Introspective
In an earlier column, Fiscal imperative for the next administration (Oct. 5, 2009), I wrote on why there is compelling need for the next administration to plug leakages in tax collection and push for tax policy reform early in its term. The imperative is driven by structural erosion in revenues from non-indexation of excise taxes to inflation over the past decade, from legislated tax breaks more recently, and from newly legislated salary and pension adjustments over the next three years. Behind it also is a desperate need for spending on catch-up infrastructure and social services which had been held back by weak revenues in the past.
Presentations at the forum showed how miserably we underperformed in key social indicators such as health and education compared to our peers - Indonesia, Malaysia, Thailand, and Vietnam - with our rankings dropping steadily over time and consistently landing near or at the bottom. This comes as no surprise since government has been consistently underspending compared to these countries especially in the last decade. This is true as well for capital outlays where our annual spending is a mere 3% of GDP compared to an average of twice that for these countries. Quite obviously, our expenditure trends largely follow declining revenues.
President-elect Noynoy Aquino has said that before he would support tax increases, his government would first try to fix the leaky tax bucket. His finance secretary designate and prospective heads of the internal revenue and customs bureaus as reported by the media are well-known and highly regarded professionals with strong track records and hence well placed to do just that. But can reforms in the tax system wait?
Finance Undersecretary Gil Beltran makes a good case for doing it sooner rather than later. He said tax breaks given by the last Congress already exceeds P100 billion in total, or about 1.2% of GDP. Add to this the legislated increases in wages and pensions set to take effect over the next three years estimated at P125 billion, or 1.6% of GDP. These two elements alone equal roughly 3% of GDP. The projected national government deficit for 2010, which is deemed unsustainable by many, is already at 3.6% of GDP.
How much can administrative reform under the best tax authorities with the full backing of a determined President who has strong public mandate for governance reform yield over the short term? Undersecretary Beltran said that improved tax administration yielded the equivalent of just 0.6% of GDP during the administration of President Cory Aquino and only 0.5% during the term of President Fidel Ramos. Judging from international experience validated by former heads of internal revenue agencies of Chile and Guatemala who gave presentations at the forum, an improvement in revenue collection equivalent to 1% of GDP over a one-year period would already be a feat.
I am prepared to grant that incoming fiscal authorities can set such a record on this. In part because of my knowledge of and regard for the named collectors and in part because of well-known low-lying fruit, including wholesale oil smuggling euphemistically referred to by the IMF in a 2008 report as undervaluation of imports due to election-related lenience (which GlobalSource estimated at around P20 billion in 2007).
But where will the additional revenues needed come from? Policy analysts, including this one, have pushed for two measures:
a) Adjustment in excise taxes whose value has been eroded over time to the tune of 1.8% of GDP.
b) Rationalization of redundant fiscal incentives costing the government 1% of GDP annually.
Bulk of the erosion in value on excise taxes has been on petroleum, rather than on tobacco and alcohol, so most of the revenue yield can be obtained from this. As many studies have shown, including most recently by the World Bank (World Bank Philippines Quarterly Update: Laying Out the Exit Strategies), oil taxes are progressive, i.e., the rich pay proportionately more, while our oil taxes are among the lowest in the world even compared to our peers. There are in addition social costs to burning fuel particularly for the environment that are not reflected in price. The case for upward adjustments in tobacco and alcohol, on the other hand, rests more on health reasons than revenue generation, as demand for these products is elastic and may not necessarily lead to a substantial increase in government tax take.
The scholarly case for rationalizing incentives, especially scrapping the redundant ones, has already been laid out well in a study by Philip Medalla and Renato Reside of the UP School of Economics. They argue not only on revenue grounds but also for levelling the playing field. This almost passed in Congress under the lead of Senator Ralph Recto. Resuscitating it should not be too difficult.
One can easily take the position that these reforms can wait until government plugs tax leakages. But such a stance means lost time in raising tax effort to a level at par with similarly-rated peers, spurring development, and bringing the country to a higher growth path. It makes the country more vulnerable to financial market sentiment that is becoming less forgiving of growing fiscal deficits and debt ratios (as seen in the case of Greece and other crisis countries in the euro zone) especially as the world exits recession and begins to reverse from a fiscal stimulus mode. Moreover, it potentially wastes the good political capital of a new administration blessed with a strong popular mandate. Based on past experience, such political potency erodes through the years if not just months.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc., managing director of Lazaro Bernardo Tiu & Associates, Inc., and a GlobalSource partners advisor. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
