THE FINANCIAL EXECUTIVE
Business World
After much controversy, the VAT law, the centerpiece of fiscal reform advocated by government, academic and business economists as well as multilateral institutions was finally passed. Its passage ignited hopes of finally putting the fiscal problem behind us. (In a twist that surprised financial markets, the Supreme Court issued a TRO under somewhat mysterious circumstances, putting the law's implementation on hold. It is still the market's expectation that the Supreme Court will lift this TRO not too distantly; were it not so, we would have seen markets plummet by much more than what we observed so far.)
The VAT, however, was never intended as a panacea for government's fiscal problems; in economics parlance, it is necessary but not sufficient for fiscal sustainability. Rather it is only part of a package of measures to put government's fiscal position on solid footing - albeit an important one that buys time for government to implement the rest of the reforms and not be trapped in a vicious debt spiral.
The rest of the work involves strengthening institutional capacities to improve fiscal management and put public finances back on a sustainable track - something that was achieved for the first and last time during the Ramos administration. The list is long and many of the needed reforms have been in government's to-do list since way back.
Sadly, inability to push through with these reforms - a reflection of "political fractionalization" or lack of political cohesion in the legislature as discussed in the latest IMF country report - has increasingly weakened the country's public finances (e.g., narrow tax base, compressed spending on basic services, increasing share of debt service in the budget, exposure to off-budget risks and vulnerability to event risk).
The one area where improvements have been noteworthy is tax administration, i.e., plugging tax leakages and raising the stakes of corruption and nondeclaration of income. Over time, the BIR, during Commissioner Willie Parayno and the DoF Revenue Operations Group under Undersecretary Noel Bonoan have been altering the risk-reward equation for both taxpayers and collectors through high profile filing of tax evasion cases and lifestyle checks. Tactics include appealing to famous personalities' patriotism (e.g., published letter to boxer Manny Pacquiao to pay taxes after his most recent international fight), which has the effect of impressing upon the public that it is vigilant in collecting what is due the government.
Systems-driven reforms have also enabled the BIR to exploit information available within itself, such as matching seller's VAT payments to buyer's VAT claims, and run after those that have underpaid or not paid at all. The plan, I gather, is to be able to fully take advantage of information within government, through plain old coordination with data-rich agencies such as Bureau of Customs, Securities and Exchange Commission, Land Transportation Office, Philippine Deposit Insurance Corp., Mines and Geo-Sciences Bureau and to the extent allowed by law, the Bangko Sentral ng Pilipinas. (In the latter case, it may be worthwhile to revisit the bank secrecy law for tax and bank regulation as well as for anti-money laundering purposes.)
Reforms in tax administration are already bearing fruit as seen in growing tax receipts (BIR collections increased 10% last year compared with less than 8% in 2003 and only 1.5% in 2002). In contrast, the pace of reforms on the expenditure side has been slower. One important development is the Procurement Act passed in 2003 intended to increase transparency and achieve budgetary savings. However, implementation suffers from birth pains so it may take a while to reap the full benefits.
Civil service reform is another area. The bureaucracy, with over 1.5 million employees taking up almost a third of the budget is generally perceived to be bloated. Overlapping functions result following each administration's wont to create new divisions and ad hoc bodies for special tasks. Overstaffing is likewise evident especially at lower levels of the bureaucracy. On the other hand, there is also the problem of inability to attract and retain high-quality personnel based on subsistence pay. Political appointments (down to the director level) have not helped as these have led to high turnover in senior positions and weakened institutional memories. Thus, the civil service is characterized by pockets of efficiencies (where good people opt to toil) but on the whole, perceived as inefficient and unmotivated.
Unfortunately, attempts in the past to pass legislation aimed at "reengineering" the bureaucracy have not been successful given its unpopularity political-wise. Unfortunately also, the present administration was not able to take advantage of that rare window of opportunity following last year's elections to undertake civil service reform. Instead, the strategy has been to implement a voluntary retirement program to trim the number of employees and cut down on personnel costs. However, based on similar past programs, the impact may not be that significant and with adverse selection effects (only the talented who can find work in the private sector avail of the retirement program), government may end up worse off.
Another public expenditure reform area relates to government's contingent liabilities, i.e., off-budget guarantees extended by the national government either explicitly, e.g., to public corporations and build-operate-transfer projects or implicitly, e.g., banking system. These obligations can trigger fiscal crises, especially when realized liabilities proved large. Examples of past blowups include the restructuring of the old Central Bank in the early '90s, the recurring rehabilitation of PNB, and most recently, government's absorption of debts of the National Power Corp. (Napocor). With power firm's successful privatization, the risk of further debt assumption may be reduced.
One critical area where reform is urgently needed is the pension system, particularly SSS. The design of the system is such that government, through its guarantee, is effectively subsidizing all the members, rich and poor. This is because even for members who put in the highest monthly contributions, the estimated present value of the benefits they can expect to receive in the future is larger than all their contributions. The benefit-contribution ratio is even larger for those making the minimum contributions (multiple of 7 times). With this structure having persisted through the decades, the implicit public debt associated with the SSS pension obligations alone was estimated at almost P1.5 trillion in 1999 or approximately 50% of GDP. This is much, much larger than any of the past assumed obligations (e.g., Napocor is P200 billion) and does not count yet obligations of the GSIS (for government employees) and RSBS (for the military - already requiring annual budget appropriations in excess of P10 billion annually for several years now).
While the pension debt is for all intents and purposes real (just a timing issue especially if government opts for band-aid solutions such as the 1% increase in contribution rate early last year) and requires that government takes action immediately, there are other contingent liabilities with largely unknown risks. The problem is that no one really knows when and in what area the next crisis will happen (or likely magnitude), especially without a good monitoring system - yet another area where reforms are needed to help government better appreciate and manage the risks it is exposed to.
There are other fiscal reforms that government needs to pursue, especially on the expenditure side. It needs to devolve more functions to local governments to match higher internal revenue allotments. In the case of public corporations, it needs an honest-to-goodness appraisal of which are vital to national interests and which are better sold to the private sector.
Fiscal reform cannot stop with the VAT (now itself "stopped" we hope temporarily), difficult though this may be in the middle of a political tsunami.
