A Comment on Raising the Ceilings on

Tax-free 13
th
Month Bonuses
SA. Quimbo
22 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

Source: 2013 LFS



-
5,000
10,000
15,000
20,000
25,000
First Decile Second Decile Third Decile Fourth Decile Fifth Decile Sixth Decile Seventh
Decile
Eight Decile Ninth Decile Tenth Decile
Salary and wage earner
Self-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 13
th
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 13
th

month bonus

Simulations
Can be partially
recovered from VAT
(77% of expenditures
are subject to VAT)
Distribution of Income Tax Payments,
by ceiling amount
17.23% 16.81% 16.64% 16.57% 16.52%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
30K tax-exempt
bonus
40K tax-exempt
bonus
50K tax-exempt
bonus
60K tax-exempt
bonus
70K tax-exempt
bonus
1000 individuals earning at least PhP10M - 16M
(assumed)
From TOP 500 (over 16M)
Prof
Self-employed
Over PhP500K
Over PhP250K but not over PhP500K
Over PhP140K but not over PhP250K
Over PhP70K but not over PhP140K
Over PhP30K but not over PhP70K
Over PhP10K but not over PhP30K
Not 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 50,000
Annual 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 20,000
Annual 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 13
th

month pay to monthly basic pay or limits on frequency of payments
of the 13
th
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