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Policy Notes

ISSN 2350-7152
June 2013

Non-Investment-Related Tax Incentives

(NITIs): A Policy Paper 1
Renato E. Reside, Jr. and Ruperto Alonzo 2
This Note analyzed non-investment related tax incentives (NITIs)tax mitigation instruments geared toward
enhancement of social values from promotion of education, arts, and science, to assistance of charitable institutions,
non-government and non-profit organizations (NPOs) and cooperatives and grant of tax privileges to individuals. It
found that governments largest NITI fiscal exposures were to NPOs, seniors VAT exemptions and cooperatives.
NITIs were subjected to rigorous economic efficiency criteria. Philippine standards, norms, practices, rules and laws
for NITIs were compared with international best practice and were found wanting. Institutional shortcomings in NITI
administration and tax system were pronouncedaggravated by a lack of thorough audits of NPOs and cooperatives
by regulators and absence of agency coordination in implementation and monitoring of NITIs. The resulting nontransparency gives rise to mis-targeting of subsidies and taxpayer abuse (money laundering by taxpayers, given the
lack of oversight over many foundations). The Note concluded by offering stakeholder recommendations.

Introduction
Economics offers fundamental reasons for public interventions in markets for goods
and servicesconcepts of market failure, equity or redistribution and merit goods. Market
failures occur when people do not have complete information about markets when making
decisions; when institutions wield monopoly power; when spillover effects on others arise
from actions by market participants; and when goods and services are public in character.
Under each of these three circumstances, economic theory stipulates that too much or too
little of a good is produced relative to optimal. Thus, government interventionsactions to
raise or lower production closer to efficient levels, are justified. 3

This paper draws from Reside, Alonzo, et al. (2012)

The authors are from the UP School of Economics. The views expressed are those of the authors and do not necessarily represent the views of
PCED.
3
Economic efficiency is most often associated with allocative, or Pareto efficiency; a condition where the distribution of resources is such that no
consumers can be made better off without others being made worse off. Economic efficiency can be impaired under conditions of market failure.
1
2

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A paternalistic government motivated by a desire for greater equity may compel people
to make purchases of merit goods or services (Musgrave, 1959) deemed so intrinsically
desirable that people should possess them independent of consumer preferences and ability
or willingness to pay. Governments can justify merit good interventions by citing that certain
consumers may not be fully capable of making judgments about goods they purchase, so
myopic individuals under-consume them. Spillover effects of merit goods such as education
and public health lead to market failure and under-provision in free markets. This paper
analyzes a mode of financing delivery of such goods to societythrough the grant of
tax incentivesinstruments that mitigate tax liabilities of taxpayers through tax deferrals,
mitigation or exemptionsreducing cost of production (or consumption) of socially desirable
goods and services.
Tax incentives can be broadly classified into two types. Investment-related tax incentives
(ITIs) are geared toward spurring investments. Non-investment related tax incentives (NITIs)
are geared toward enhancement of social values from promotion of education, arts, sports,
and science, to assistance of charitable institutions and cooperatives and grant of privileges
to sectors of society by reason of their inherent traits in relation to national values.
Tax incentives for private producers reduce the price of undertaking socially beneficial
activities (stimulating supply) or of purchasing merit goods (stimulating demand), with tax
benefits hopefully passed eventually to end-consumers/institutions. Since they represent
an alternative form of government assistance with financial implications similar to direct
expenditures (e.g., spending for entitlement programs, grants, and subsidies granted based
on established rights and justified as consistent with moral or social principles or social
equality), they are referred to as tax expenditures (Government of Canada, 1995).
NITIs come in a wide variety of forms, including tax deductions for charitable contributions,
duty and tax free import privileges and exemptions from paying donors taxes (Table 1).
Examples of market failure- or public good-addressing tax incentive laws include addressing
pollution abatement environment-enhancing activities. Non-stock, non-profit organizations
(NPOs) engaged in social welfare, education and health related activities which receive tax
incentives also fall under this category. So do cooperatives capable of addressing market
failures (credit constraints, agricultural delivery systems, etc.). The Securities and Exchange
Commission (SEC) and Bureau of Internal Revenue (BIR) play prominent roles in certification
and registration for NITIs. The Philippine Council for Non-Government Organization
Certification (PCNC) screens charities wishing to obtain tax deductible donations.
NITIs can be configured either as performance-based tax incentives (PBTI) or as nonperformance-related tax incentives (NPBTI) (Table 2). Tax deductions and tax credits are
performance-based high powered incentives since one cannot obtain tax benefits without first
reporting the size of the activity. NPBTI such as full tax exemptions, income tax holidays (ITH), are
low powered incentives and the most generous form of tax benefits, as they zero out tax liabilities.
Since ITH, outright tax exemptions and reduced rates of taxation do not target the level of the

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June 2013

Table 1.

Institutional Requirements for Typical NITI Availment

Type of NITI

Agency responsible for

screening, audit and
monitoring

Organizational form

IBCL Rate
(in percent)

SDA Rate
(in percent)

Income tax exemption

SEC, BIR

Nonprofit organizations (NPOs); 4.5395

Independent public charities;
religious organizations

4.5320

Corporate or private
foundations

1,705,495

4.2500

4.3924

4.3494

Reduced income tax

rates

SEC, BIR, Commission on

Higher Education (CHEd),
Department of Health

Private hospitals and schools

(10% income tax rate)

4.1882

4.1182

Tax deduction for

charitable giving and
donors tax exemption

PCNC, BIR

Independent charities

4.1809

4.1033

Income tax exemption

Cooperative Development
Authority (CDA), BIR

Cooperatives

4.1156

4.0993

Trade tax exemption

Bureau of Customs (BoC)

Relevant taxpayers

4.1405

4.0970

Value-added tax
exemption

Relevant implementing agency,

such as Municipal Office of
Senior Citizens Affairs

Senior Citizens and other

favored individuals

4.0700

4.0300

activity directly and instead target income, researchers often describe NPBTI as inefficientthere
is no need to demonstrate non-trivial investment to gain the benefits of tax abatement.
While procurement of public goods and services via tax expenditures or NITIs is financed through
mechanisms that reduce or defer tax liabilities, conventional procurement of public goods and
services is financed through the regular government budget. The next section discusses patterns
of conventional government budgeted expenditures in the last few years.

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Table 2.

Kinds of tax incentives utilized in the Philippines by power of incentive

Kind of incentive

Example

Nature

Performance-related
(more powerful)

Tax deductions, tax credits

Extent of tax benefit is proportional to expense incurred to

qualify for it

Non-performance-related
(less powerful)

Income tax reductions, income Extent of tax benefit is not proportional to expense incurred
tax holidays, tax exemptions
to qualify for it

Source: Authors

Budget-financed vs. tax-expenditure-financed government

expenditures
Table 3 gives conventional national government expenditures by sector, on obligation basis,
as a percent of GDP over various administrations from 1975 to 2012. While it initially appears
that share of government spending in GDP has been increasing since the mid-1970s, from
13.4 percent during the Marcos regime to 16.9 percent over the last two years, the bottom
line of Table 3 shows that net of debt service, there has hardly been any increase over almost
five decades.
Among the four major sectorseconomic, social, national defense, and general public
services it is perhaps in social services that many governments give leeway to private
initiatives in the production and provision of public goods and even offer incentives for private
sector participation through the NITIs. In the Philippines, for example, private schools and
hospitals, even if proprietary, get a reduced income tax rate of only 10 percent; donations to
state universities and colleges (SUCs) are not only exempt from the donors tax but may also
be claimed for additional deductions from gross income.
A significant development in the post-Marcos era is the shift in relative priorities from economic
services to social services. From an average of 46.6 percent during the last decade of
Marcos, the share of economic services fell to 34.3 percent during the term of President
Corazon Aquino and further down to 19.9 percent during the first two years of President
Benigno Aquino III. Much of the decline went to social services, particularly education, as
the 1987 Constitution mandates that basic education should have the biggest share in the
national budget.
Also worth noting in Table 4 is the huge increase in transfers to local government units (LGUs)
beginning with the Ramos government. With the passage of the Local Government Code
(LGC) in October 1991, the primary responsibility for the provision of basic social services has

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Table 3.

National Government Expenditures, Obligation Basis, as a Percentage of GDP, 1975-2012 (based on current prices)
Marcos

Aquino 1

Ramos

Estrada

Arroyo

Aquino 2

1975-85

1986-92

1993-98

1999-2000

2001-10

2011-12

GRAND TOTAL

13.4

16.9

17.7

18.5

17.1

16.9

Total Economic Services

5.5

4.1

3.7

3.4

3.0

2.8

Total Social Services

2.7

3.5

4.3

4.7

3.4

4.0

Education

1.6

2.5

3.0

3.2

2.5

2.7

Health

0.5

0.6

0.5

0.4

0.3

0.5

Soc. Security, Labor/Emp., & Welfare

0.1

0.3

0.6

0.8

0.4

0.6

Housing & Community Development.

0.3

0.1

0.1

0.2

0.1

0.2

National Defense

1.7

1.2

1.1

1.0

1.1

1.0

General Public Services

1.4

2.1

2.6

2.5

2.4

2.3

Others n.e.c. (incl. transfers to LGUs)

0.7

1.1

2.6

3.2

3.0

3.8

Debt Service

1.3

5.0

3.5

4.6

4.2

3.0

Transfer to LGUs

0.5

0.7

2.5

3.1

2.9

2.7

Grand Total less Debt Service

12.1

11.9

14.2

14.9

12.9

13.9

Sector

MEMO ITEMS:

Source: Department of Budget and Management, Budget of Expenditures and Sources of Financing, as compiled by R.G. Manasan, Analysis of
the Presidents Budget for 2013, PIDS Discussion Paper Series No. 2013-13 (2013).

been devolved to LGUs. Under the LGC, central internal revenue allotments (IRAs) are given
by national government to LGUs for their use in delivery and finance of selected government
services. Better targeting of government interventions, lower transactions costs, rapid adoption
of efficiency-enhancing innovations, and improved matching of resources with needs were
expected over the long run with decentralized governance. Provision of health and other basic
social services were the main functions that have been devolved from the national government
agencies (NGAs). Basic education remains the responsibility of the national government.
While the data and discussion presented above attest to continuing efforts by both the
national and local governments to provide basic social services that are traditionally
considered as public goods or merit goods, they do not per se suggest that the provision
of such goods and services should be solely the domain of the public sector. In the end,
ideally, NITIs given to the private sector should be subject to a social cost-benefit analysis

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June 2013

Table 4.

Sector Shares in National Government Expenditures, Obligation Basis, 1975-2012 (based on current prices)
Marcos

Aquino 1

Ramos

Estrada

Arroyo

Aquino 2

1975-85

1986-92

1993-98

1999-2000

2001-10

2011-12

GRAND TOTAL

100.0

100.0

100.0

100.0

100.0

100.0

Total Economic Services

46.6

34.3

26.1

23.1

23.1

19.9

Total Social Services

22.0

29.4

30.1

31.8

26.4

28.8

Education

13.8

20.9

21.8

22.6

20.2

19.7

Health

4.4

5.3

3.2

2.9

2.2

3.3

Soc. Security, Labor/Emp., & Welfare

1.2

2.2

4.4

5.0

3.4

4.6

Housing & Community Development.

2.6

2.0

0.8

1.2

0.6

1.2

National Defense

13.7

10.1

7.7

6.9

8.2

7.4

General Public Services

11.8

17.3

18.0

16.5

18.8

16.7

Others n.e.c. (incl. transfers to LGUs)

5.7

9.0

18.1

21.8

23.5

27.2

Transfer to LGUs

4.5

6.2

17.5

20.6

22.2

19.4

Grand Total less Debt Service

26.5

18.8

15.7

14.6

14.1

12.4

Sector

MEMO ITEMS:

Source: Department of Budget and Management, Budget of Expenditures and Sources of Financing, as compiled by R.G. Manasan, Analysis of
the Presidents Budget for 2013, PIDS Discussion Paper Series No. 2013-13 (2013).

(SCBA), just as direct outlays by the public sector on the same types of activities should be.
The choice is not either/or: if both public and private sector projects show social internal
rates of return that are higher than the social opportunity cost of capital, then both initiatives
should be undertaken. Unfortunately, however, at present, neither public nor private
initiatives undergo the thorough scrutiny given to large infrastructure projects. Fortunately,
there is a growing awareness of the need to subject public sector social projects to SCBA,
both ex ante and ex post.
In contrast to conventional on-budget expenditures, NITIs are a form of off-budget subsidy
provided by the government because they do not form part of the regular annual budget of the
government. Off-budget subsidy interventions can take place within or outside the tax system.
In general, off-budget state interventions and subsidies are not easily quantifiable in peso

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07

terms. This makes them less transparent and in general, their institutional approval systems
less subject to regulation and accountability than conventional formally budgeted expenditures.
In a recent study, Reside, Alonso, et al. (2012) estimated the value of NITI tax expenditures
(Table 5). In general, this was done by first determining which laws constitute deviations
from norms of taxation, then constructing tax bases under normal taxation and subtracting
from them taxes collected with NITIs imposed. It was found that the largest NITI-related tax
expenditures in the Philippines are (by far) income tax exemptions of institutions classified as
nonprofit organizations (NPOs). Next come tax benefits for senior citizens (VAT exemptions),
cooperatives (income tax exemptions), proprietary educational institutions and hospitals
(reduced tax rates), which have considerably less claims. The large tax expenditure to
GDP ratio of NPOs (comprised of many foundations) suggests that this sector needs to be
scrutinized the most.
Unlike conventional social on-budget government expenditures weighted towards education,
NITIs are generally weighted toward NPOs that deliver non-education social services and
groups the state recognizes as having special needs, such as senior citizens and members
of cooperatives. From a broader perspective, however, while on-budget expenditures are
weighted towards social services, estimates from Reside (2006) and Reside et al (2012)
suggest that ITIs dominate NITIs, so off-budget expenditures are heavily weighted towards
economic services.
On-budget subsidies and off-budget NITIs may require costly and complex government
administrative effortas required by the need to screen, verify and deliver such subsidies
(to say nothing of the SCBA required ex post as well as mentioned previously). In the case
of NITIs, examples include locally-run senior citizens affairs offices to screen applicants for
identification cards used in claiming seniors tax benefits, the creation of specialized groups
within the CDA and BIR for similar purposes. Thus, both on-budget subsidies and NITIs tend
to entail potentially large administration costs imposed on the government. Table 5 describes
the level of effort required in administration of various types of government procurement.
There are important differences and trade-offs between on- and off-budget supports. The
major difference between on-budget expenditures and off-budget tax expenditures is that
the former involves a conscious use of public cash resources from the treasury while the
latter involves a conscious decision to forego revenue generation for the treasury.
One potential disadvantage of off-budget tax expenditures is the potential for them to crowd
out on-budget government expenditures. The introduction of an increasing number of laws
granting tax incentives for investment and various social objectives makes it more likely that
off-budget expenditures will crowd out budgeted expenditures. Experience in the Philippines
suggests that the more fiscal constraints are binding, the more likely is it to be the case
that governments will rely on off-budget expenditure financing. Reside (2006) argues that
tax incentives for investors in the Philippines are poor substitutes for on-budget cash
expenditures and also drain fiscal resources away from government cash expenditures.

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Table 5.

Philippine NITI Tax Expenditure Estimates

Year

Percent of
2009 GDP

Estimate of tax
expenditures

Type of tax
incentive

Law

2007

1.1427

87,743,987,424.00 Income tax

exemptions

Non-stock corporation or association organized and

operated exclusively for religious, charitable, scientific,
athletic, or cultural purposes, or for the rehabilitation
of veterans; Civic league or organization not organized
for profit but operated exclusively for the promotion of
social welfare; Business league chamber of commerce,
or board of trade, not organized for profit; Labor,
agricultural or horticultural organization not organized
principally for profit; a beneficiary society, order or
association, operating for the exclusive benefit of the
members; Cemetery company owned and operated
exclusively for the benefit of its members; [Section 30
(A) (C) (D) (E) (F) (G), National Internal Revenue Code].

2006

0.1535

11,788,000,000.00 VAT Incentives

(Unless otherwise
stated, the laws
below provide VAT
exemptions)

Certain purchases of goods and services by senior

citizens (RA 9994).

2009

0.0439

3,374,188,289.96

VAT Incentives
(Unless otherwise
stated, the laws
below provide VAT
exemptions)

Sales by all cooperatives registered under the Cooperative

Development Code (RA 9520)

2009

0.0323

2,477,783,932.04

Income tax
exemptions

All cooperatives registered under the Cooperative

Development Authority, regardless of classifications
(RA 9520)

2007

0.0128

983,360,320.00

Income tax
exemptions

Tourism Infrastructure and Enterprise Zone Authority

(RA 9593).

2008

0.0115

886,459,053.33

Reduced income
tax rate

Proprietary educational institutionstax rate of 10%

only [Section 27 (B), National Internal Revenue Code]

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Table 5. continued

Philippine NITI Tax Expenditure Estimates

Year

Percent of
2009 GDP

Estimate of tax
expenditures

Type of tax
incentive

Law

2008

0.0114

874,106,012.80

Income tax
exemptions

Public education institutions [Section 30 (I) National

Internal Revenue Code], including state universities and
colleges [Respective charters; Article XIV Constitution;
RA 8292]

2009

0.0030

229,698,086.04

VAT Incentives
(Unless otherwise
stated, the laws
below provide VAT
exemptions)

Zero rate on purchases by the Philippine Normal

University (RA 9647) and the University of the
Philippines (RA 9500)

2008

0.0020

157,129,920.00

Additional
deductions from
gross income

Donations to state colleges and universities*

(Respective Charters; RA 8292. Higher Education
Act of 1997) Note: 150% of amount of donations
to Philippine Normal University (RA 9647) and the
University of the Philippines are deductible (RA 9500).

2009

0.0020

150,534,659.84

Income tax
exemptions

Duty-free Corporation (RA 9593).

2008

0.0019

146,065,088.89

Reduced income
tax rate

Proprietary hospitalstax rate of 10% only [Section 27

(B), National Internal Revenue Code]

2008

0.0013

102,121,829.00

VAT Incentives
(Unless otherwise
stated, the laws
below provide VAT
exemptions)

Educational services rendered by private educational

institutions, duly accredited by the DepED, CHED, and
TESDA and those rendered by government educational
institutions (Section 109 H, National Internal Revenue
Code)

2008

0.0013

98,206,200.00

Donors' tax
exemption

Donations to state colleges and universities

(Respective Charters; RA 8292. Higher Education Act
of 1997)

2010

0.0009

67,332,471.00

Exemption from
import duties

RA 9513 Renewable Energy Act of 2008, Duty Exempt

2009

0.0006

47,682,000.00

Additional
deductions from
gross income

Fifteen percent (15%) of the total amount paid as

salaries and wages to senior citizens (RA 9994).

Note: Tax expenditures were estimated for the latest year in which data was available

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Evaluating the effectiveness and efficiency of NITIs

When used as a criterion for deciding whether NITIs are desirable or not (in a later section),
economic efficiency refers to allocative efficiencythe extent to which society apportions its
resources to financing activities with the highest social benefits. When used to describe the
motive for a NITI (as in this section), economic efficiency refers to the motive of government
to correct various market failures. Meanwhile, equity-based NITIs aim to improve income
distribution. Finally, merit-based NITIs aim to make certain goods and services available to all
people. In this case, the effectiveness of the tax incentive is directly tied to whether: (a) the
recipient of the subsidy is legitimately a member of the special group; and (b) the subsidy is
appropriate (i.e., is just sufficient to address the specific needs of the special group and is not
excessive) and whether it in fact makes the good available to all.
The efficiency of the tax incentives also depends on the power of the tax benefit to truly
motivate the desirable behaviorthe elasticity (sensitivity) of the supply or consumption of the
activity or good with respect to the lowering of its price. Whether granted to special groups
or for spillover-producing activities, tax incentives lower the prices of goods being acquired
or purchased. Reducing the price of undertaking specific activities is supposed to stimulate
greater demand for or production of the good or service. In this case, the key is gaining
some sense of the magnitude of the price elasticity of the good or service. If the good is not
very responsive to a reduction in price brought about by the tax reductionthat is, the good
is price-inelastictax incentives play a minimal role in stimulating the good or service. A
reduction in the price of the good will not induce a large positive movement along its supply
curvethere may be other ways to stimulating increases in supply other than changing prices.
There may exist other (non-tax-incentive-related) factors that determine the quantity supplied
of a socially desirable good or service. Here, a case can be made for simply eliminating the
incentive and using the tax revenues generated to: (a) directly provide cash welfare assistance
to the targeted special group; and (b) publicly finance the spillover-generating activity directly.
Certain caveats need to be recognized when subsidies are granted, however. The first is
that the per-unit subsidy entails a fiscal cost. The second is the possibility that the subsidy
will lead to an excess burden. An excess burden of a subsidy can arise if the activities being
subsidized would have been carried out even without the benefit of a NITI (i.e. the NITI is
redundant). The third caveat has to do with the design of the subsidy mechanism. When the
government has imperfect information about the true state of market participants, or when
there are flaws in the process of screening subsidy recipients, granting a subsidy may not
be justified. The fourth is the requirement that the spillovers be ascertainable and verifiable.
Granting subsidies entails a fiscal cost if there are no spillovers, or if the fiscal cost clearly
exceeds the extent of the spillovers generated. Thus, an important prerequisite to efficient
subsidy provision is a feedback mechanism, which includes valuing the subsidy, as well as
ascertaining the spilloversenhancing transparency throughout the incentives system.

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Results of NITI evaluation vs. cross-country comparators

A recent study by Reside, et al (2011) sought international benchmarks for various efficiency
and regulatory criteria. These benchmarks consisted of standards, norms, practices, rules and
laws in other countries administering similar NITIs through similar institutions. Tax systems for
NITIs in Thailand, Chile, Brazil and the United States were studied. When Philippine standards,
norms, practices, rules and laws were compared to international best practice and those of
Thailand, Chile and Brazil, it was found lagging far behind in efficiency and other economic
criteria. One of the main reasons for the gaps was the lack of dynamism in the tax system,
being less responsive than counterparts overseas to changing needs of the tax system.
The shortcomings were also pronounced at the institutional level, with the quality of NITI
administration also lagging far behind comparators. A key problem was the lack of thorough
audits by the BIR of NPOs and cooperatives, as well as the absence of inter- and intraagency coordination with respect to the implementation and monitoring of NITIs. The resulting
non-transparency of NITIs could then give rise to other problems, such as mis-targeting and
taxpayer abuse. Abuses could take the form of money laundering by taxpayers, given the
relative lack of oversight over non-PCNC-registered foundations.
In almost all the efficiency criteria, the Philippines scored below comparator countries
visited as part of the study, such as Thailand, Chile, Brazil and the United States. Efficiency
was found to be very much correlated with the quality of regulation, supervision and laws
themselves. It was found that since seniors were mostly non-poor, the seniors tax benefits
were regressive (in violation of the equity principle). The team developed a database of
nonprofit institutions registered with the SEC and after reviewing NPO financial reports
concluded that there may be potential violations of the principles of public benefit, private
inurement, unrelated business, excess benefit and the nondistribution constraint typical
of nonprofits. These violations were more likely in the Philippines given the infrequency of
audits conducted by implementing institutions and the relative laxity of rules and practices
for screening and validating claims for taxpayer benefits. Given these, it was highly likely that
other taxpayer abuses took place as well, including potential money launderingand these
abuses were more likely the less likely taxpayers were to get audited by any institution (and
there are thousands of nonprofits not registered with the PCNC) and cooperatives that do
not undergo the extra layer of BIR audits annually.
Finally, the major NITI implementing, regulating and supervising institutions (including
administrative, tax and legislative institutions) were themselves scoredrelative to their
capacities, internal rules, practices, decision-making, etc. The scoring criteria included
determining whether codified verification and screening standards, as well as checks and
balances existed. Whether such standards were consistent with well-known economic
efficiency justifications for subsidy provision (e.g., externalities, public goods, merit goods)
and whether there were adequately trained workers for carrying out the needed verification

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and screening functionsfor validating taxpayer claim, for example. The study also scored
the adequacy of ex post oversight and supervision during implementation phases (i.e., after
the institution is granted tax benefits), as well as the capacity of implementing institutions
to gather and analyze tax expenditure data for budget and policy purposes and whether tax
return forms capable of extracting information to track tax expenditures (NPOs)as part of
the assessment of the transparency and accountability within the system.
Critically, the quality of intra- and inter-agency coordination on NITIsin sharing experiences,
data, profiling taxpayers, facilitating processes, carrying out reforms, etc. also play an
important role in enhancing the efficiency of NITIs and were graded. Similar to the broad
efficiency criterion, the Philippines NITI-implementing institutions also scored generally
below comparators in supervision and regulation.
Overall, the team concluded that both NITI laws and implementing and regulatory institutions
in the Philippines could fare much better in terms of economic efficiency. The team also
offered a large number of short- and medium-term recommendations for stakeholders and
implementing agencies such as the DoF, BIR, PCNC, Congress, CDA, BoC and others.

Recommendations
Reside, et al, (2012) came up with a slew of recommendations regarding Philippine NITIs.
A good prerequisite for analyzing NITIs is to first identify the market failures they are intended
to address. This is an excellent first step in NITI reform, to enhance their targeting and
efficiency. However, one must recognize that not only are NITIs designed to address market
failure, they themselves are subject to it. Implementing institutions should know that NITIs
are themselves subject to market failure with gaps in regulation, oversight and capacity.
Implementing institutions should strive to know taxpayers better and what truly motivates
them; to understand better their behavioral incentives and motivations. Hence, deeper study
of taxpayer motivations (such as NPOs, corporations, etc.) is required. To improve screening of
taxpayers, implementing agencies such as the BIR, CDA and PCNC should refine administrative
rules to prevent up-front, needless and outright grant of income tax benefits without subjecting
taxpayers to more rigorous performance tests. Revenue collection officers are also encouraged
not to presume tax exemption of institutions at the outset. Hence, it is recommended that the
law be amended so that NPOs can only be eligible to avail of exemptions after three years from
start of operations, after which they can only be exempt from income taxes after securing a
certificate of exemption from the Legal Division of the BIR.
To improve taxpayer audits, the BIR should occasionally audit foundations, NPOs and
cooperatives and revoke licenses for violators and non-reporters (which the United States
Internal Revenue Service (IRS) does). Hence, it should incorporate into its annual audit program:
(a) a clear definition of public benefit; (b) avoidance of private inurement; (c) penalties for excess

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benefit; (d) taxation of unrelated business income. This requires a lot of capacity-building and
training. BIR revenue district officers should abolish the practice of presuming NPOs are incometax exempt in their first three years (and beyond) and instead levy a low but nonzero tax rate prior
to eligibility for income tax exemption, a la Thailand. In addition, in the medium term, BIR, SEC,
CDA and PCNC should enhance their minimum annual reporting and disclosure requirements.
The BIR should immediately amend annual information return (AIR) forms to enable NPOs to yield
annual information richer than NPO data possessed by SEC. The BIR could also consider (a)
requiring NPO boards to disclose their financial interests in entities doing business with NPO;
(b) having more thorough independent reviews for large foundations; (c) reporting the details of
compensation and reimbursement for travel and meeting expenses of NPO management; (d)
requiring short descriptions of annual activities (annual report); and (e) requiring report of minutes
of board meetings. The same could be required of cooperatives as well. One can distinguish
between small and large NPOs/cooperatives to ease compliance (more on suggested methods
for classifying taxpayers for administrative purposes and tax and risk analysis later).
Apart from obtaining better information from taxpayers, the government should be
encouraged to further enhance transparency within NITIs by:

Investing in good information technology (IT) systems and good field information
collecting systems in implementing, screening and monitoring agencies.

Immediately setting up information sharing protocols among institutions possessing

and requiring data on tax expenditures and eliminating inter- and intra-agency
frictions in the flow of data regarding taxpayers and tax expenditures.

Encouraging Congress to require publication of tax expenditures associated

with existing laws and making it standard practice to require an estimate of the
extent of potential tax expenditures and fiscal risk associated with each new law
being introduced or being considered, as well as potential costs and benefits of
alternative means of financing social benefits.
Subsequent NITIs passed by Congress should have clear sunset dates to further reduce
government exposure and to provide a window for ex post evaluation of incentives laws.
The quantitative analysis of NITIs for refining and calibrating tax policy and publishing tax
expenditures depends critically on the free flow of information and data across agencies.
Hence, we strongly urge the DOF to work with the BIR, CDA, PCNC and SEC to consider
an institution or commission devoted to developing standards and principles for improving
government-wide transparency and data exchange policy. In line with these, BIR should
develop a public use e-file accessible to policymakers and researchers (as in USA). The BIR,
PCNC, CDA and SEC should develop and make accessible for research, a public use file to
facilitate analysis of taxpayer data by DoF, NTRC, and academics.

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In light of these, the BIR, SEC and DoF should consider forming a working group to work
out a viable taxpayer data and information transparency policy (and consider over the
long-run) perhaps an institution or commission permanently devoted to assessing current
levels of transparency and developing standards and principles for improving government
transparency. In line with this, the BIR should develop a public use file accessible to other
government policymakers and researchers. Once systems are in place for collecting and
processing better taxpayer information, the government should ease taxpayer compliance
and improve risk profiling by developing criteria for classifying taxpayers, taking care
to identify those taxpayers that are well- (and not well-) behaved. Once taxpayers are
better profiled, implementing institutions can adopt the practice seen in other countries of
classifying taxpayers by criteria such as asset size and number of donors (or members or
patrons) then base compliance and audit rules on these criteria. Implementing institutions
may also classify by type, for example:

Independent or public charities (less risk)

Corporate or private foundations (more risk)
Political organizations (more risk)
Religious organizations (less risk)
Private schools , hospitals, NGOs (develop criteria)
Trade associations and social clubs (develop criteria)
With history of previous abuse and with long history of operating without abuse
The kind of information presently culled from data voluntarily submitted by taxpayers
should also be exploited further to enhance legislation, policy, NITI administration and tax
analysis. Hence, amendments to the NIRC and other rules governing other NITI-regulating
and administering agencies should be made to enable them to distinguish between public
charities and private foundations, as well as across institutions by size, in areas of regulation
and tax administration (as other countries do). The BIR and SEC databases should be sorted
to allow policymakers to distinguish NPOs by type (public charities and private foundations),
size (big, medium or small, perhaps by asset size) and by past performance.
Implementing agencies must introduce risk-based and performance-based criteria in
claiming tax benefits and charge risk-based (higher/nonzero) user fees for beefing up
regulatory capacity at point of registration and renewal of licenses. They should also enforce
automatic revocation of exemption and qualification to receive tax deductible donations
for failing to satisfy SEC/BIR/PCNC/CDA/BoC reporting requirements and for engaging in
criminal activity and enforce automatic suspension of operations upon suspicion of use in
money laundering. Failure of cooperative or NPO to file reports with CDA/SEC/BIR should
qualify their income for taxation. The BIR, SEC, CDA and PCNC should strictly enforce

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June 2013

15

penalties on NPOs and cooperatives that fail to report their activities to the authorities on
a regular and timely basis (as what the IRS does in the US). Once penalized, these erring
taxpayers should be tracked by PCNC, SEC and BIR.
The government should exploit synergies in joint and coordinated work on NITIs. Therefore,
the DoF should assert its leadership over NITI implementing agencies. The DoF should
immediately assert greater influence over PCNC and exert greater pressure on partner public
sector institutions to attend PCNC board meetings. This would help develop coordinated
responses and solutions to tax system and taxpayer needs and also add dynamism and
responsiveness of tax laws to needs of the country. In this regard, it is also recommend that
DoF, BIR and the National Economic and Development Authority (NEDA), DBM and Congress
work together in synchronizing tax expenditure policy with conventional expenditure budget
allocation policies.
Congress, working in concert with implementing agencies should also strengthen NITI
administrative rules and legislation to make them more dynamically responsive to the
economic needs of the country and changing behavioral incentives and motives of
taxpayers. Implementing agencies should also apply international standard taxability tests,
principles and doctrines to guide tax audits to upgrade these to international standards in
the medium-term. These points to the necessity for capacity-building to upgrade the tax
and NITI systems. The BIR and DoF should also be encouraged to develop long-run training
partnerships with IRS, institutions in Latin America, etc. Related to this, Congress and BIR
may wish to beef up its own legal, economic analysis and audit capacities in international
legal doctrines and principles. They should also develop executive and legislative
performance review mechanisms for NITIs. Scandals should trigger reform of laws and
administrative rules.
In medium-term, PCNC should endeavor to strengthen screening and administrative rules to
guard against outright (or close to outright) grant of donee status. Academic institutes and
NPOs can be encouraged to rate and evaluate tax-exempt institutions and implementing
agencies. These would help mitigate large information asymmetries plaguing the sector.
NPOs would then set up a database with all of the information and publish these online (as
in the US).
The government should consider long-run reform of architecture of the NITI sector, like
setting up a commission like UKs Charity Commission, to regulate NPOs (to go around
weak incentives to do so at the BIR). Given its issues with all other institutions granting tax
expenditures, such as investment-related tax incentives, the DoF may also consider a larger
institution to oversee all institutions receiving tax benefits. The DoF may wish to amend the
cooperatives law in the medium-term to put in place stronger incentives for patronage and
genuinely collective decision-making in cooperatives. Meanwhile, CDA should immediately
allow cooperatives to be audited for tax purposes and should improve reporting forms,
creating the same level of transparency expected of NPOs.

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June 2013

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Senior citizens tax benefits are generally regressive and will only tend to worsen inequality
over time. Hence, government should refrain from further expansion of the tax benefits and
consider using finely targeted approaches to addressing poor sector (e.g., conditional cash
transfer (CCT) and CCT targeting approachesgeographical targeting and proxy means
testsare much more refined than NITIs, but also cost more to administer). The government
may wish to assess the quality of NITIs targeting of the poor by surveying those currently
targeted by the CCT regarding whether they benefit from NITIs.
In line with the need for better targeting of NITIs, subsequent NITIs and tax laws should strive
to institutionalize means-testing. Since efficiency and equity are important criteria of taxation,
it follows that the notion of means-testing should be incorporated as much as possible in the
design of tax laws and NITI administrative procedures. Means-testing is a further check and
containment against the costs of potential mistargeting of benefits. For this purpose, future
tax laws may wish to consider means-testing mechanisms currently being employed by the
Department of Social Welfare and Development for their subsidy programs. The best thing
government can do to protect entitlements and to provide safety nets for poorer seniors is to
increase the scope of pension and health coverage through efforts to increase the size of formal
sector employment and facilitate the conversion of informal businesses into formal business (as
in Brazil) and increase business compliance with formal pension and health contributions.
Finally, with respect to social cost benefit analysis, the National Statistical Coordination
Board (NSCB) should continue, with what it began in late 1990s, institutionalizing the explicit
accounting for the contribution of NPOs to GDP, employment, and other macro variables.
They should continue monitoring the time allocation behavior of economically active
population through use-of-time surveys, as it has many other uses. It should also continue
to pursue the valuation of leisure time, valuation of household production work, especially
among women. NPOs and cooperatives should also be more deeply engaged in monitoring
and evaluation.

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June 2013

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References
Brixi, H. P., C.M.A. Valenduc, Z. L. Swift, eds. (2004). Tax ExpendituresShedding Light
on Government Spending through the Tax System. Lessons from Developed and Transition
Economies. World Bank.
Caucus of Development NGO Networks. (2008). NPO Sector Assessment: Philippine Report.
Report prepared for the NPO Sector Review Project, Charity Commission for England and Wales.
Canadian Government, Government of Canada Expenditures (1995).
Jenkins, G.P. and Chun-Yan Kuo. (2004). Tax Expenditures in the Dominican Republic.
Working Paper. USAID July.
R.G. Manasan, Analysis of the Presidents Budget for 2013, PIDS Discussion Paper Series
No. 2013-13 (2013)
Medalla, F. M. (2006). On the Rationalization of Fiscal Incentives. United States Agency for
International Development.
Musgrave, Richard A. (1959). The Theory of Public Finance: A Study in Public Economy.
National Internal Revenue Code of the Philippines. (2007).
Reside, R. E. (2006). Towards Rational Fiscal Incentives (Good Investments or Wasted
Gifts?). University of the Philippines School of Economics Discussion Paper DP 2006-01.
Reside, R. E. (2007). The Cost of Redundant Fiscal Incentives for Investment in the
Philippines. Paper presented at State University of New York Economics Conference 2007.
Reside, Renato, Jr. (2006). Fiscal Incentives and Investment in the Philippines. (UPSE)
Discussion Paper No. 0601. Quezon City: University of the Philippines School of Economics
June 2006.
Reside, Renato, Jr., DM Sanchez, R Alonzo, G Magoncia, N del Castillo JD Atanacio and JR
Corpuz (2012). An Analytical Study of the Non-Investment Related Tax Incentive Laws of the
Philippines. Japan International Cooperation Agency, Philippines.
Stiglitz, J. E. (2000). Economics of the Public Sector (3 rd ed). New York: Norton&Company.
World Bank. (2007). Guiding principles in the use of investment incentives: A report for the
Government of the Philippines, June.

Policy Notes
June 2013

The Notes are available online at http://www.pced.gov.ph/pcedpolicynotes.

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PCED Policy Notes are based on the PCED-supported research of faculty and graduate students of the University of the Philippines School of
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