A tale of two taxes, two presidents

Business World
Introspective

President Aquino's leadership and resolve is at a test as he and his congressional allies are lobbied, bombarded and Noynoyed by divergent interest groups on two very live tax policy issues: a) the rollback of the VAT on oil products, and b) reform of excise taxes on cigarette and tobacco (sin taxes). Having just co-authored a case study on the political economy of the reformed VAT for the ADB, I think there are lessons in the field of tax policy reform that can be learned by the President from his predecessor and former teacher, including what not to do.

THE EXPANDED VAT - IT TOOK PRESIDENTIAL BACKING
The reform of the VAT in 2005 has been credited with reversing the alarming deterioration in fiscal numbers during the first part of the Arroyo administration and made the economy more resilient to the global financial crisis of 2008/2009. It also introduced structural reforms to the VAT system, making it more robust, broader and fairer, while plugging major leakages.

The process of getting the legislation through was not an easy one - it involved not only players in both houses of Congress and civil servants but academic institutions, development partners, business groups and civil society pushing for it, on the realization that this was the essential medicine needed at that time to forestall a fiscal crisis.

Ultimately, what made it happen though was full support of President Arroyo. After initial reluctance, she pulled all stops to get her congress and senate allies behind it. While there was a later knee-jerk attempt to back-track, after the hello Garci episode weakened her politically, the dire consequences of such flip-flopping on our the country's credit rating - and perhaps more viscerally, her own credibility - returned policy making to sobriety.

SPECIAL VAT TREATMENT FOR OIL PRODUCTS?
Fast forward to present: This 2005 VAT reform law with the desirable feature of having a broad base that was passed with great difficulty is under attack by transport groups, mass organizations, media columnists, and a few academics clamoring for special treatment of oil products. The reasons why it would be wrong to cave in were excellently argued in this space by my fellow IDEA director and Introspective columnist, UP Professor Noel de Dios (The right thing is doing nothing, March 18 ).

The crux of it is that there are no good reasons to tinker with the VAT rate for a product like oil. Moreover, similar policy, like the preferential, i.e. lower excise tax on diesel compared to gasoline, has led to wasteful distortions in consumption and production.

The recommendation of former UP professor and Planning secretary, now Monetary board member, Philip Medalla is not to tinker with the VAT system, but for the government to give rebates to jeepney operators/drivers. This is both more effective and more equitable in that it does not give tax cuts to car owners, a privileged minority in our society. Under Energy Secretary Rene Almendras' watch, this is exactly what the administration is doing.

(Lesson 1 for the current administration: Stay the course. Don't undo a good thing.)
As to how to respond to anNoynoyers? I second Prof de Dios's recommendation - Ignoy them!
SIN TAX REFORM, IT'S TIME!
There were serious shortcomings in the law amending tobacco and alcohol excise taxes passed in 1997, as a result of successful lobbying by dominant tobacco and alcohol manufactures. These flaws included - no automatic indexation mechanisms (the tax is eroded by inflation); and heavy discrimination in favor of existing dominant players.
As a consequence, the government's take from sin taxes dropped progressively over a decade, contributing importantly to its deteriorating fiscal position.

This, even as the Philippines with among the cheapest cigarettes and alcohol products tops the list of countries with high incidence of the young taking up smoking and drinking, with its attendant high social costs.

Efforts at remedial legislation to correct these flaws yielded only watered-down versions of the DoF proposals being passed. Though this can be traced again to the enormous lobbying power of the dominant players, at the heart of it, what doomed reform was lukewarm support of President Arroyo for this, a sharp contrast to her vigorous sponsorship of the VAT reform law.

(In truth, sin tax reform where potential adverse impact is concentrated on a few big players who have been experts in the game of influencing legislators has turned out to be more politically difficult than the VAT reform where the tax incidence is broadly shared by the general public.)

Fast forward to today: There is a new sin tax reform bill being deliberated in Congress that has garnered tremendous support from civil society, business groups, including former secretaries and undersecretaries of Finance and Health across administrations. The bill brings compelling benefits - it will raise revenues of about P60 billon, the bulk of which will be for universal health care, a key pillar in the government's inclusive growth agenda.

The P-Noy administration has a critical window before the next election to pass this long-delayed reform legislation and mark a game chance in being able to overcome entrenched interests that have captured Congress in the past.

(Lesson 2 from the VAT experience in 2005 - The President needs to pull all stops to get this bill passed.)
The passage of such a law may well be the acid test for credit rating agencies and investors on government's seriousness and ability to deliver on its governance and economic reform agenda. It addresses concerns over the sustainability of government's long-term fiscal position and financeability of its social and infra spending program.

An upgrade to investment grade level, where all our original ASEAN neighbors are, can unlock a virtuous circle of investments, job creation, and confidence, including for bolder reform, that can finally bring us to a higher growth path. Tuwid at maunlad na daan!

Romeo Bernardo is a board member of The Institute for Development and Econometric Analysis. He was undersecretary of Finance during the Aquino 1 and Ramos administrations.