The VAT Slash: Relief or Risk?

You can’t escape the ubiquitous VAT. You see them in your receipts when you eat at your favorite restaurants, or when you visit the salon.

The Value-Added Tax (VAT) is a tax placed on goods and services at every stage of production and sale. It serves as one of the Philippine government’s primary sources of revenue. The VAT is set at 12%, raised from 10% in 2005 under Republic Act 9337. Since then, VAT collections have grown sharply, from about PHP 156.67 billion in 2005 to around PHP 1.2 trillion in 2024, showing how vital it is in supporting government programs.

Highest in the region

Among the ASEAN-5 economies, the Philippines has the highest VAT rate. For example, Thailand charges only 7%, Singapore is at 9% (goods and services tax), Malaysia at 10% for sales tax and 8% for service tax, and Indonesia at 11-12%. This puts the Philippines at a disadvantage regarding consumer costs and business competitiveness. Arguably, lowering taxes could make prices more manageable and align the country closer with regional peers.

Will it substantially lower prices across the board?

A proposal in the House of Representatives seeks to reduce the VAT rate from 12% to 10%. In theory, this should lead to around 1.8% decrease in prices, offering a modest relief to consumers, particularly those in lower-income brackets. However, the question remains: Will businesses pass on the savings to consumers, or will they retain the slight price difference to increase profit margins?

Should most businesses choose to absorb the tax cut rather than adjust prices slightly downward, the actual impact could be more muted. In this scenario, they may opt to utilize the price difference to offset rising input costs or improve cost structures.

Nonetheless, the proposed decrease could help ease some inflationary pressure, which would free up more purchasing power, thus increasing household consumption. However, the overall effect may not be substantial enough to significantly alter consumer behavior, particularly since some essential goods like medicines are already exempt from VAT.

Government revenue losses

One thing is clear: reducing the VAT rate would result in a substantial loss of government revenue. The lawmaker backing the proposal estimates a potential shortfall of around PHP 200 billion. At a time when the government needs funds to meet its budgetary obligations amid threats to growth associated with external headwinds, three possible scenarios emerge.

The first potentially scenario is for the government to offset the revenue loss through increased borrowing. However, the current 63.1% debt-to-GDP ratio, which is above the internationally accepted threshold of 60%, provides limited space for further debt accumulation and makes this a less likely scenario.

The second is that the government will seek alternative sources of revenue to offset the losses. This could involve raising taxes on specific goods or services, which may, in turn, lead to higher prices on these items, potentially undermining the intended relief from the VAT reduction.

The third possible scenario is that businesses lower prices to reflect lower VAT. This could stimulate household consumption. With more disposable income, consumers might spend more on goods and services, which in turn could expand the overall tax base. While this may not fully cover the shortfall, it could soften the revenue impact by boosting economic activity.

The challenge, however, is that the scale of this effect would depend heavily on consumer response and whether businesses pass on the tax savings to their customers.

Relief or risk?

The proposed VAT cut offers both opportunities and risks. On one hand, it could ease consumer costs and align the Philippines more closely with ASEAN standards. On the other hand, it threatens to reduce revenues that fund government projects and programs. The challenge is to find a balance with creating tax policies that support economic competitiveness while maintaining fiscal responsibility. Sound data-driven decision-making will be key to determining whether a 10% VAT is right for the country.

(Disclaimer: This is general investment information only and does not constitute an offer or guarantee, with all investment decisions made at your own risk. The bank takes no responsibility for any potential losses.)

JAMES NATHAN ANG is an intern in both the Investment Counselor Department and the Research and Market Strategy Department under the Institutional Investors Coverage Division at Metrobank. He is currently completing his Bachelor’s degree in Management of Financial Institutions at De La Salle University and hopes to work in the financial sector after graduation. His interests include exercising and traveling with his loved ones.

MARIAN MONETTE FLORENDO is a Research Officer of the Research and Market Strategy Department, Institutional Investors Coverage Division, Financial Markets Sector, at Metrobank. She is a certified treasury professional, holds an undergraduate degree in Mathematics from Ateneo de Naga University and gained her master’s degree in Economics from UP Diliman. She loves traveling with her loved ones and watching mystery movies in her spare time