D47Report-Tax Reform Final Report-Nov 09-NRamos

Land Administration and Management Project Phase 2
Real Property Valuation and Land Taxation Report November 2009

TOWARDS A REFORM PACKAGE FOR
REAL PROPERTY TRANSFER TAXES
I N THE PHI LI PPI NES

FINAL REPORT
November 2009

REPORT D47

Prepared by:
Land Equity International Pty Ltd


Towards a Reform Package for Real Property Transfer Taxes in the Philippines i

ACKNOWLEDGMENTS

This study was conducted in cooperation with the National Tax Research Center (NTRC) of
the Department of Finance.
A Land Equity International (LEI) consultant, Norman R. Ramos, acted as Property Tax
Advisor. The technical advisory work focused on a) a review of available previous related
local and international studies, relevant data and information; b) development of a revenue
simulation model for real property taxes including the estimation of the relevant numerical
parameters; and using the findings and results of the revenue simulations to formulate a
proposed package of tax rate reforms for selected real property transfer taxes.
The team would like to acknowledge the highly relevant technical inputs and suggestions
as well as the organizational support given by the NTRC headed by Executive Director
Lina D. Isorena and Deputy Executive Director Dante V. Sy.
The key NTRC technical personnel led by the Executive Director and the Deputy Executive
Director provided technical papers, data, information and experiences through a series of
meetings/discussions that helped shape and refine the results of the technical assistance
work.
The LAMP 2 PMO provided valuable logistical support to the Property Tax Advisor.
This synchronized and multi-level support enabled the Consultant to effectively function
and meet the extremely tight survey deadline.


Towards a Reform Package for Real Property Transfer Taxes in the Philippines ii
This report is a result of technical assistance managed by Land Equity International to the
Government of the Philippines. The TA was funded by AusAID and the views expressed in this work
do not necessarily represent the views of the Commonwealth of Australia.
TABLE OF CONTENTS
ACKNOWLEDGMENTS i
Table of Contents ii
Tables iii
FIGURES iv
ANNEXES iv
ACRONYMS v
DEFINITION OF TERMS vi
EXECUTIVE SUMMARY 1
1. Introduction 4
2. Analytical Framework 8
3. Statistical estimates of the parameters of the Real Property Market models 22
4. Guiding Points in the Formulation of Real Property Tax Rate Reform Package 30
5. The Proposed Real Property Transfer Taxes Reform Package 37
6. Tax Revenue Simulation Results 39
7. Conclusions and Recommendations 46
REFERENCES 47
Appendix A. Mathematical Derivation of the Elasticity Estimate A-1


Towards a Reform Package for Real Property Transfer Taxes in the Philippines iii
TABLES
Table 1 Parameter Estimates of Chaos-Type GDP Growth Forecast Equation With
Time Trend Variable
17
Table 2 Parameter Estimates of Chaos-Type GDP Growth Forecast Equation With
Time Trend Variable
18
Table 3 Regression Estimates for the Parameters of the Gross Value Added in Real
Estate (REGVA) Model
22
Table 4 Regression Estimates for the Parameters of the New Residential Floor Area
(RFA) Model
23
Table 5 Regression Estimates for the Parameters of the New Non-Residential Floor
Area (NRFA) Model
23
Table 6 Regression Estimates for the Parameters of the New Alterations and Repairs
Floor Area (ARFA) Model
24
Table 7 Inverse Matrix and Resulting Output Multipliers, Year 2000 Input-Output
Table
24
Table 8 Effective RPT Rates and Collection Efficiency, All Cities, 2007 25
Table 9 Effective RPT Rates and Collection Efficiency, Cities with 100 or Greater COE
Excluded, 2007
25
Table 10 Alternative Unadjusted GDP Forecasts, at Current Prices: 2009-2014 25
Table 11 Base GDP Growth Projections at Current Prices 26
Table 12 Revenue Simulation Results, Alternative Capital Gains Tax Rates, In Million
PhP at Current Prices: 2010-2014
37
Table 13 Revenue Simulation Results, Alternative Reductions in the Documentary
Stamp Tax, In Million PhP at Current Prices: 2010-2014
38
Table 14 Summary of Simulation Results of Tax Reforms Considered in the Short Term:
In Million PhP at Current Prices: 2010-2014
38
Table 15 Revenue Simulation Results, Abolition of the Estate and Donors Tax, In Million
PhP at Current Prices: 2010-2014
39
Table 16 Revenue Simulation Results, Impact of Proposed Medium-Term Tax Rate
Reform Package on the Capital Gains Tax, In Million PhP at Current Prices:
2010-2014
39
Table 17 Revenue Simulation Results, Impact of Proposed Medium-Term Tax Reform
Package on the Documentary Stamp Tax, In Million PhP at Current Prices:
2010-2014
40
Table 18 Revenue Simulation Results, Combined Revenue Effect of Proposed Medium-
term Property Transfer Tax Reform Package, In Million PhP at Current Prices:
2010-2014
40
Table 19 Revenue Simulation Results, Combined Revenue Effect of the Proposed
Medium-term Property Transfer Tax Reform Package on the Local Tax on the
Transfer of Land, In Million PhP at Current Prices: 2010-2014
41

Towards a Reform Package for Real Property Transfer Taxes in the Philippines iv
FIGURES
Figure 1 Collection Efficiency and Size of Taxable Property Values, Philippine
Provinces, 2007
3
Figure 2 Collection Efficiency and Size of Taxable Property Values, Philippine Cities,
2007
3
Figure 3 Relationship between the Market for Real Property, Overall Economic Activity,
and the Effective Real Property Tax Rate
5
Figure 4 Structure and Flow of Simulation Model 8
Figure 5 Tracking Performance of Two Alternative Chaos-Type
GDP Growth Forecast Equations
17
Figure 6 Statutory Maximum-Level Estate Tax Rate and
Gross Domestic Capital Formation, Selected Countries: 2005
20
Figure 7 Periodogram Values for Per Capita Local Revenues at 1985 Prices and the
Dummy Variable for Election Years: 1991-2004
31
ANNEXES
Appendix A Mathematical Derivation of the Elasticity Estimate A-1

Towards a Reform Package for Real Property Transfer Taxes in the Philippines v
ACRONYMS
ADB - Asian Development Bank
ARFA - Alterations and repairs floor area
AusAID - Australian Agency for International Development
BIR - Bureau of Internal Revenue
BLGF - Bureau of Local Government Finance
COE - Collection Efficiency
CGT - Capital Gains Tax
DILG - Department of Interior and Local Government
DOF - Department of Finance
DST - Documentary Stamp Tax
DOT - Donors Tax
EPTR - Effective Property Tax Rate
EST - Estate Tax
GDP - Gross Domestic Product
GDCF - Gross Domestic Capital Formation
IO - Input-Output
IRA - Internal Revenue Allotment
LAMP - Land Administration and Management Project
LEI - Land Equity International
LGC - Local Government Code
LGU - Local Government Unit
LN - Natural Logarithm, base = e = 2.71238
NEDA - National Economic and Development Authority
NFA - New Floor Area
NRFA - New Non-Residential Floor Area
NSO - National Statistics Office
NTRC - National Tax Research Center
OLS - Ordinary Least Squares
PMO - Project Management Office
PSY - Philippine Statistical Yearbook
REGVA - Gross Value Added for Real Estate
RFA - New Residential Floor Area
RPT - Real Property Tax
SIE - Statement of Income and Expenditure
SMV - Schedule of Market Values
TTRPO Tax on Transfer of Real Property Ownership
TXAV - Taxable Assessed Value
VAT - Value Added Tax


Towards a Reform Package for Real Property Transfer Taxes in the Philippines vi
DEFINITION OF TERMS
CAPITAL GAINS TAX originally intended as a tax imposed on the gains presumed to
have been realized by the seller from the sale, exchange or other disposition of capital
assets. As presently applied, however, it has become a fixed sales tax with rate of 6% of
whichever is higher among the following: Bureau of Internal Revenues zonal value, fair
market value of Provincial or City Assessor, or selling price of the property.
CHAOS-TYPE EQUATIONS are deterministic systems (exhibiting regular and
predictable behavior) that also exhibit seemingly irregular, random, and even turbulent
behavior and are highly sensitive to initial conditions.
COLLECTION EFFICIENCY ratio of actual amount collected to the total amount
collectible.
CORRELATION ANALYSIS evaluates causal, complementary, parallel, or reciprocal
relationship, especially a structural, functional, or qualitative correspondence between two
comparable entities.
CROSS SECTION DATA a series of observations generated across units of
classification, e.g. cities, municipalities, households, income classes, etc., at a single point
in time. A series of cross-sections across time is known as panel data.
DOCUMENTARY STAMP TAX tax imposed on documents, instruments, loan
agreements, and papers evidencing the acceptance, assignment, sale, or transfer of an
obligation, rights, or property incident thereto. Rate is based on a schedule, with PhP 15
minimum and 1.5% for consideration exceeding PhP 1,000 for deeds of sale and
conveyances of real property.
DONORS TAX tax on a donation or gift, imposed on the gratuitous transfer of property
between two or more persons who are living at the time of the transfer. When the
beneficiary or donee is a stranger, the tax payable by the donor is 30% of the net gift.
When the beneficiary is a relative, the amount of tax is based on a schedule of rates
ranging from exempt to 15% of the net gift.
EFFECTIVE PROPERTY TAX RATE ratio of property tax revenue collection to the
corresponding property tax base.
ESTATE TAX tax on the right of the deceased person to transmit his/her estate to his/her
lawful heir and beneficiaries at the time of death and on certain transfers which are made
by law as equivalent to testamentary disposition. The amount of tax due is based on a
schedule of rates ranging from exempt to 20% of the net estate.
GROSS DOMESTIC CAPITAL FORMATION (GDCF) is a macroeconomic concept used
in official national accounts and statistically measures the value of additions to fixed assets
purchased by business, government and households less disposals of fixed assets sold off
or scrapped.
GROSS DOMESTIC PRODUCT (GDP) or gross domestic income (GDI) is a basic
measure of a country's economic performance and is the market value of all final goods
and services made within the borders of a country in a year. It is a fundamental
measurement of production and is often positively correlated with the standard of living.

Towards a Reform Package for Real Property Transfer Taxes in the Philippines vii
GROSS VALUE ADDED (GVA) a productivity metric that measures the difference
between output and intermediate consumption. Gross value added provides a peso value
for the amount of goods and services that have been produced, less the cost of all inputs
and raw materials that are directly attributable to that production.
INPUT-OUTPUT MODEL in economics, an input-output model uses a matrix
representation of a nation's (or a region's) economy to predict the effect of changes in one
industry on others and by consumers, government, and foreign suppliers on the economy.
NATURAL LOGARITHM logarithm to the base e, where e is an irrational constant
approximately equal to 2.718281828. The natural logarithm is generally written ln(x),
log
e
(x) or sometimes, where the base of e is implicit, just log(x). In simple terms, the
natural logarithm of a number x is the power to which e would have to be raised to equal x.
For example, the natural log of e
2
(approximately 7.389) is 2, the natural log of e itself is 1
because e
1
= e, while the natural logarithm of 1 would be 0, since e
0
= 1.
NEW FLOOR AREA new floor area in square meters (sq.m.) constructed consisting of
residential, non-residential, and alterations and repairs.
NON-LINEAR RELATIONSHIP is a relationship where there is a wider range of possible
dependencies allowed.
PROBIT REGRESSION an alternative log-linear approach to handling categorical
dependent variables. It is used to analyze relationships between one or more independent
(predictor) variables and a categorical dependent variable at two levels. Its assumptions
are consistent with having a categorical dependent variable assumed to be a proxy for a
true underlying continuous normal distribution. The probit model ensures that predictions
for the dependent variable will always lie between 0 and 1.
REAL PROPERTY TAX levied on owners of land, building, machinery and other
improvements; based on the assessed value of the property, which is derived by applying
assessment levels to the fair market value of the property.
REGRESSION ANALYSIS includes techniques for modeling and analyzing several
variables, when the focus is on the relationship between a dependent variable and one or
more independent variables. More specifically, regression analysis helps us understand
how the typical value of the dependent variable changes when any one of the independent
variables is varied, while the other independent variables are held fixed. Most commonly,
regression analysis estimates the conditional expectation of the dependent variable given
the independent variables that is, the average value of the dependent variable when the
independent variables are held fixed.
RIDGE REGRESSION - used when the explanatory variables are highly inter-correlated
and stable estimates of the regression coefficients cannot be obtained through ordinary
least squares (OLS). Ridge regression adds a constant to the diagonal of the correlation
matrix, which is then re-standardized, so that all diagonal elements are equal to 1.0, and
the off-diagonal elements are divided by the constant. In other words, ridge regression
artificially decreases the correlation coefficients so that more stable estimates of the beta
coefficients can be computed.


Towards a Reform Package for Real Property Transfer Taxes in the Philippines viii
SIMULATION the process of starting with an initial value in each variable and running the
set of equations for multiple time increments. At each time increment, all equations are
processed to generate new variable values from the current values. The resulting data for
variables at each time increment represents one run of the simulation. During simulation, a
model is driven by input data and produces output data. Data can come from initial values
in the model, user entry, or a data file.
TIME SERIES a set of observations generated sequentially in time.
TIME SERIES FORECASTING a category of forecasting that assumes that the historical
data is a combination of a pattern and some random error. Its goal is to isolate the pattern
from the error by understanding the patterns level, trend, and seasonality.
TAX ON TRANSFER OF REAL PROPERTY OWNERSHIP imposed by a province or city
on the sale, donation, barter, or any other mode of transferring ownership or title of real
property. Maximum rate set by the Local Government Code is 0.5% for provinces and 1%
for cities based on the total consideration involved in the acquisition of the property or fair
market value, whichever is higher.
VALUE ADDED TAX business tax imposed and collected from the seller in the course of
trade or business on every sale of properties, lease of goods or properties, or vendors of
services; an indirect tax and thus can be passed on to the buyer. Imposed on VAT-
registered persons with sale/lease above the following amounts: PhP 1.5 million for sale of
residential lot, PhP 2.5 million for sale of residential house and lot and other residential
dwellings, and PhP 10,000 for monthly rental of residential units.


Towards a Reform Package for Real Property Transfer Taxes in the Philippines 1
EXECUTIVE SUMMARY
The real property market-- land and improvements
1
-- is among the oldest asset market in
human history. Social structure, marriage institutions, inter-state relations and, more
broadly, socio-economic organizations, have been affected by and simultaneously have
influenced the nature and functioning of real property markets.
2

Housing is a mixed consumption-investment good, and the attributes of commercial real
estate are a function of derived demand emanating from the user business sector. Both
types of real property demand will ultimately be affected by the state of economy as
measured by the Gross Domestic Product (GDP).
3

The positive impact of growing macroeconomic activity on the demand for real estate is,
however, restricted by statutory limitations on land ownership and use. Regulations,
especially property tax laws, affect real estate operations and profitability, and
consequently, demand for real estate.
While there is general consensus on the degree of the positive impact of the macro-level
economic performance on the real property market, the degree to which property taxes
affect the real estate market and tax compliance is a subject of continuing debate.
The tax instruments used by governments to raise revenues can have an impact on the
nature, location, and density of development. Urban form can be influenced not only with
planning tools but also with financial tools. In some cases, financial tools work together
with planning tools, but in other cases they may have the opposite effect.
4
Changes in tax
rates could also affect tax compliance.
The total market for real property estate is a function of the economic activity as measured
by the countrys Gross Domestic Product (GDP) and effective real property tax rate
(EPTR).
The Philippine real property market as measured in value terms gross value added for
real estate at current prices and physical area terms new floor space construction
positively responds to changes in economic activity ( GDP) and negatively related to
changes in tax rates ( EPTR).
In the Philippines, landowner reactions to changes in the aforementioned economic
variables in terms of both magnitude and speed may be affected by the strong attachment
of Filipinos to land. People may hold on to their land even if not economically viable
5
or

1
Collectively referred to as real estate.
2
See Ashok Bardhan and Robert Edelstein. Real Estate Through The Ages: The Known, The Unknown, and
The Unknowable, in Diebold, Doherty and Herring, eds., The Known, The Unknown, and the Unknowable
in Risk Management. Princeton: Princeton University Press, 2007.
3
The phenomenon of globalization has added another dimension affecting both the level and quality of
demand for commercial real estate.
4
See a study of 25 countries by Richard M. Bird and Enid Slack, eds., Land Taxation in Practice: Selected
Case Studies, Toronto, March 2002.
5
This has been succinctly pointed out by NTRC Executive Director Lina D. Isorena and Deputy Executive
Director Dante V. Sy during a discussion held 24 September 2009.

even resort to outright violence to defend their real property holdings against public
auctions of tax delinquent properties
6
.
The net tax revenue effect of reductions in real property tax rates will be a balance of the
revenue reductions arising from the rate cutbacks vis--vis the potential positive revenue
effects of the resulting increase in the revenue base (REGVA) through the tax rate effect
and the increase in GDP due to the increased real property market activity via the multiplier
effect of the property sector.
The revenue effect of the tax reforms will come from increased real property market
activities arising from the direct tax rate effect and the secondary income effect arising from
an increased GDP stimulated by increased property market activities.
Considering a) the revenue yield aspects, b) fiscal decentralization and growth aspects, c)
administrative cost aspects, d) taxpayer resistance aspects, and e) the government
viewpoint, the focus of the proposed property tax reform program will be the four (4)
national property transfer taxes Capital Gains Tax (CGT), Documentary Stamp Tax
(DST), Estate Tax (EST), and Donors Tax (DOT).
The Value Added Tax (VAT) on the sale and lease of real property option is not at this
point considered a politically viable option given that it will require redefining the concept of
VAT and amending a recent piece of legislation that had faced stiff public resistance.
Reforming the local Tax on the Transfer of Real Property Ownership (TTRPO) will require
amending the 1991 Local Government Code (LGC), which may not be easily done
considering that amendments to the LGC have been brought up as early as the 1998-2001
Congress and no progress has been attained since then.
The tax reform package proposes combined tax rate changes that seek to:
a) Reduce property transfer taxes to stimulate the real property sector and to
encourage formalization of property transfers. Such stimulative effects are
expected in the long-run to more than compensate for revenue losses arising from
the rate reduction or even elimination of certain property taxes.
b) Do away with property related taxes that have relatively low revenue yields vis--vis
administrative costs.
c) Maintain revenue neutrality during the critical first year of the projection period
2010.
Reduction or abolition of certain property transfer taxes like the EST and DOT could in the
long-run enhance the volume of property market transactions, encourage tax compliance
and thus, enhance revenues from the other remaining property taxes. Expected to be
benefitted are the CGT, the DST and the TTRPO.
In 2010, the Department of Finance (DOF) could seriously consider reducing the CGT rate
from the present 6% to 5%, and effecting a 10% reduction in the DST. These tax breaks
will help boost the real property market during the present economic downturn and result in
improved revenue collection. At the same time, if implemented or even publicly announced

6
This has been observed in many LGUs across the Philippines, a few of which were personally observed by
the Advisor.

by 2010, it can boost the popularity rating of the present administration in an election year.
a) The expected annual average net increase in CGT revenues arising from the
proposed 1% CGT tax rate cut for the period 2010-2014 is about PhP 1.2 billion.
The proposed tax rate cut is expected to be revenue neutral if implemented in 2010.
The present value of the potential net revenue gain from the 1% CGT rate cut
between 2010 and 2014 (with reform less without reform tax revenues) at a
discount rate of 4.5%
7
could be expected at PhP 5.1 billion.
b) The expected annual average net increase in DST revenues arising from the
proposed 10% DST tax rate cut for the period 2010-2014 is about PhP 343 million.
The proposed tax rate cut is expected to be revenue neutral if implemented in 2010.
The present value of the potential net revenue gain from the 10% to 15% DST rate
cut between 2010 and 2014 (with reform less without reform tax revenues) at a
discount rate of 4.5%
8
could be expected reach PhP 1.5 billion.
Beyond 2010, the DOF should seriously consider adopting the proposed real property
transfer tax reform package consisting of a) halving both the CGT and DST rates and b)
abolition of the EST and the DOT.
a) The abolition of the EST and the DOT is in line with current international practices
in both developed and developing countries.
b) It will result in higher national revenue collections from real property transfer taxes
as the expected increases in the revenue collection from the CGT and DST arising
from the implementation of the overall tax rate reform package will more than
offset the revenue losses from the abolition of the EST and DOT.
- The annual average net national revenue gain from the proposed tax rate
reform package is projected at PhP 7.0 billion for the period 2010-2014,
and the present value of the net revenue gain attributable to the reform
package for the period is estimated at PhP 30.1 billion.
c) It will also help improve LGU collection from the local TTRPO. For provinces with
their relatively limited revenue base, the improvement could be critical in their drive
for lesser dependence on the Internal Revenue Allotment (IRA).
- The reform package at the national level can be expected to result in
annual average TTRPO collection of PhP 2.6 billion over the five-year
period or about double the PhP 1.3 billion average annual TTRPO revenues
from 2003 to 2007. The present value of the net revenue effect of the
national transfer tax reform package on the TTRPO is estimated at PhP 5.6
billion over the 5-year period.

7
This is the current 1-year Treasury Bill rate. The T-Bill rate serves as the opportunity cost of property tax
revenues raised since government revenue shortfalls are financed through borrowings.
8
This is the current 1-year Treasury bill rate. The T-Bill rate serves as the opportunity cost of property tax
revenues raised since government revenue shortfalls are financed through borrowings.

1. INTRODUCTION
The real property market-- land and improvements
9
-- is among the oldest asset market in
human history. The significance of various types of real property assets (agricultural,
residential and commercial real estate assets) in human history is well known in terms of
both oral and written stories. Social structure, marriage institutions, inter-state relations
and, more broadly, socio-economic organizations, have been affected by and
simultaneously have influenced the nature and functioning of real property markets.
10

In terms of the risk-return trade-off, real estate is either lower or at par with the risk-return
profile of common stocks, and higher risk-reward than Treasury Bills (T-Bills), municipal
bonds, mortgage backed securities, and investment grade corporate bonds, in that order.
11

Housing is a mixed consumption-investment good, and the attributes of commercial real
estate are a function of derived demand emanating from the user business sector. Both
types of real property demand will ultimately be affected by the state of economy as
measured by the Gross Domestic Product (GDP).
12

The positive impact of growing macroeconomic activity on the demand for real estate is,
however, restricted by statutory limitations on land ownership and use. Every nation
imposes certain public limitations on land ownership and use for the common good of all
citizens. Four forms of governmental control include:
13

a) Taxation -- Power to tax the land to provide public revenue and to return to the
community the costs incurred to pay for the various public benefits, services and
environmental protection, which are provided by the government;
b) Eminent Domain -- Right to use, hold or take land for common public uses and
benefits;
c) Police Power -- Right to regulate land use for the welfare of the public, in the areas
of safety, health, morals, general welfare, zoning, building codes, traffic regulations
and sanitary regulations; and
d) Escheat -- Right to have land revert to the public's agent, the government, when
taxes are not paid or when there are no legal heirs.
These regulations, especially property tax laws, affect real estate operations and
profitability, and consequently, demand for real estate.
While there is general consensus on the degree of the positive impact of the macro-level
economic performance on the real property market, the degree to which property taxes
affect the real estate market and tax compliance is a subject of continuing debate.

9
Collectively referred to as real estate.
10
See Ashok Bardhan and Robert Edelstein. Real Estate Through The Ages: The Known, The Unknown, and
The Unknowable, in Diebold, Doherty and Herring, eds., The Known, The Unknown, and the Unknowable
in Risk Management. Princeton: Princeton University Press, 2007.
11
Ibid.
12
The phenomenon of globalization has added another dimension affecting both the level and quality of
demand for commercial real estate.
13
See Chapter 2 of the Philippine land market study prepared by the Property Tax Policy Adviser in LAMP 1-
DENR. Final Report: Land Markets Study. Manila, May 2004.

The tax instruments used by governments to raise revenues can have an impact on the
nature, location, and density of development. Urban form can be influenced not only with
planning tools but also with financial tools. In some cases, financial tools work together
with planning tools, but in other cases they may have the opposite effect.
14

Changes in tax rates could also affect tax compliance. In the Philippines, for example,
where the nominal annual real property tax (RPT) rate is as high as 2% to 3%,
15
the
effective rate has been estimated at only 0.07% during the early nineties.
16

The effective real property rate is defined as the Effective Annual Property Tax Rate
(EPTR) which is equal to the Real Property Tax Collected in Year t (RPT
t
) divided by the
Taxable Assessed Value in Year
t-1
(TXAV
t-1
), or:

(1.0)
where: EPTR = Effective Annual Property Tax Rate
RPT
t
= Real Property Tax collected in year t
TXAV
t-1
= Taxable Assessed Value in year t-1
Effective rates have since then improved but are still below the nominal rates. Available
2007 RPT collection and local government unit (LGU) property assessment data from the
Bureau of Local Government Finance (BLGF)
17
indicate that the average effective RPT
rates for cities stand at 1.67% (1.81% for Metro Manila cities and 1.44% for cities outside
Metro Manila).
18
For provinces, the average effective property tax rate is only 0.55%.
The same set of data indicates no statistically significant relationship between collection
efforts and the size of taxable property values. Larger property tax bases do not
necessarily get translated to more intensive and productive collection efforts.
Collection Efficiency (COE) for the real property tax is defined as the Real Property Tax
Collected in Year t (RPT
t
) divided by the Total RPT Collectible in Year t, or:

(2.0)
where: COE = Collection Efficiency for Real Property Tax
RPT
t
= Real Property Tax collected in year t
RPT Collectible = Total Real Property Tax Collectible in year t

14
See a study of 25 countries by Richard M. Bird and Enid Slack, eds., Land Taxation in Practice: Selected
Case Studies, Toronto, March 2002.
15
The total RPT rate cannot really go down below 1% since the 1991 Local Government Code pegs the
Special Education Fund (SEF) tax rate at 1%.
16
See Milwida M. Guevara, Joyce P. Gracia, and Ma. Victoria C. Espano, A Study of the Performance and
Cost Effectiveness of the Real Property Tax, Manila, July 15, 1994 as cited in Bird and Slack.
17
There is probably an upward bias in these average results as the real property tax (RPT) collection figures
include arrears and penalties that artificially increase the current year performance.
18
116 cities and 79 provinces with complete data were represented in the sample.

Figure 1. Collection Efficiency and Size of Taxable Property Values,
Philippine Provinces, 2007

Figure 2. Collection Efficiency and Size of Taxable Property Values,
Philippine Cities, 2007
19

Given these complex interactions, real property tax reform efforts in the Philippines have
become more of a political exercise as it is a technical study.

19
Collection efficiencies close and above 100% are due to the inclusion of arrears and penalties in the RPT
collection data for the year.

This technical report presents a quantitative model that views the real property market
model as basically a demand function for real property with demand being influenced by an
income effect and a tax effect. The quantitative model also includes a GDP forecasting
module with a chaos-type structure. The developed model can be used to simulate
20
the
impact of alternative real property tax rate reforms for use as technical inputs in the
formulation of a package of reforms for selected property taxes in the Philippines. Tax
revenue simulation results for alternative real property transfer tax rate reforms using the
model are also presented. Based on the simulation results, a proposed set of short- and
medium-term tax rate reforms are proposed for a selected set of national real property
transfer taxes.
Chapter 1 of this paper sets the background and describes the content of the paper.
Chapter 2 lays down the analytical framework, the structure of the simulation model, and
the GDP forecasting module.
Chapter 3 presents the results of the statistical analyses on the real property market
models as well as the alternative GDP forecasts.
Chapter 4 lays out the key points and considerations that guided the choice of the real
property transfer taxes to be considered for inclusion in the tax package subjected to tax
rate reform analysis.
Chapter 5 presents the tax rate reform package subjected to revenue simulation.
Chapter 6 shows the revenue simulation results for selected national real property transfer
taxes the Capital Gains Tax (CGT), the Documentary Stamp Tax (DST), the Estate Tax
(EST), and the Donors Tax (DOT).
Chapter 7 summarizes the proposed recommendations.
Appendix A sets out the mathematical derivation of the elasticity estimate.

20
Simulation is the process of starting with an initial value in each variable and running the set of equations for
multiple time increments. At each time increment, all equations are processed to generate new variable
values from the current values. The resulting data for variables at each time increment represents one run
of the simulation. During simulation, a model is driven by input data and produces output data. Data can
come from initial values in the model, user entry, or a data file. See Harold Hableib. System Models and
Simulation. The Project Perfect White Paper Collection in www.projectperfect.com.au, July 11, 2007.

2. ANALYTICAL FRAMEWORK
This section sets out the conceptual basis and the theoretical framework that served as the
basis for the formulation of the simulation model. Section 2.1 presents the analytical model
that formalizes the interactions between real property markets, macroeconomic activity
level, and real property tax rates. Section 2.2 lays out the form of the empirical equation,
parameters of which are estimated from available time series and cross-section data.
Section 3 presents the statistical techniques used in estimating the parameters.
2.1. Analytical Model
The demand for physical space comes from different types of users: residential,
commercial or industrial. These users need to maintain the same level of space services
that may have been reduced by demolition or withdrawal. In equilibrium, the supply of
property should be equal to the demand at various levels of property prices.
21

The impact of real property taxes on the market for real estate measured in terms of Gross
Value Added for Real Estate (REGVA) or new floor space construction (FA) is shown in
Figure 3. Both will be analyzed in this paper. However, since property tax is imposed
based on value per area rather than floor area per se, it was deemed that the property
market expressed in value terms (REGVA) be the one utilized for simulation purposes.
Figure 3. Relationship
22
between the Market for Real Property,
Overall Economic Activity, and the Effective Real Property Tax Rate

21
Property prices respond to demand changes and over time, such price changes are translated to new
construction (with corresponding financing sources) to keep the market in equilibrium.
22
The relationship need not be linear. The linear representation was made to simplify the graphic
presentation. In fact, the empirical equation used in the simulations posited a power curve in log-linear
form.

The total market for real property estate is a function of the economic activity as measured
by the countrys Gross Domestic Product (GDP) and effective real property tax rate
(EPTR). Mathematically, this can be expressed as:
M = f(GDP, EPTR) (3.0)
where: GDP = Gross Domestic Product
EPTR = Effective Real Property Tax Rate
As the solid market line M
0
23
indicates, there is an inverse (or negative) relationship
between real property tax rates (EPTR) and the market for real estate (M
0
).
24
Whenever
there is an increase (decrease) in the property tax rate while keeping economic activity
level constant, quantity demanded decreases (increases) correspondingly.
25

On the other hand, the level of economic activity as measured by the GDP positively (direct
relationship) affects the real property market. Whenever economic activity increases (or
decreases), there is a corresponding upward (or downward) shift in the real property
market.
26

In the Philippines, landowner reactions to changes in the aforementioned economic
variables in terms of both magnitude and speed may be affected by the strong attachment
of Filipinos to land. People may hold on to their land even if not economically viable
27
or
even resort to outright violence to defend their real property holdings against public
auctions of tax delinquent properties.
28

The structure of the simulation model is presented in Figure 4.
A reduction in the tax rate will result in a direct tax rate effect consisting of:
a) Reduction in tax revenues as a direct immediate result; and
b) Increase in the real property revenue base as measured by the Gross Value
Added in Real Estate (REGVA) due to:
- people undertaking a larger volume of real property transactions; and
- more people formalizing their property transactions.

23
The market line need not be linear, it could be curvilinear.
24
This is so because the real property tax acts as a tax on capital and increases the cost, and consequently,
the selling price of real estate. In some research work, the effective property tax rate is referred to as a tax
price. The market curve in Figure 3 shows the relationship between the tax price (EPTR in this case) of
real estate and real property market size while keeping the level of economic activity (GDP) constant.
25
This downward (or upward) movement along the same market line (often referred to in the literature as a
change in quantity demanded) is illustrated by the downward (or upward) sloping arrows on top and
parallel to M0.
26
Whenever the level of economic activity changes, the entire market line correspondingly shifts upwards (as
indicated by dashed market line M2) or downwards (as indicated by dashed market line M1).
27
This has been succinctly pointed out by NTRC Executive Director Lina D. Isorena and Deputy Executive
Director Dante V. Sy during a discussion held on 24 September 2009.
28
This has been observed in many LGUs across the Philippines, a few of which were personally observed by
the Advisor.

Figure 4. Structure and Flow of Simulation Model


Because of the multiplier effect, the increase in economic activities in the real estate sector
will also increase economic activities in related sectors such as construction, mining and
quarrying, manufacturing, services and finance. All the increased economic activities will
increase the total economy as measured by GDP.
The increase in GDP will have a second round income effect, leading to an additional
increase in REGVA.
The net tax revenue effect of reductions in real property tax rates will thus be a balance of
the revenue reductions arising from the rate cutbacks vis--vis the potential positive
revenue effects of the resulting increase in the revenue base (REGVA) through the tax rate
effect and the increase in GDP due to the increased real property market activity via the
multiplier effect of the property sector.
The revenue effect of the tax reforms will come from increased real property market
activities arising from the direct tax rate effect and the secondary income effect arising from
an increased GDP stimulated by increased property market activities.
The model will estimate the initial REGVA with and without tax reform. The multiplier
effect of the REGVA on the GDP will then be estimated and the 2
nd
round effect of the
increased GDP on REGVA calculated. Based on 1988 to 2008 data, the countrys GDP --
with and without reform -- will be forecasted using a chaos-type time trend equation.
The primary (initial tax rate effect on GVARE) and secondary (second round GDP effect on
GVARE) net tax revenue resulting from the tax reform will be measured and its present
value derived using the current Treasury-Bill rate of 4.5%.
2.2 The Empirical Real Property Market Models
Two empirical real property market models will be tested against available time series data.
The first model has gross value added in real estate (REGVA) as the dependent variable
which is measured in peso terms (000 PhP) at current prices while the second model has
new floor space construction (FA) as the dependent variable which is measured in floor
area (000 sqm.).
2.2.1 Gross Value Added in Real Estate as a Measure of the Real Estate Market
The empirical counterpart of the conceptual model presented in 2.1 in value terms is shown
as Equation 1.0.
REGVA
t
= a
0
+ a
1
* GDP
t
+ a
2
* EPTR
it
(4.0)
where: REGVA
t
= Gross Value Added in Real Estate in million PhP at current prices in year t
GDP
t
= Gross Domestic Product in million PhP at current prices year t
EPTR
it
= the effective property tax rate in percent for property tax type i in year t
a
0
= the intercept
a
1
= the change in REGVA resulting from a unit change in GDP keeping EPTR
constant (
)
29

29
Mathematically, a1 and a2 are interpreted as the partial derivatives (denoted by ) of REGVA with respect to
GDP and EPTR, respectively.

a
2
= the change in REGVA resulting from a unit change in EPTR keeping GDP
constant (
)
The expected signs are (+) for a
1
and (-) for a
2
.
2.2.2 New Floor Space Construction as a Measure of the Real Estate Market
The empirical counterpart of the conceptual model presented in 2.1 in terms of additional
physical space constructed is shown as Equation (5).
NFA
kt
= a
0
+ a
1
* GDP
t
+ a
2
* EPTR
it
(5.0)
where: NFA
kt
= new floor space construction of type k in year t with k = residential (RFA),
non-residential (NRFA), and alteration/addition/repairs (ARFA)
GDP
t
= Gross Domestic Product in million PhP at current prices year t
EPTR
it
= the effective property tax rate in percent for property tax type i in year t
a
0
= the intercept
a
1
= the change in NFA
kt
resulting from a unit change in GDP keeping EPTR
constant (
)
a
2
= the change in NFA
kt
resulting from a unit change in EPTR keeping GDP
constant (
)
1
and (-) for a
2
.
To derive the elasticities of the property market (REGVA) with respect to the economic
activity level (GDP) and the effective real property tax rate (EPTR), Equations (4.0) and
(5.0) were transformed to their respective natural logarithmic forms
30
shown as Equations
(6.0) and (7.0).
LN REGVA
t
= LN a
0
+ a
1
* LN GDP
t
+ a
2
* LN EPTR
it
(6.0)
LN NFA
kt
= LN a
0
+ a
1
* LN GDP
t
+ a
2
* LN EPTR
it
(7.0)
where: LN = natural logarithm, variables are as previously defined in Equations (4.0) and
(5.0)
LN a
0
= intercept in logarithmic form
a
1
= % change in REGVA or NFA as the case may be resulting from a 1% change
in GDP keeping EPTR constant: (

) or (

a
2
= % change in REGVA or NFA as the case may be resulting from a 1% change
in EPTR keeping GDP constant: (

) or (

1
and (-) for a
2
.

30
See Appendix A for the mathematical derivation.

The equations were estimated with the intercept LN a
0
= 0 since if GDP = 0, then REGVA,
a component of the GDP, is necessarily equal to zero, and there will be no new
construction.
2.3 Related Models
2.3.1 Output Multiplier Effect of the Real Property Markets
The impact of the increased real estate market activity (REGVA) on GDP will be measured
based on the following natural log regression equation (Equation 8.0) relating GDP in year t
to REGVA in year t.

LN GDP
t
= a
1
* LN REGVA
t
(8.0)
where; LN = natural logarithm
GDP
t
= Gross Domestic Product in million PhP at current prices in year t
a
1
= % change in GDP resulting from a 1% change in REGVA: (

)
REGVA = Gross Value Added in Real Estate in million PhP at current prices in year t
The full impact of REGVA on GDP the total industry activity multiplier will be fully
realized within the current year. Regression runs indicate that almost all of the multiplier
effects occur within the year in which the real estate expenditure was made with only
0.02% spilling over to the next year.
2.3.2. Real Property Tax Rates and Tax Compliance
The impact of statutory real property tax rates on compliance as proxied by the collection
efficiency (COE) rate will be measured against available 2007 city level data using the
elasticity measure shown in Equation (9.0).

(9.0)
where: COE = Collection Efficiency for the Real Property Tax (see Equation 2.0)
EPTR = Effective Real Property tax rate (see Equation 1.0)
Note that this model could not be tested against provincial data because there was no
variation in the statutory RPT rate imposed by provinces. In addition, no municipal level
property assessment data could be secured.
2.3.3 National Transfer Taxes and the Local Tax on the Transfer of Real Property
Ownership (TTRPO)
The TTRPO is the last tax to be paid by a real property transferor after the CGT for a sale
and EST and DST for an inheritance or a donation followed by the DST in order to
formalize/legalize the transfer.
With no change in the TTRPO rate and assuming the same assessment and collection,
efforts by LGUs, the potential effect of the proposed national transfer tax reform package
on the TTRPO will be made to depend on the statistical relationship between the TTRPO

and the CGT the biggest and first tax to be paid during the transfer formalization
process. This relationship is as follows:
LN TTRPO
t
= a
1
* LN CGT
t
(10.0)
where; LN = natural logarithm
TTRPO
t
= Tax on the Transfer of Real Property Ownership in million PhP at current
prices in year t
a
1
= % change in TTRPO resulting from a 1% change in CGT: (

)
CGT = Capital Gains Tax in million PhP at current prices in year t
2.4 Statistical Estimation Techniques
In most of the cases, ordinary least squares (OLS) regression techniques using the
regression module of Microsoft EXCEL 2007 or the General Regression Module (GRM) of
STATISTICA 6.0 were utilized in estimating the regression parameters.
31

In cases where simple correlation analyses indicated significant multi-collinearity between
the explanatory variables, ridge regression technique using STATISTICA 6.0 was used in
estimating the regression coefficients.
32

2.5 The GDP Forecasting Module
A key driver of the analytical model used to simulate the revenue effects of the selected
property tax reform proposals is the level of economic activity represented by the Gross
Domestic Product (GDP) at current prices.
This section presents the results of the GDP forecasting efforts done by the consultant in
terms of the alternative forecasting techniques used and the results of the application of
such techniques on available Philippine national income accounts data.
The alternative forecasting techniques used were all based on time series models since the
limited amount of time available to the Consultant precluded the estimation and use of full-
blown econometric models of the Philippine economy. Furthermore, given the relatively
short forecast period of six years, the use of time series analysis models will probably yield
better growth forecasts in terms of closeness to the historical growth performances as
international forecasting experiences have shown.
One of the models tracked seemingly chaotic movements of the annual percentage
changes in GDP between 1990 and 2008 based on chaos model principles. This time
series model with a chaos type structure was used to estimate GDP data to generate the
trend without tax reform GDP forecasts.

31
Since no categorical or dummy explanatory variables are used in the model, the two regression modules
yield identical results.
32
Ridge regression is used when the explanatory variables are highly inter-correlated and stable estimates of
the regression coefficients cannot be obtained through ordinary least squares (OLS). Ridge regression
adds a constant to the diagonal of the correlation matrix, which is then re-standardized, so that all
diagonal elements are equal to 1.0, and the off-diagonal elements are divided by the constant. In other
words, ridge regression artificially decreases the correlation coefficients so that more stable estimates of the
beta coefficients can be computed. See A. E. Hoerl. Application of Ridge Analysis to Regression
Problems, Chemical Engineering Progress, 58, 54-59.

The period of analysis is limited to five (5) years. Beyond five years the forecast errors for
the without tax reform GDP becomes too large making the forecasts statistically
unreliable.
To make the multi-year net revenue effects comparable across time, they are converted to
their present value equivalent using the 1-year T-Bill rate as the discount rate. The T-Bill
rate serves as the opportunity cost of property tax revenues raised since government
revenue shortfalls are financed through borrowings.
2.5.1 Time Series Forecasting and Models
Time series is a set of observations generated sequentially in time. The usage of time
series models is two-fold:
a) obtain an understanding of the underlying forces and structures that produced
the observed data; and
b) fit a model and proceed to forecasting and monitoring.
Time series forecasting is a category of forecasting that assumes that the historical data is
a combination of a pattern and some random error. Its goal is to isolate the pattern from
the error by understanding the patterns level, trend, and seasonality.
33

A simple and pragmatic model for a time series would be to consider each observation as
consisting of a constant (b) and an error component (Epsilon), that is:
X
t
= b +
t
.
The constant b is relatively stable in each segment of the series, but may change slowly
over time.
For this study, three (3) major non-seasonal time series models were utilized in developing
alternative GDP forecasts.
2.5.2. Single Exponential Smoothing Model
One way to isolate the true value of b, and thus the systematic or predictable part of the
series, is to compute a kind of moving average, where the current and immediately
preceding ("younger") observations are assigned greater weight than the respective older
observations. Simple exponential smoothing accomplishes exactly such weighting, where
exponentially smaller weights are assigned to older observations. The specific formula for
simple exponential smoothing is:
S[1]
t
= *X
t
+ (1-)*S
t-1
(11.0)
where S[1]
t
= single exponential smoothing smoothed estimate for time period t
X
t
= historical value at time t
= smoothing constant between 0 and 1.

33
In this particular case, the data are annual so seasonality is not a concern.

When applied recursively to each successive observation in the time series, each new
smoothed value (forecast) is computed as the weighted average of the current observation
and the previous smoothed observation; the previous smoothed observation was computed
in turn from the previous observed value and the smoothed value before the previous
observation, and so on. Thus, in effect, each smoothed value is the weighted average of
the previous observations, where the weights decrease exponentially depending on the
value of parameter (alpha). If is equal to 1 (one) then the previous observations are
ignored entirely; if is equal to 0 (zero), then the current observation is ignored entirely,
and the smoothed value consists entirely of the previous smoothed value (which in turn is
computed from the smoothed observation before it, and so on; thus all smoothed values
will be equal to the initial smoothed value S
0
). Values of in-between will produce
intermediate results. Regardless of the theoretical model for the process underlying the
observed time series, simple exponential smoothing will often produce quite accurate
forecasts.
34

A trend component may be included in the exponential smoothing process, wherein an
independent trend component is computed for each time, and modified as a function of the
forecast error and the respective parameter. If the (gamma) parameter is 0 (zero), then
the trend component is constant across all values of the time series (and for all forecasts).
If the parameter is 1, then the trend component is modified "maximally" from observation
to observation by the respective forecast error. Parameter values that fall in-between
represent mixtures of those two extremes.
Two alternative trend components were tried in the analyses:
a) a linear trend; and
b) an exponential trend.
1) Linear Trend
The introduction of a linear trend assumes that the level of a particular variable slowly
increases across time by a fixed absolute amount over time (the linear trend component).
In order to compute the smoothed value (forecast) for the first observation in the series,
both estimates of S
0
and T
0
(initial trend) are necessary. By default, these values are
computed as:
T
0
= (X
n
-X
1
)/(N-1) (12.0)
where N is the length of the series; and
S
0
= X
1
-T
0
/2. (13.0)
The single exponential smoothing with a linear trend GDP forecasts were based on =
0.10 and = 0.10.

34
Empirical research has shown simple exponential smoothing to be the best choice for one-period-ahead
forecasting, from among 24 other time series methods and using a variety of accuracy measures. See
Makridakis, S., Andersen, A., Carbone, R., Fildes, R., Hibon, M., Lewandowski, R., Newton, J., Parzen, R.,
& Winkler, R. (1982). The accuracy of extrapolation (time series) methods: Results of a forecasting
competition. Journal of Forecasting, 1, 11-153.

The mean average percent error (MAPE) is 3.27%.
35

2) Exponential Trend
The introduction of an exponential trend assumes that the variable being forecast
increases by a certain percentage or factor, resulting in a gradual exponential increase in
the absolute value of the variable.
To compute the smoothed value (forecast) for the first observation in the series, both
estimates of S
0
and T
0
(initial trend) are necessary. By default, these values are computed
as:
T
0
= (X
2
/X
1
) (14.0)
and
S
0
= X
1
/T
0
(15.0)
The data was further smoothened using the 4253h filter provided in STATISTICA 6.0. This
transformation consists of several passes of moving average/median smoothing, and is a
powerful filter for smoothing a series. The following transformations were performed:
a) A 4-point moving median centered by a moving median of 2;
b) A 5-point moving median;
c) A 3-point moving median;
d) A 3-point weighted moving average using Hamming weights
36
(.25, .5, .25);
e) Residuals were computed by subtracting the transformed series from the
original series;
f) Steps 1 through 4 above were then repeated for the residuals; and
g) The transformed residuals were added to the transformed series.
In practice, this filtering method often produces a smooth series while maintaining the
salient characteristics of the original series.
The single exponential smoothing with an exponential trend GDP forecasts were also
based on = 0.10 and = 0.10.
The mean average percent error (MAPE) is 2.69%.

35
This means that on the average, estimated values differed from the actual values by 3.27%.
36
The process smoothens out spikes in the data via a weighted moving average transformation. This weight
function will assign the greatest weight to the observation being smoothed in the center of the window, and
increasingly smaller weights to values that are further away from the center. The weights are standardized
so that their sum is 1.

2.5.3. Double Exponential Model
The double exponential model applies single exponential smoothing twice, once to the
original data and then to the resulting single exponential smoothed data.
Crystal Ball Predictor (a simulation and forecasting add-in to Microsoft EXCEL) uses Holts
double exponential smoothing as follows:
S[2]
t
= * S[1]
t
+ (1 ) * S[2]
t-1
(16.0)
Where S[2]
t
= double exponential smoothing smoothed estimate for time period t
S[1]
t
= single exponential smoothing smoothed estimate for time period t
= smoothing constant between 0 and 1, which may or may not be
different from the
The double exponential model forecasts based on the raw GDP time series data were
based on = 0.945 and a = 0.923.
The double exponential model forecasts based on the 4253H-filtered GDP time series data
were based on = 0.999 and = 0.999.
2.5.4. Chaos-Type Model
Chaos-type equations are deterministic systems (exhibiting regular and predictable
behavior) that also exhibit seemingly irregular, random, and even turbulent behavior and
are highly sensitive to initial conditions.
Seemingly chaotic movements of the annual percentage changes in GDP ( GDP
t
) from
1990 to 2008 shown in Figure 5 were statistically modeled using the two alternative
dynamic equations:
37

a) One with a time trend variable, and
b) Another without:
The equation with a time trend variable shows a better performance in terms of tracking the
turning points in Figure 5 although the statistical significance of the time trend variable is
only 0.76.
38

The lagged change in GDP ( GDP
t-1
) follows usual time series models where the past
periods value affects the current period value. Introducing a quadratic GDP term
introduces a hump in this case a maximum. Changes or variations in the value of

37
They are considered dynamic because of the time lag elements. The form of the equation used is as
follows:

* Square Root of the Time Trend (t,, ,,n

38
The time trend variable is represented by the square root of time. The statistical significance of the
regression coefficient of the square root of time is computed as 1 probability of insignificance (0.24 in Table
1) = 0.76. The relatively low statistical significance of the time trend variable is probably due to the presence
of strong multicollinearity between the variable and the explanatory variables GDPt and GDPt-1.

variables like GDP and prices have been observed to be proportional to the square root
of the time.
39

The election variable introduces a cyclical element wherein elections dampen the
growth of the economy probably due to the uncertainties and fears generated by
administration changes. The uncertainty generated by the constant challenge, e.g., EDSA
3, to the legitimacy of the presidency between 2001 and 2003 dampened the growth of the
economy. The extraordinary huge presidential election expenditures in 2004 boosted the
growth of the economy.
The standard errors of estimate of both equations (See Tables 1 and 2) are within 15% of
their mean historical values from 1990 to 2008.
Given the better historical tracking performance of the chaos model with a time trend
variable, the model forecasts were the ones adopted as unadjusted GDP base forecasts.
Adjustments were made on the original and unadjusted model forecasts using the
deviations of the model projections for 2009 and 2010 from the Asian Development Bank
(ADB) revised forecasts for those years

. The adjustment
factors linearly increases
40
based on the assumption that it will take about 5 years before
the Philippine economy can fully get back to its modeled potential growth path from the
2009 downturn. The adjusted GDP growth projections at current prices are presented in
Table 11 in Chapter 3.

39
See Regnault Jules. 1863. Calcul des chances et philosophie de la Bourse. Paris: Mallet-Bachelier. As
quoted by Benoit Mandelbrot in Mandelbrot, Benoit. 2004. The (Mis)Behavior of Markets: A Fractal View of
Risk, Ruin and Reward. New York: Basic Books, p. 283.
40
The deviation from the potential growth path correspondingly declines.

Figure 5. Tracking Performance of Two Alternative Chaos-Type
GDP Growth Forecast Equations

Table 1. Parameter Estimates of Chaos-Type
GDP Growth Forecast Equation With Time Trend Variable

0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
2
0
0
2
2
0
0
4
2
0
0
6
2
0
0
8
A
n
n
u
a
l

G
D
P

G
r
o
w
t
h

R
a
t
e
% Change % Change (est1) % Change (est2)

Table 2. Parameter Estimates of Chaos-Type
GDP Growth Forecast Equation Without Time Trend Variable


3. STATISTICAL ESTIMATES OF THE PARAMETERS OF THE REAL
PROPERTY MARKET MODELS
This section presents and discusses the findings of the statistical analyses done to validate
the conceptual models presented in Section 2.0. A total of 27 time series-based equations
and two (2) cross-section based equations were estimated for the two basic real property
market models. The regression estimates for the REGVA model and the three (3)
components of NFA RFA, NRFA, and ARFA are presented in Tables 3, 4, 5, and 6.
The multiplier effect of the real property sector in terms of annual GDP growth rate is
shown in Equation (17.0).
3.1. Results of Elasticity Analyses
- The elasticities of both gross value added in real estate (REGVA and new floor
area construction with respect to economic activity (GDP) and the effective real
property tax rate (EPTR) are all statistically significant and are of the correct
signs: (+) with respect to GDP and (-) with respect to EPTR. The (-) sign with
respect to EPTR confirms the often expressed belief/opinion that property taxes
have a dampening effect on real estate investment. In fact, almost all of the
estimated tax rate elasticities with respect to new floor area constructi on are all
greater than 1.
- Analyses of available international cross-section data indicate that the estate
tax negatively affects investments. Figure 6 shows a negative tax rate
elasticity of 0.84
41
between the statutory estate tax rate
42
of a country and its
gross domestic capital formation (GDCF). This implies that for every 1%
reduction in the maximum level estate tax rate of a country, there is a potential
0.84% increase in a countrys GDCF.
- In recognition of this negative effect of the estate tax rate on a countrys capital
formation, 24 developed and developing countries out of 50 countries surveyed by
Price Waterhouse Coopers have no estate or inheritance tax. They include
Argentina, Australia, Canada, China, Colombia, Cyprus, Czech Republic, Estonia,
India, Indonesia, Israel, Latvia, Lithuania, Malaysia, Malta, Mexico, N. Zealand,
Portugal, Russia, Slovak Republic, Slovenia, Sweden, Switzerland, and Thailand.
43

41
R
2
= 0.54 which can be considered quite high for a cross-section based regression equation. The elasticity
estimate is significant at the 99% confidence level.
42
Refers to the maximum statutory tax level. The maximum level estate tax rate is the more relevant measure
since it is the high income brackets who save the most and whose estates constitute bulk of a countrys
GDCF.
43
See Chris Edwards. Repealing the Federal Estate Tax. Tax and Budget Bulletin. No. 36, June 2006.

Figure 6. Statutory Maximum-Level Estate Tax Rate and
Gross Domestic Capital Formation, Selected Countries: 2005

Source: Calculated from estate tax rate data from coming from the Cato institute and GDCF data from
the World Bank web page.
44

- The coefficients of determination (R
2
) of the regression equations are all higher
than 90% indicating that the equations are useable for forecasting purposes.
45

- Substantial tax rate effects can be expected from the Estate Tax, the Donors
Tax, and the Value Added Tax (VAT).
- The floor area-based model exhibited much higher tax rate elasticities for the
Capital Gains Tax (CGT), the Documentary Stamp Tax (DST), the Tax on
Transfer of Real Property Ownership (TTRPO), and the RPT compared to the
REGVA-based models. REGVA includes land while new construction floor area
is limited to improvements. This implies that the real estate market land +
improvements is less responsive to tax rate changes than improvements
alone especially when measured in physical terms. The results can thus be
viewed as probably symptomatic of the failure to regularly update the land
values which serve as the basis of property tax assessment. With people
paying a lesser amount of tax on the land component of their real estate
properties than what they should actually pay, their response to tax rate
changes imposed on the value of the combined land and improvements is lower
than their response in terms of physical improvements alone.
46
Their passive

44
Ibid and World Bank webpage, www. Worldbank.org.
45
Even the R
2
adjusted for sample sizes are all within 85 to 90%.
46
In the case of the property-related transfer taxes, this is exacerbated by numerous avoidance techniques. A
thriving industry of lawyers and accountants specializing in estate planning is in place, and their services
are effectively availed of by the high value estates the main target of these transfer taxes. Thus, it is this
industry that thrives from the transfer of high value estates rather than the government.

land tax avoidance arising from government neglect makes them less sensitive
to tax rate changes that affect both land and improvements.
3.2. Output Effect of the Real Property Sector
Equation (17) implies that for every 1% change in REGVA in year t, there will be a
corresponding 1.45% change in GDP.
LN GDP
t
= 1.45199 * LN REGVA
t
(17.0)
(0.99999)
R
2
= 0.99962
The number in parentheses represents the statistical significance of the regression
equation.
Input-output analysis also indicates a substantial output multiplier for the real property
sector. Available Year 2000 Input-Output (IO) data show that the real property sector has a
total industry activity multiplier 1.20, meaning that every peso spent in real property yields
a peso of direct sales to the other sectors plus PhP 0.20 of indirect sales to the other
sectors of the economy.
47

Table 7 shows the inverse matrix of the 11 X 11 sector Year 2000 IO table for the
Philippines along with the corresponding output multipliers.
3.3. Local RPT Rates and Compliance
As shown in Tables 8 and 9, real property tax compliance and statutory RPT rates are
inversely related with a tax rate elasticity that ranges from -0.09 to -0.12 indicating that a
1% reduction in RPT rate could increase collection efficiency by 0.09 to 0.12%.
No relevant statistical analyses could be made for provinces as there is no variation in their
statutory rates all provinces pegged their statutory rates to the maximum allowed by the
1992 LGC. For purposes of comparison, the average collection efficiency of provinces is
just 27.38% as against the 63.18% average of Philippine cities. Against a statutory rate of
2.0%, provinces only attained an effective rate of 0.55% or just about one-fourth of the
statutory rate. Cities with their more varied statutory rates and assessment levels were
able to attain an average effective rate of 1.67% against an average statutory rate of
2.46%. Metro Manila cities attained an average effective rate of 1.81% versus an average
statutory rate of 2.56% with an average collection efficiency of 70.52%.
The result is supportive of the proposal to base the RPT directly on market values and just
compensate by lowering the tax rate. Such a lowering will help encourage RPT
compliance in Philippine LGUs.
3.4. CGT and TTRPO
Equation 18.0 indicates that for every 1% change in CGT revenues, there is a
corresponding 0.84% change in TTRPO revenues.

47
Computed as QMULTj = i INVij where INVij are the coefficients of the inverse matrix. The output
multipliers represent the sum across rows of the inverse matrix.

LN TTRPO
t
= 0.838727 * LN REGVA
t
(18.0)
(0.99999)
R
2
= 0.99843
The below 1.0 elasticity is symptomatic of the widespread evasion in the payment of the
TTRPO even if the CGT and the DST are paid for at the BIR.
3.4. The GDP Forecasts
The adjusted GDP forecasts presented in Table 11 were used as the base GDP
forecasts in the revenue simulations. From a forecast 4.8% growth rate at current prices in
2009, the economy is expected to pick up steadily to reach a growth rate of 12.4% by
2014.
The Asian Development Bank (ADB) 2009 and 2010 forecasts were used to calibrate the
results of the chaos model forecasts since they were more updated than the comparable
National Economic Development Authority (NEDA) forecasts, and the Philippine growth
forecasts prepared by the ADB were consistently linked to global and regional model
forecasts. Furthermore, the update of the most recent available NEDA forecasts was only
for 2009 and 2010.
The use of the more optimistic NEDA forecasts for 2009 and 2010 would only result in
higher potential tax revenue gains and would thus strengthen the recommendations based
on the simulation results using the adjusted GDP forecasts.
Table 3. Regression Estimates for the Parameters of the
Gross Value Added in Real Estate (REGVA) Model


Table 4. Regression Estimates for the Parameters of the
New Residential Floor Area (RFA) Model

Table 5. Regression Estimates for the New Non-Residential Floor Area (NRFA) Model


Table 6. Regression Estimates for the Alterations/Repairs Floor Area (ARFA) Model

Table 7. Inverse Matrix and Resulting Output Multipliers,
Year 2000 Input-Output Table

Source: NSCB web page for the inverse matrix. Output multipliers were calculated by the author.


Table 8. Effective RPT Rates and Collection Efficiency, All Cities, 2007

Table 9. Effective RPT Rates and Collection Efficiency,
Cities with 100 or Greater COE Excluded, 2007

Table 10. Alternative Unadjusted GDP Forecasts, at Current Prices: 2009-2014


Table 11. Base GDP Growth Projections at Current Prices


4. GUIDING POINTS IN THE FORMULATION OF REAL
PROPERTY TAX RATE REFORM PACKAGE
This section lays out the guiding facts and points considered in formulating the property
transfer tax reform options. These guiding facts and points include: a) revenue yield
aspects, b) fiscal decentralization and growth aspects, c) administrative cost aspects, d)
taxpayer resistance aspects, and e) government viewpoint.
48

4.1. Revenue Yield Aspects
In this section, the real property tax revenue performance of the Philippines is
benchmarked against co-developing countries and against advanced countries.
a) Property taxes in 29 selected developing countries including the Philippines for
the years 2000 and 2001 constituted on the average 0.6% of Gross Domestic
Product (GDP).
49

b) In the Philippines, national property related taxes constituted 1.81% of total
Bureau of Internal Revenue (BIR) collections in 2005 or a decline of 0.15% from
its 1.96% share in 2001.
50

c) Relative to GDP
1) National property-related taxes represented just 0.18% of GDP in 2005
or a decline of 0.03% from its 0.21% in 2001.
2) Local property-related taxes constituted 0.46% of GDP in 2005 or more
than double its 0.15% share in 2001.
51

3) Combined, the two constituted 0.64% of GDP in 2005 or just about the
average for developing countries.
52

d) In comparison, the ratio in Organization for Economic Cooperation and
Development (OECD) countries is about 2.12% or more than 3 times.
53

e) The International Monetary Fund (IMF) does not classify property taxes as a
major tax.
54

48
These guiding points and the developed simulation model formulated during the TA work benefitted from
the comments and suggestions made by key NTRC staff members led by Executive Director Lina Isorena
and Deputy Executive Director Dante Sy.
49
See Bahl, Roy and Jorge Martinez-Vazquez (2008). The Property Tax in Developing Countries: Current
Practice and Prospects in Making The Property Tax Work in Developing and Transitional Countries, ed. By
Roy Bahl, Jorge Martinez-Vazquez and Joan Youngman. (Cambridge: Lincoln Institute of Land Policy).
Computed by the authors from IMF (various years) Global Financial Statistics Data.
50
See

Land Equity International Pty, Ltd. (August 2008). Report D-22: Review of National and Local Land-
Related Taxes and Fees. Manila, NTRC/LEI.
51
Computed by the author from unpublished Statement of Income and Expenditure (SIE) data generously
provided by the Bureau of Local Government Finance (BLGF) of the Department of Finance (DOF) and
from national accounts data published in the 2007 Philippine Statistical Yearbook (PSY).
52
Ibid.
53
See Bahl, Roy and Jorge Martinez-Vazquez (2008).
54
Ibid.

f) Reduction or abolition of certain property transfer taxes like the Estate Tax and
Donors Tax could in the long-run enhance the volume of property market
transactions, encourage tax compliance and thus, enhance revenues from other
property taxes.
1) The real property market as measured by the gross values added in
real estate (REGVA) is significantly and negatively affected by property
tax rates
55
as shown in Table 3.
56

2) Substantial tax rate effects can be expected from the Estate Tax, the
Donors Tax, and the Value Added Tax (VAT).
3) Every 1% increase in the Estate Tax and Donors Tax rate in the
Philippines depresses the property market as measured by REGVA by
1.4% (see Table 3). It also discourages new floor area construction.
For every 1% increase in the Estate Tax and Donors Tax rate in the
Philippines, new floor space constructed is reduced by 1.2% (see Table
4).
4) In the case of Philippine cities, real property tax compliance and
statutory RPT rates are inversely related with a tax rate elasticity that
ranges from -0.09 to -0.12 indicating that a 1% reduction in RPT rate
could increase collection efficiency by 0.09 to 0.12%.
57

4.2. Fiscal Decentralization and Growth Aspects
a) The property tax is an important component of fiscal decentralization. The
share of local real property-related taxes to total local revenues is positively
associated with local revenue size.
58

55
The coefficients of determination (R
2
) of the regression equations are all higher than 90% indicating
that the equations are useable for forecasting purposes. The elasticity estimates are also statistically
significant at the 80 to 90% confidence levels.
56
Similar results are obtained using new floor area construction as measure of the real property market.
57
Ibid. No analyses can be done for provinces and municipalities since they all adopted uniform statutory
rates the maximum allowed by the 1991 Local Government Code (LGC).
58
See NR Ramos et al. (2008). Survey of Public Perception on Real Property-Related Taxes and Fees.
Manila, Philippines: Philippine-Australia Land Administration and Management Project Phase 2 (LAMP 2)
and the National Tax Research Center (NTRC).

b) Higher income countries and more decentralized countries use property taxes
more intensively.
59

c) 1990, 1995 and 2000 panel data from 70 countries show that expenditure
decentralization and per capita GDP have significant positive effects on the
effective property tax rate.
60

4.3. Administrative Cost Aspects
a) Benchmark annual administrative costs (International Property Tax Institute)
61

1) 2 to 5% of revenues in developed countries.
2) 10% or greater are symptomatic of problems.
b) In the Philippines
62

1) Capital Gains Tax (CGT): 1.28%
2) Documentary Stamp Tax (DST): 5.12%
3) Estate Tax (EST): 11.38%
4) Donors Tax (DOT): 17.22%
5) Value Added Tax (VAT): 3.13%
The high ratio of administrative costs to total revenue collected for the Estate and Donors
Tax is due to the high costs of administration and enforcement combined with a taxable
base that is effectively reduced at the highest level by a large and wasteful estate
planning and avoidance industry.
63
The Philippines has numerous high-paid lawyers and
accountants doing paperwork, litigation, asset appraisals, and creating financial structures
to minimize the tax burden using trusts, life insurance, and private foundations.
4.4. Taxpayer Resistance Aspects
a) Visibility of property taxes relative to other taxes.
1) People know how much property tax to pay and the amount is paid in lump-
sum and quite early in the year, generally to take advantage of discounts.
2) Who could even guess how much VAT they pay for the commodities and
services they consume.
b) Property tax awareness and transparency issues.

59
See Bahl, Roy and Jorge Martinez-Vazquez (2008).
60
Ibid.
61
See International Property Tax Institute (2007). Benchmarking 2007: Summary Report Toronto, Canada:
IPTI.
62
See

Land Equity International Pty, Ltd. (August 2008).
63
See Chris Edwards (2006).

1) Property taxpayers owners and developers in four (4) study LGUs
Iloilo City, Naga City, Marikina City and the Municipality of Pili in Camarines
Norte had no problems with the CGT, DST, VAT, TTRPO, and RPT as
they found the tax base and tax rates easy to understand and compute.
They, however, considered the schedules and rates of the EST and DOT as
complicated and difficult to understand.
64

2) The tax authoritys assessment is perceived to be judgmental.
c) Break between the amount of tax liability and the ability to pay.
1) The EST imposes a cash burden on taxpayers especially during a period of
family crisis, and discourages registration of properties transferred to
surviving heirs, given the cash flow burden imposed by a one-time payment
with six months deadline, and the large penalty and accumulated interests
imposed after the six month period lapses.
2) Issue of being asset rich and cash poor property taxes being based on
the accumulated value of the property rather than on the annual income
derived from the property.
d) Special attachment to land especially in rural areas.
e) Present levels of public service provision are considered not worth the property
taxes they pay.
4.5. Government Viewpoint
65

a) Devolution of national property-related taxes desirable from BIR viewpoint since
it would mean reduction in work effort with only a small (1.8%) reduction in
revenues.
b) LGUs would welcome devolution since it would mean a substantial increase in
their local revenues with minimum additional administrative costs. The track
record of the average LGU, however, indicates serious problems with their
willingness-to-charge as evidenced by the following:
1) LGUs postponing the regular revision of the Schedule of Market Values as
mandated by the 1991 Local Government Code (LGC).
2) LGUs providing generous and regular property tax amnesties.
3) Elected officials finding it politically difficult to bring aggressive enforcement
measures against delinquents, especially against the politically powerful.
c) This track record has resulted in poor property tax collection performances with
cities as exceptions.
66

64
See N.Ramos (2008).
65
The importance of this point was emphasized by NTRC Executive Director Lina D. Isorena during a
discussion held 16 July 2009.

1) For RPT, both provinces and municipalities have revenue to tax base
elasticities that are less than 1 0.20 for provinces and 0.33 for
municipalities indicating their failure to fully capture the taxes due from
the growing real property base proxied by the gross value added in real
estate (REGVA).
2) The cities are more aggressive in capturing the taxes due from their
rapidly growing real property bases with an elasticity of 1.70.
3) There is a three-year revenue cycle associated with election years.
Election years negatively affect major local revenue sources of LGUs.
67
Results of cross-spectrum analysis
68
between per capita local revenues at
1985 prices (PCLR85) and the dummy variable
69
for election years between
1991 and 2004 shown in Figure 7 shows only one peak indicating a
statistically significant periodic relationship between PCLR85 and the
election year dummy only at a wave frequency of 0.33
70
or once every 3
years.
71
The squared coherency
72
at the same frequency is 0.7307
meaning that the election dummy can account for 73% of the periodicity of
PCLR85.
4) The cities are more aggressive in capturing the taxes due from their
rapidly growing real property bases with an elasticity of 1.70.
d) The DOF equates reduction in current national revenues with the widening
national budgetary deficits.

66
See ADB and BLGF (2007) and Asian Development Bank (ADB) and the Bureau of Local Government
Finance (BLGF), (2007). Appendix A.6. Proposed Time Period Interval for the Periodic Review of the
Income Reclassification of Local Government Units (LGUs). Philippines: Local Government Finance and
Budget Reform (ADB TA 4556) Final Report Technical paper prepared by the Consultant of the TA
project, pp. 4-9.
67
See also Asian Development Bank (ADB) and the Bureau of Local Government Finance (BLGF), (2007).
Appendix D.1. A Financial and Economic Model for Determining LGU Fiscal Capacity for use by the
Bureau of Local Government Finance (BLGF). Philippines: Local Government Finance and Budget Reform
(ADB TA 4556) Final Report Technical paper prepared by the Consultant of the TA project, p. 29.
68
Cross-spectrum analysis may be thought of as the frequency analysis equivalent of correlation analysis.
69
The variable assumes a value of 1 during the election years and 0 in all other years.
70
There is zero or near-zero interaction between the two variables in the other frequencies.
71
Period = 1/frequency.
72
The squared coherency in cross-spectrum analysis is the equivalent of the R
2
.

Figure 7. Periodogram Values for Per Capita Local Revenues at 1985 Prices and the
Dummy Variable for Election Years: 1991-2004

Source: Computed from local revenue data from the BLGF BOS and SIE data,
NSO population data, and NSCB GDP Implicit Price Deflators.
Given these facts, the following points were considered in formulating the property tax
reform recommendations:
a) Administration is costly in terms of both the setup and operating costs in
comparison to current tax yields, especially for the EST and DOT.
b) Trade-offs characterize the development of property tax policy options.
1) Issue of piecemeal tax-by-tax reform that would yield marginal revenue
improvements but less politically costly versus a comprehensive reform that
will redefine the property tax as a consolidated package that has the
potential to reach a revenue yield comparable to that of developed
countries, say 1% of GDP or about half of that of developed countries at
administrative costs no more than 5% of revenues.
2) Devolution of national property taxes could enhance long-term revenue
yields and the local tax revenues of LGUs, but reduce national revenues.
Such a move should, however await the implementation of key property
valuation reforms as well the professionalization of key LGU finance
managers.

c) Consolidating all real property-related transfer taxes under a high yield, low
administrative cost VAT could result in higher net tax take for the government
but could be regressive and could face significant taxpayer resistance and
political costs, especially at the beginning.
Given these guiding facts and points, the focus of the proposed property tax program will
be the four (4) national property transfer taxes CGT, DST, EST, and DOT.
The VAT option is not at this point considered a politically viable option given that it will
require redefining the concept of VAT and amending a recent piece of legislation that had
faced stiff public resistance.
Reforming the TTRPO will require amending the LGC, which may not be easily done
considering that amendments to the LGC have been brought up as early as the 1998-2001
Congress and no progress has been attained since then.
The tax rate reform package will formulate tax rate changes that seek to:
a) Reduce property transfer taxes to stimulate the real property sector and to
encourage formalization of property transfers. Such stimulative effects are
expected in the long-run to more than compensate for revenue losses arising
from the rate reduction or even elimination of certain property taxes.
b) Do away with property related taxes that have relatively low revenue yields vis-
-vis administrative costs.
c) Maintain revenue neutrality during the critical first year of the projection period
2010.


5. THE PROPOSED REAL PROPERTY TRANSFER TAX
REFORM PACKAGE
This section presents the tax rate reform package subjected to revenue simulation.
The proposed tax rate reform package that is subjected to revenue simulation was
formulated based on the following considerations.
a) The Estate Tax and Donors Tax
i) Of the four taxes proposed to be subjected to reforms, the two lowest in terms
of revenue yield are the Estate Tax and the Donors Tax. In 2007, the Estate
Tax only yielded PhP 647 million and between 2000 and 2007 only averaged
PhP 487 million per year. The Donors Tax only yielded PhP 311 million in 2007
and between 2000 and 2007 only averaged PhP 237 million per year.
ii) These two taxes also have transaction costs that are 2 to 3 times higher than
the international benchmark of 5% collection costs. For every peso of tax
collected, the BIR spends PhP 0.11 for the Estate Tax and PhP 0.17 for the
Donors Tax.
iii) The two taxes also have highest negative effect on the growth of the real
estate market (see tax rate elasticities in Table 3, where tax rate elasticities of
Estate Tax = -1.44; and Donors Tax = - 1.45).
iv) The two are also the most disliked of the national real property transfer
taxes.
73

The Estate Tax and the Donors Tax mainly affect the middle class. The rich are
able to avoid these taxes by hiring lawyers and accountants who undertake estate
planning. In the United States, it is estimated that the resources spent on avoiding
estate taxes may be as large as the amount that the tax collects.
74

v) The two taxes also have high and statistically significant cross-tax rate
elasticities with the CGT and the DST. The cross-tax rate elasticities of the
CGT with respect to the Estate Tax and the Donors Tax are -1.14 and -1.16,
respectively. For the DST, the cross-rate elasticities are 0.95 for the Estate Tax
and 0.96 for the Donors Tax. The cross tax elasticity is the elasticity of the
revenue collection of a certain tax with respect to the tax rate of another tax.
For instance, when Estate Tax rate decreases by 1%, CGT collections increase
by 1.14%. This indicates that reductions in the Estate and Donors Tax rates
can be readily captured by the CGT and the DST through the stimulative effects
of such reductions on the real property market.

73
See N. Ramos (2008).
74
This statement is attributed to Alicia Munnell, a member of former US Pres. Clintons Council of Economic
Adviser by D. Miller (May 2006). Costs and Consequences of the Federal Estate Tax as quoted in Chris
Edwards (June 2006).

a) The Capital Gains Tax
i) The CGT has the highest revenue yield among the four taxes proposed to be
subjected to reforms. Between 2000 and 2007, CGT collections averaged PhP
4.0 billion yearly.
ii) Its transaction cost of 1.28% is just about one-fourth (25.6%) of the international
benchmark of 5%.
b) The Documentary Stamp Tax
i) Annual DST collection averaged PhP 1.0 billion between 2000 and 2007.
ii) While it is perceived as onerous, property owners still willingly pay it because it
makes property transfers official.
Given these considerations, the proposed tax reform package will consist of small
reductions in the CGT and DST rate in the period 2010 to 2011 and complete abolition
of the Estate and Donors Tax combined with a major reduction in the CGT and the
DST rates after 2011.


6. TAX REVENUE SIMULATION RESULTS
This section presents revenue simulation results for the proposed tax rate reform directions
for 1) the Capital Gains Tax, 2) the Documentary Stamp Tax, 3) the Estate Tax, and 4) the
Donors Tax. The revenue simulations were generated using the simulation process
presented in Figure 4 and on the base economic growth scenario shown in Table 11. The
simulations also assume existing collection efforts by the BIR, but improved tax compliance
by taxpayers at 0.12% per 1% cutback in the nominal CGT rate (see Table 8).
6.1. Short-term: Period 2010 to 2011
a) The Capital Gains Tax: The revenue simulation results shown in Table 12
indicate that if implemented singly, the DOF should consider a 1% reduction in
the CGT rate from the existing 6.0% rate to 5.0%. Implementation is financially
feasible by 2010 when the economy will be starting on a higher growth
trajectory. Within this range, the stimulative effect of a tax rate reduction will
more than outweigh revenue losses from the rate cut. The expected annual
average net increase in CGT revenues arising from the proposed 1% CGT tax
rate cut for the period 2010-2014 is about PhP 1.2 billion. The proposed tax
rate cut is expected to be revenue neutral if implemented in 2010. The present
value of the potential net revenue gain between 2010 and 2014 (with reform
less without reform tax revenues) at a discount rate of 4.5%
75
can be expected
at PhP 5.1 billion.
Implemented singly, the originally proposed halving of the CGT from 6 to 3% is
not financially feasible during the period 2010 to 2014 as the potential
revenue gains arising from the stimulative effects of the rate cut on the real
property market will not be enough to compensate for the revenue losses
arising from the rate cut. With such a halving of the CGT rate, a total net
revenue loss of PhP 3.3 billion over the five-year period in present value
terms can be expected.
b) The Documentary Stamp Tax: The revenue simulation results shown in Table
13 indicate that if implemented singly, the range of reduction for the DST rate
that the DOF should consider is between 10% and 15%. Implementation by
2010 seems to be feasible when the economy will be starting on a higher
growth trajectory. Within this range, the stimulative effect of a tax rate reduction
will more than outweigh revenue losses from the rate cut. Within this range, the
expected annual average net increase in DST revenues arising from the
proposed 10% to 15% DST tax rate cut during the period 2010-2014 can range
from PhP 343 to 837 million. The proposed tax rate cut is expected to be
revenue neutral if implemented in 2010. Within this range, the present value of
the potential net revenue gain between 2010 and 2014 (with reform less
without reform tax revenues) at a discount rate of 4.5% can be expected to
range from PhP 1.5 to 1.1 billion.
c) Table 14 shows a table summary of revenue simulation results of the tax
reforms considered in the short term.

75
This is the current 1-year T-Bill rate. The T-Bill rate serves as the opportunity cost of property tax revenues
raised since government revenue shortfalls are financed through borrowings.

Table 12. Revenue Simulation Results, Alternative Capital Gains Tax Rates,


Table 13. Revenue Simulation Results, Alternative Reductions in the Documentary Stamp
Tax, In Million PhP at Current Prices: 2010-2014


Table 14. Summary of Simulation Results of Tax Reforms Considered in the Short Term:

6.2. Medium-term: Period beyond 2011
a) The Proposed Real Property Tax Reform Package
The proposed reform package that DOF should consider for implementation
beyond 2011 consists of the following:
1) A halving of the CGT from 6 to 3%.
2) A halving of the DST rate.
3) Abolition of the Estate and Donors Tax in line with current international
practices in both developed and developing countries.
b) Revenue Impact of Tax Rate Reform Package
1) Abolition of Estate and Donors Tax. The abolition of the Estate and
Donors Tax is projected to result in an average yearly revenue loss of
PhP 1.2 billion between 2010 and 2014, the present value of which for the
five year study period is about PhP 5.7 billion (see Table 15).


Table 15. Revenue Simulation Results, Abolition of the Estate and Donors Tax,

2) Abolition of Estate and Donors Tax Combined with Halving of CGT
Rate. The combined stimulative effects of the abolition of the Estate and
Donors Tax and a halving of the CGT rate on the real property market
transactions in terms of new investments and increased formalization of
transactions can be expected to result in a net average annual revenue
gain of PhP 6.8 billion. The present value of the net gains for the five
year study period is PhP 29.6 billion (see Table 16).
Table 16. Revenue Simulation Results, Impact of Proposed Medium-Term Tax Rate
Reform Package on the Capital Gains Tax, In Million PhP at Current Prices: 2010-2014


3) Abolition of Estate and Donors Tax Combined with Halving of DST
Rate. The combined stimulative effects of the abolition of the Estate and
Donors Tax and a halving of the DST rate on the real property market
transactions in terms of new investments and increased formalization of
transactions can be expected to result in a net average annual revenue
gain of PhP 1.4 billion. The present value of the net gains for the five
year study period is PhP 6.2 billion (see Table 17).
Table 17. Revenue Simulation Results, Impact of Proposed Medium-Term Tax Reform
Package on the Documentary Stamp Tax, In Million PhP at Current Prices: 2010-2014

4) Proposed Tax Reform Package: Abolition of Estate and Donors Tax
Combined with Halving of CGT and DST Rate. The annual average net
revenue gain from this proposed reform package is projected at PhP 7.0
billion during the period 2010-2014 and the present value of the net
revenue gain attributable to the reform package during the period is
estimated at PhP 30.1 billion (see Table 18).
Table 18. Revenue Simulation Results, Combined Revenue Effect of Proposed Medium-Term
Property Transfer Tax Reform Package, In Million PhP at Current Prices: 2010-2014


Thus, the expected increases in the revenue collection from the CGT and
DST will more than offset the revenue losses from the abolition of the
Estate and Donors Tax due to the high cross tax rate elasticity of the
Estate and Donors Tax with the CGT and the DST.
In the United States, Edwards (2005) argued that the bigger damage of the
Estate Tax is its negative effect on savings, investment and business
activity. Its abolition is expected to result in higher CGT revenues.
76

5) Effect of Proposed Tax Reform Package on TTRPO. An added positive
effect is that with increased real estate activities and formalization of such
activities, LGU collection from the local TTRPO can be expected to
increase. As shown in Table 19, the reform package at the national level
can be expected to result in annual average TTRPO collection of PhP 2.6
billion over the five-year period or about double the PhP 1.3 billion average
annual TTRPO revenues from 2003 to 2007. The present value of the net
revenue effect of the national transfer tax reform package on the TTRPO is
estimated at PhP 5.6 billion over the 5-year period.
Table 19. Revenue Simulation Results, Combined Revenue Effect of the Proposed Medium-
Term Property Transfer Tax Reform Package on the Tax on Transfer of Real Property
Ownership (TTRPO), In Million PhP at Current Prices:2010-2014

76
See American Council for Capital Formation, New International Survey Shows U.S. Death Tax Rate among
Highest, July 2005.

7 CONCLUSIONS AND RECOMMENDATIONS
a) The Philippine real property market as measured in value terms gross value added
for real estate at current prices and physical area terms new floor space
construction positively responds to changes in economic activity ( GDP) and
negatively related to changes in tax rates ( EPTR).
b) Reduction or abolition of certain property transfer taxes like the Estate Tax and Donors
Tax could in the long-run enhance the volume of property market transactions,
encourage tax compliance and thus, enhance revenues from the other remaining
property taxes. Expected to be benefitted are the CGT, the DST, and the TTRPO.
c) In 2010, the DOF should seriously consider reducing the CGT rate from the present 6%
to a range of 5 to 4.75%, and effecting a 10% reduction in the DST. These tax breaks
will help boost the real property market during the present economic downturn and
result in improved revenue collection. At the same time, if implemented or even
publicly announced by 2010, it can boost the popularity rating of the present
administration in an election year.
d) Beyond 2010, the DOF should seriously consider adopting the proposed real property
transfer tax reform package consisting of a halving of both the CGT and DST rates and
the abolition of the Estate Tax and Donors Tax.
1) It will result in higher national revenue collections from real property transfer
taxes.
2) It will also help improve LGU collection from the local TTRPO. For provinces
with their relatively limited revenue base, the improvement could be critical in
their drive for lesser dependence on the Internal Revenue Allotment (IRA).


REFERENCES
American Council for Capital Formation. (July 2005). New International Survey Shows
U.S. Death Tax Rate among Highest, July 2005.
Asian Development Bank (ADB) and the Bureau of Local Government Finance (BLGF),
(2007). Appendix D.1. A Financial and Economic Model for Determining LGU
Fiscal Capacity for use by the Bureau of Local Government Finance (BLGF).
Philippines: Local Government Finance and Budget Reform (ADB TA 4556) Final
Report Technical paper prepared by the Consultant of the TA project.
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Towards a Reform Package for Real Property Transfer Taxes in the Philippines A-1
APPENDIX A. MATHEMATICAL DERIVATION OF THE
ELASTICITY ESTIMATE
The relevant elasticities are estimated by fitting a multivariate logarithmic function (Y = +
1
ln X
1
+

1
ln X
2
+, B
n
ln X
n
) using multiple regression analysis on the paired time series
and cross-section data for each revenue item, by LGU type and where the variables are
expressed in terms of natural logarithms (ln). The partial slope coefficients (Bs) of the
estimated multiple regression equations for each revenue item and for each LGU category
measures the elasticity (% change) of the revenue item for each LGU type with respect to a
% change in each of the explanatory variables, e.g., gross value added in real estate, gross
domestic product, etc. The mathematical derivation is as follows:
The elasticity of Y with respect to X () =
Y
X
dX
dY

With the functional form Y
B
A = X
=
Y
X
dX
dY
=
B
B
A
BA
X
X
X
1
=
B
B
A
BA
X
X
= B
This can be shown more rigorously as follows:
If Y = f(X) and a change X are imposed leading to a change Y, then:
Y
X
X
Y
X
X
Y
Y
A
A
=
A
A

measures the proportionate change in Y per unit proportionate change in X, i.e., the %
change in Y resulting from a 1% change in X. The elasticity of Y with respect to X is defined
as the limiting value of this ratio as X0, that is:
Elasticity of Y with respect to X () =
Y
X
dX
dY
) (ln
) (ln
X d
Y d

where ln denotes the natural log.
Given a double-log functional form
ln Y= A + ln X,
) (ln
) (ln
X d
Y d
=

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Real Property Valuation and Land Taxation Report November 2009

* Square Root of the Time Trend (t,, ,,n

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