incidence recorded among the self-employed and the wage earners employed in the agriculture sector.

### Key Findings Reported in the Paper (introductory statements)
- The VAT reform had a moderate adverse effect on poor households.
- The VAT reform was progressive in its overall distributional impact.

*Source: _wp07153 - 1. Household Expenditure Shares and Average Expenditure ....................................................7*

### Appendix I provides a more detailed description of the VAT law before and after the reform.

### _wp07153 - Appendix I provides a more detailed description of the VAT law before and after the reform.

### Scope of reform and principal assumptions
- Components of the simulated reform:
  - VAT rate increase from 10 to 12 percent.
  - Broadening of the VAT base to petroleum products, electricity, and professional services.
  - Reduction in fuel excises.
  - Removal of the franchise taxes.
  - Reduction in the oil tariff from 5 to 3 percent.
  - Devotion of a portion of additional VAT revenue to increased education and health spending.
- Fiscal allocation assumptions:
  - Authorities announced that at least 30 percent of the additional revenue proceeds will be set aside for infrastructure and social spending.
  - The analysis assumes 60 percent of the additional expenditure is devoted to social spending and 40 percent to infrastructure.
  - Social spending is assumed split equally between education and health.
- Modeling assumptions:
  - First-order price effects only; household and firm demand held fixed (estimates are upper bounds on income effects).
  - Firms assumed to pass all cost increases to customers.
  - Indirect effects estimated using a simple input-output model based on the 2000 input-output table for the Philippines.
  - Household consumption data from the 2003 FIES used to compute budget shares and aggregate impacts.
  - Additional social spending modeled as transfers to existing users of education and health facilities.

### Methodology highlights
- Direct impact measure: percent change in final prices due to tax changes (example: a 2 percentage point VAT increase results in about a 2 percent direct increase in final prices of VATed items).
- Indirect impact: changes in after-tax prices of intermediate goods passed to final goods using input-output linkages.
- Incidence calculation: budget share of each consumption item × corresponding price increase, summed to estimate percentage decline in household real income; averaged by income quintile.
- Welfare measure: income per capita from the 2003 FIES (sensitivity analysis shows robustness to using consumption per capita).
- Caveats noted:
  - Model likely overstates income loss by about 30 percent compared with estimated revenue gain.
  - Assumed universal tax compliance may overstate total household income loss; distributional implications unaffected if noncompliance is uniform across groups.
  - Modeling of additional social spending likely overstates benefits (efficiency losses, valuation by users) and understates benefits from infrastructure.

### Distributional impact — key findings
- Average gross reduction in household consumption due to VAT reform (without mitigation): 2.5 percent.
  - Bottom quintile: 2.4 percent reduction in real consumption.
  - Top quintile: 2.7 percent reduction in real consumption.
- Progressivity drivers:
  - Poor households disproportionately consume unprocessed agricultural products exempt from VAT.
  - Petroleum products (except kerosene) are largely consumed by wealthier households.
- Modelled mitigating package effect:
  - The package reduces the average income loss from 2.5 percent to 1.9 percent of income (about a 25 percent reduction in income loss).
  - The mitigating measures are progressive in percent-of-income terms: calculated to give back 1.2 percent of consumption to the bottom decile, but only 0.4 percent to the top quintile.
- Targeting and absolute benefit distribution:
  - In peso terms, wealthier households receive a large share of benefits due to higher consumption.
  - Bottom quintile receives about 15 percent of the benefit from the overall package; top quintile receives about 30 percent of the benefit.
  - Reductions in energy and franchise taxes account for over 40 percent of the mitigating package and are poorly targeted:
    - Bottom quintile receives only 7 percent of the total benefit from these tax cuts.
    - Top quintile receives 43 percent of the total benefit from these tax cuts.
  - Assumed social spending measures would be relatively better targeted: almost 28 percent of the social spending benefit would accrue to the bottom quintile.
- Fuel tax cuts:
  - Substantial leakages to better-off households associated with fuel tax cuts; diesel and gasoline reductions especially favor wealthier consumers directly and indirectly via lower prices across the economy.
  - Kerosene reduction is best targeted to the poor but constitutes a negligible share of the total mitigating package.

### Social spending options — targeting and coverage insights
- Five alternative social spending forms evaluated: improving public health facilities, expanding access to health facilities, expanding health insurance uniformly, improving existing educational facilities, and expanding school access.
- Coverage and targeting summary (selected figures from analysis):
  - Improving public health facilities: coverage for Bottom Decile = 57.0 percent; targeting (percent of beneficiaries in Bottom Decile) = 13 percent.
  - Expanding access to health facilities: coverage for Bottom Decile = 90.6 percent; targeting = 14.3 percent.
  - Expanding insurance: coverage for Bottom Decile = 95.1 percent; targeting = 13.5 percent.
  - Improving school facilities: coverage for Bottom Decile = 28.1 percent; targeting = 15.9 percent.
  - Expanding school access: coverage for Bottom Decile = 4.8 percent; targeting = 34.1 percent.
- Trade-offs emphasized:
  - Programs that expand access tend to have higher targeting to the poor but may cover fewer households in absolute terms (e.g., expanding school access gives large share to poorest but reaches relatively few households due to near-universal attendance).
  - Improving existing facilities benefits fewer poor households in absolute numbers than expanding access would, because utilization is already concentrated among less-poor households.
- Measurement caveat:
  - Use of measured per capita income likely understates the true targeting performance of programs that expand access (because those who forego services are more likely truly poor) and overstates the targeting performance of programs that improve existing services.

### Alternative compensation schemes (high-level comparative numbers)
- Mitigating package average income effect: 1.2 percent of measured consumption (all households).
- Tax measures alone average income effect: 0.3 percent.
- Social spending measures average income effect: 0.9 percent.
- Examples of transfer schemes (average transfer per household, pesos per month):
  - Mitigating measures: 503 pesos per month (All).
  - Proxy means transfer: 200 pesos per household per month (All), coverage 30.0 percent, share of benefit to Bottom Decile = 29.5 percent.
  - Poor municipality transfer and transfer to poor barangays show higher shares of benefits to poorer groups with varying coverage.
- Per capita income by quintile (from survey):
  - Bottom Decile: 6,123 pesos.
  - 2nd Decile: 9,532 pesos.
  - 2nd Quintile: 14,073 pesos.
  - 3rd Quintile: 22,053 pesos.
  - 4th Quintile: 36,155 pesos.
  - Top Quintile: 97,791 pesos.
  - All: 35,579 pesos.

### Policy-relevant implications
- The VAT reform as modeled is slightly progressive in percent-of-income terms but imposes a measurable average real consumption loss of 2.5 percent absent mitigation.
- Mitigating tax reductions (notably on fuels) are poorly targeted in absolute terms and deliver a disproportionate share of benefits to wealthier households.
- Redirecting a larger share of mitigating resources toward well-designed, targeted social spending or transfers (e.g., proxy means tests, transfers to poor municipalities, targeted expansions of access) can increase benefits to the poorest quintiles at lower fiscal cost, subject to implementation capacity and administrative costs.
- Choice among social spending options involves trade-offs between coverage (number of beneficiaries) and targeting (share of benefits accruing to the poor); expanding access often achieves better targeting, while improving existing facilities may benefit fewer poor households.
- Effective implementation of social spending measures requires proper selection, design, costing, and execution of projects, as well as efficient use of administrative budget.

*Source: Appendix I and excerpts from IMF staff analysis based on the 2000 input-output tables and the 2003 Family Income and Expenditure Survey (FIES) as presented in the source document.*

### 4.8 percent of the children in the bottom decile and 3.3 percent of the second decile do not

### _wp07153 - 4.8 percent of the children in the bottom decile and 3.3 percent of the second decile do not

### Targeting of social programs versus fuel tax cuts
- 4.8 percent of the children in the bottom decile and 3.3 percent of the second decile do not attend school.
- All forms of social spending considered are better targeted than fuel tax cuts, but only expanding access to schools delivers a high percentage of benefits to the poor.
- Of the programs considered, improving existing school facilities combines appealing coverage and targeting because poor households tend to have more children and school attendance is high nationally.
- Except for expanding access to education, the five social spending programs considered provide only marginally bigger benefit to the poor than uniform untargeted transfers.
- The report suggests investigating alternative compensation approaches for poor households, including direct targeted transfers.

### Four alternative targeted transfer schemes (design and cost parity)
- Each transfer scheme is designed to cost as much as the existing mitigating measures; transfer amounts vary by program according to coverage.
- Scheme 1: Target the poorest municipalities (NSCB poverty map) to cover 30 percent of all households. Each participating household receives P2,300 per month.
- Scheme 2: Target households living in the municipalities currently benefiting from the KALAHI-CIDSS program. The KALAHI program operates in 177 municipalities from the poorest 42 provinces. Six percent of households lived in KALAHI municipalities, and the simulated scheme granted each residing household a P11,700 per month transfer.
- Scheme 3: Proxy means test targeting with a threshold at the 30 percentile of the score distribution. Transfers to eligible households amount to P2,300 per month.
- Scheme 4: Target households in poor barangays ranked by average proxy means score, covering 30 percent of households with a monthly transfer per household of P2,300.

### Targeting performance and coverage: key statistics and comparisons
- All four alternative transfer schemes are more progressive and better target the poor than the existing mitigating measures.
- The KALAHI and proxy means schemes are slightly better targeted than transfers to poor municipalities or barangays.
- KALAHI program coverage: 6 percent of all households.
- Proxy means transfer coverage and targeting:
  - Covers over 88.5 percent of households in the lowest decile.
  - Covers only 0.6 percent of households in the top quintile.
  - Total coverage: 30 percent (by design).
  - Under the proxy means program, households in the first two deciles receive over half of the benefits.
- Comparative shares of benefits to the first two deciles:
  - Proxy means: over half of benefits.
  - KALAHI: about 47 percent.
  - Poor municipality and barangay schemes: less than 43 percent.
  - Current compensation program: 15.1 percent.
- When coverage is low, household-level targeting raises the bottom quintile’s share of benefits from 50 to 80 percent (illustrative comparison described).
- Geographic heterogeneity:
  - For municipalities, the poorest households live in places where roughly 30 percent of neighbors are in the bottom quintile.
  - Richest households live in municipalities with slightly less than 20 percent of households in the bottom quintile.
  - Roughly 95 percent of the variation in log per capita income is attributable to variation within municipalities.

### Cost-efficiency of targeted transfers versus existing mitigating package
- Replacing existing tax and assumed spending measures with targeted transfers can compensate the poorest households at a fraction of cost.
- Example: Fully compensating the bottom quintile for adverse VAT reform effects using transfers to poor municipalities rather than the existing mitigating package requires 72 percent fewer pesos.
- Caveats:
  - Transfers are not perfectly targeted; not all households in the bottom decile would receive compensation—compensation is on average across the decile.
  - Analysis does not account for administrative costs or implementation inefficiencies and leakages, which would reduce attractiveness of targeted transfers relative to tax cuts.
  - Cash transfers considered are relatively small—only amounting to 5 percent of consumption for the poorest decile.
  - Reference: Mexico’s Progresa program delivered transfers equal to 20 percent of consumption and had a negligible effect on incentives to work (Skoufias and Maro, 2006).

### Policy implications and recommendations
- Targeted transfer schemes (especially proxy means testing) offer superior combination of targeting performance and coverage compared to untargeted social spending and across-the-board energy tax cuts.
- Household-level targeting minimizes benefit leakage to wealthier households; advantage narrows as coverage increases.
- A well-designed social safety net:
  - Can enhance fiscal policy conduct and flexibility.
  - Generally targets the poor more effectively than untargeted social spending and much more effectively than tax reductions.
  - Builds institutional capacity to mitigate adverse effects of economic shocks and reforms, reducing reliance on ad hoc mitigating measures that undermine revenues and introduce price distortions.
- Existing successful programs (e.g., KALAHI-CIDSS) can be extended and refined to deliver social assistance more effectively.

### VAT reform context and revenue figures (selected)
- Prior to 2005 VAT reform, standard VAT rate: 10 percent.
- Reformed VAT law expanded base to electricity, petroleum products, and selected professional services and increased standard rate to 12 percent.
- The VAT reform, including mitigating measures, is expected to bring about 1.3 percentage points of GDP in additional revenues annually.
- Table 5 selected yields (Fund staff estimates):
  - Widening the base: 37.1 (Billions of pesos); 0.6 (percent of GDP, full year basis).
  - Of which: crude oil and petroleum products: 30.7 (Billions of pesos); 0.5 (percent of GDP).
  - Raising the rate from 10 to 12 percent: 33.4 (Billions of pesos); 0.6 (percent of GDP).
  - Raising the CIT rate: 17.2 (Billions of pesos); 0.3 (percent of GDP).
  - Changing refund procedures: 17.6 (Billions of pesos); 0.3 (percent of GDP).
  - Mitigating measures (includes reduction in oil import tariff from 5 to 3 percent): -26.9 (Billions of pesos); -0.4 (percent of GDP).
  - Net impact: 78.4 (Billions of pesos); 1.3 (percent of GDP).

*Source: IMF staff estimates and analysis in the provided document.*

### Box 4. Philippines: Main Features of the VAT Reform

### Box 4. Philippines: Main Features of the VAT Reform

### VAT rate change
- Standard VAT rate increased from 10 to 12 percent on February 1, 2006.

### Previously exempt goods and services that became subject to the VAT
- Coal, natural gas, and other indigenous fuels;
- Petroleum products and their raw materials;
- Power;
- Electric cooperatives;
- Domestic transport of passengers by air and sea;
- Medical services;
- Legal services;
- Cotton and cotton seeds; non-food agricultural products;
- Works or art, literary works, musical composition.

### Goods and services that became zero-rated
- Transport of passenger or cargo by air or sea to a foreign country;
- Services rendered to aircrafts and vessels engaged in international transport;
- Sale of goods, supplies, and fuel to aircrafts and vessels engaged in international transit.

### Other changes to VAT treatment and administration
- The staggering of input VAT on capital equipment over a 5-year period;
- An input VAT credit cap at 70 percent of output VAT in a given quarter;
- Removal of 1.5 percent presumptive input VAT on public works contractors;
- A 5 percent sales tax on government purchases of goods and services and public works contracts in lieu of VAT.

### Mitigating measures adopted alongside the VAT reform
- Reduction of excise tax on kerosene, diesel, bunker fuel oil, and regular gasoline;
- Removal of a 2 percent franchise tax on gross receipts of power distribution utilities;
- Removal of a 3 percent franchise tax on gross receipts of domestic airlines and common carriers tax on domestic shipping;
- Increase in the presumptive input VAT of agro-processors from 1.5 to 4 percent of gross value of agro-input purchases;
- Increase in the marginal threshold from P 550 thousand to P 1.5 million per annum; rental threshold from P 8,000 to P 10, 000 per month; and real property threshold from P 1 to P 2.5 million.

### Non-VAT reform fiscal measures included in the reform package
- Increase in the corporate income tax rate from 32 to 35 percent, with automatic reduction to 30 percent envisaged in 2009.
- Increase in the gross receipts tax from 5 to 7 percent on royalties, rentals of property, real or personal, profits from exchange and all other items treated as gross income, of banks and non-bank financial intermediaries.
- Removal of Philippine Amusement and Gaming Corporation (PAGCOR) income tax exemption.

### Incremental revenue earmarking from VAT reform receipts
- 50 percent of local government units’ share in incremental VAT collections was earmarked for the following purposes:
  - Public elementary and secondary education, to finance construction of school buildings, school furniture, and in-service training of teachers;
  - Health premiums of enrolled indigents;
  - Environmental conservation;
  - Agricultural modernization to finance construction of farm-to-market roads and irrigation facilities.

### Fiscal cost of mitigating measures (annual estimates)
- Total: 39.1 billion pesos; 0.6 percent of GDP.
- Reduction in fuel excises: 14.2 peso bln.; 0.2 percent of GDP.
  - Of which: reduction in diesel excise: 12.1 peso bln.; 0.2 percent of GDP.
- Removal of franchise taxes: 3.3 peso bln.; 0.1 percent of GDP.
- Reduction in the oil tariff from 5 to 3 percent: 8.5 peso bln.; 0.1 percent of GDP.
- Other: 1.0 peso bln.; 0.0 percent of GDP.

*Source: Department of Finance Brief on the VAT Reform Law.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2007/_wp07153.pdf_