Yes, new taxes!

In 2009-2010, one of then Senator Benigno S. C. Aquino III’s campaign promises was “no new taxes” -- a promise his administration kept only technically. And thankfully so, as “new taxes” were needed in 2010, and as I will discuss at the end of this column, will be needed in 2016-2017, as part of a comprehensive fiscal reform program for our country to scale up to our peers.

 I said “technically” because of the sin tax increase/reform done in 2012 which was presented as a tweaking of an existing tax, and not a “new tax” despite its big impact on -- and for -- the taxpaying public. It was a long delayed adjustment to make up for decades of erosion in the real value of the tax, but at the same time there was an increase in the effective tax rates, as well reform in the structure by unifying rates and incorporating an annual 4% increase.

By packaging it as a health measure aimed especially at discouraging the young from smoking and earmarking the incremental revenues to fund universal access to health care, its prime movers -- the Department of Finance (DoF), Department of Budget and Management, Department of Health, supported by the World Bank, World Health Organization, the International Monetary Fund, and other development partners -- were able to form a broad coalition of public support for it. This included constituencies for better economic governance and for public health. The Action for Economic Reform was at the forefront of this mobilization. Business organizations like the Makati Business Club, and our Foundation for Economic Freedom (which has five former Finance Secretaries in its rolls) were proudly also part of it. On the public health side were Health Justice, New Vois Association Phils., Philippine Cancer Society, Philippine College of Physicians, etc.

With all of these advocates, and the leadership of the President, the Finance Secretary, the Senate President, the Speaker of the House and the Committee Chairs, it passed but only after exciting deliberations and drama.

It quickly yielded dividends, total alcohol and tobacco excise tax collections upped by 85% in 2013 and a further 14% in 2014. This increase contributed P101.4 billion or 1% of GDP in the first two years. The tax to GDP was only 12.1% at the time the Aquino administration took over in 2010; in 2014, it stood at 13.6%.

The improvements in collection are explained not just by the higher effective tax rates, but by improvements in plugging tax evasion. At the time the law was being deliberated, likely increase in evasion and smuggling was the strongest argument of those opposing it.

The critical administrative reform here is the introduction of security stamp taxes, a feature that is required under the Tax Reform Law passed in 1997 during the Ramos administration, but which the tobacco lobby has been able to obstruct for 15 years of the succeeding administrations. That is, until Bureau of Internal Revenue Commissioner Kim J. Henares came along.

In a transparent competitive bidding in 2013, the BIR and its partner in this project, the APO printing office, selected a provider of a highly secure stamp tax system -- IRSIS, a consortium of Israeli and Philippine companies.

Two years later, 95% of cigarettes sold nationally bear security stamps. Enforcement is aided by an innovative monitoring project conceived by the Department of Finance, and sponsored by the World Bank. A couple of hundred part time data collectors with smart phones scour the country doing “whale sighting” everywhere cigarettes are sold. The whale is the icon chosen by the BIR for the stamps -- I thought most apt for the proverbial big fish BIR has been trying to snare since I was in the DoF in the 90s. (Ok, the whale is not a fish.)

The granular data collected for these whale sightings can be seen in the DoF Web site (dof.gov.ph) showing percent compliance by brand and by locality. Clearly, a powerful aid in monitoring tax compliance, instilling deterrence and for penal enforcement.

Commissioner Henares has announced security stamp taxes will forthwith be required also for alcohol products. A similar marking system is being contemplated for oil products by Bureau of Customs Commissioner Alberto D. Lina.

This tax policy and administrative reform program has been widely applauded. The Philippines’ credit rating was boosted by three notches, contributing to lower cost of borrowing of both government and the private sector, creating additional headroom for social and infrastructure spending.

Lower interest rates have also fueled private investments especially in housing, bringing direct benefits to our people. Health benefits were likewise palpable as smoking prevalence dropped from 29% in 2012 to 26% in 2014 in the general population, most strikingly among the young from 35% to 18%.

The sin tax reform program and its fruits have been impressive, but clearly not sufficient. Why?

1) Our infrastructure spending in the last 7 years has ranged from a low 1.4% of GDP to a high 2.1% according to the Philippine Institute for Development studies -- half of the 5% average in our neighbors. And we are paying the price for it -- in terms of gridlocks in roads, airports, seaports, lack of mass transport, no piped water outside Metro Manila, inadequate sewage systems, etc. The next administration will need to ramp up infrastructure spending to at least the same level of 5% of GDP -- preferably higher as one presidential candidate aims for.

2) Our latest tax to GDP (in 2014) at 13.%, is only 1.5 percentage points higher than at the start of this administration, below our peers. And far from the 15.3% record achieved in 1996 during the Ramos administration. Despite the heroic efforts of Commissioner Henares, there are limits in yield from tax administration reform, review of tax regulation and their reinterpretations. This has been the experience as well in other countries.

3) Additional spending commitment done by Congress for the next three years -- most notably increase in salaries, will add 0.5% of GDP every year for the next three years to the budget. The fiscal deficit though manageable at around 2%of GDP over the past five years, will be under pressure as a result of these advanced budget claims. Also from likely higher interest rates in both domestic and international markets. While our public debt to GDP of around 50% is comfortable, sharp increases in deficits will risk our newly minted investment grade rating.

4) The country has become tax uncompetitive. The corporate tax rate in the Philippines at 30% is much higher than countries in ASEAN which range from 17% for Singapore to 25% for Indonesia and Malaysia. Moreover, individual income taxes, especially on the low income levels have become inequitable as inflation pushed them up into brackets that were intended for the rich. Needed lowering in both corporate and personal income tax rates will require compensatory revenue measures elsewhere.

5) More fundamentally, our tax system needs drastic reform. Too complex, too many exemptions with debatable benefits, too narrow a base, too cumbersome and costly to comply with, and too prone to corruption despite well meaning efforts of its leadership.

A future column will float directions for a tax reform program, to include a variable tax on oil and other fuels, rationalization, perhaps a guillotine, on tax incentives and exemptions, including those in favor of senior citizens like me -- a perverse regressive subsidy paid for by the more numerous young poor. There are many other such exemptions and redundant incentives favoring groups and sectors that need to go.

Romeo L. Bernardo was Finance Undersecretary during the Cory Aquino and Ramos administrations and board director of Institute for Development and Econometric Analysis Inc. (IDEA)

http://www.bworldonline.com/content.php?section=Opinion&title=yes-new-taxes&id=122380

Managing political risks of infrastructure projects

Posted on January 03, 2016 07:55:00 PM

Credit information and rating pioneer and friend, Santiago “Santi” F. Dumlao, Jr., secretary-general of the Association of Credit Rating Agencies in Asia (ACRAA), invited me to speak on political risk management for infrastructure public-private partnership (PPP) at an ACRAA seminar late last year. Allow me to share excerpts from my talk:

“My own experience on the subject starts in the nineties as Undersecretary in the Deparment of Finance, then later as an occasional adviser on policy for the Asian Development Bank (ADB), the Japan International Cooperation Agency (JICA), and a few PPP projects on the transactions end.

“First, let’s identify the various risk factors.

“Nine are project specific: cancellation and change of scope risk; environmental and other permit risk; community risk; expropriation risk (both sudden and creeping); breach of contract risk; asset-specific regulation risk; concession duration/renewal risk; asset transfer risk; and decommissioning risk. Then there are five that affect the entire sector or economy -- change of industry regulation, taxation risk, currency transfer risk, judicial risk, and corruption/market distortion risks. A whole lot of these risks can only be managed through a concerted and realistic commitment from the public and the private stakeholders since both have a clear interest in the success of the PPP.

“On the mitigation side the private sector must consider several measures: first, an appropriate use of protective financial instruments (one on risk guarantees and political risk insurance and another on tradeable instruments and ownership structure). But there are also three others which are very much interrelated and most important to prevent problems -- effective interaction with the public sector, inclusive community engagement, and responsible business conduct.

The second component of a PPP’s success is about what the public sector needs to do. We are all familiar with these, and are aware of limitations in emerging economies in government’s ability to deliver on these: robust infrastructure regulation and contracts, general stability of laws and regulation, reliable and efficient administration, reliable dispute resolution mechanisms, international commitments such as international investment agreements and transnational programs like the Trans-Pacific Partnership.

“These undertakings should result in joint public-private measures. The key room here is the management of risk perception and return expectation. And the elements that go into these include rigorous project preparation, the creation of a dedicated marketing team, a proper sounding out of the market, and proper preparation of tender.

“In the Philippines, the involvement of development partners like ADB, JICA, Australian Aid, et al., which support the PPP Center and line agencies via the hiring of international consultants, including transactions advisers, have been critical.

“Some issues on managing the risks in infrastructure are:

“The party that can best carry the risk should bear it since it is a cardinal precept in risk allocation/structuring of a PPP.

“However, the principle is simple to appreciate but not so easy to implement.

“In the case of the Philippines, in a recent example of mass transport, insistence by government that private sector carries the risk associated with the possibility of increased taxation by local governments led to long delays and failures in bidding before the lesson was learned. Similarly, the regulatory and/or licensing functions should be under the control of the one agency contractually responsible to avoid the problems that have affected the mining sector.

“At an earlier period (early ’90s), the sovereign has had to take demand risks for power via a take or pay contract.

“And this was an important to-do in a situation where there was no capital market, unclear regulatory structure, and limited experience in Build-Operate-Transfer. It did what had to be done -- address a power crisis. Power was restored in good time, and the administration and the country regained confidence of the people and investors.

“However, the story does not end there, the improvements in the credit situation of the country and the excess in power reserves as a result of reduced demand with the onset of the Asian Financial Crisis, became catalysts for the succeeding administration to revisit contracts and to pressure the private proponents to renegotiate.

“The contracts were only mildly renegotiated by reducing the current charges in exchange for lengthening the concession/project life.

“I think it helped maintain the sanctity of contracts such that the International Finance Corp. (IFC) was an equity investor and the Japan Export-Import Bank, a creditor in a number of them. So this particular risk mitigation seemed to have worked in this instance.

“Much more recently, under the Metropolitan Waterworks and Sewerage System (MWSS) concessions, hailed as the biggest water privatization in the world in 1997, the government-contracting party suddenly and unilaterally disallowed certain cost-recovery components provided for in the concession agreement operating for 17 years. The matter has been under international arbitration. IFC was also a small-equity investor here as with two Japanese companies, Mitsubishi (with Manila Water Co., Inc.) and Marubeni (with Maynilad Water Services, Inc.), but these investments, and its international implications, did not appear to have been given importance by the current administration.

“A further example of idiosyncratic reinterpretation of contract and Philippine laws after more than a decade of successful operations involves a dispute between Shell-Oxy regarding the Malampaya natural gas project -- again over a tax-related issue. In this instance, the Philippines’ Department of Energy is on the side of Shell but it is not being allowed by the Commission on Audit to comply with its contractual obligations.

“A similar case for toll roads operated by Metro Pacific Investments Corp. where a simple straightforward automatic toll adjustments per parametric formula under the concession agreements have been disregarded over the past three years by the current Toll Regulatory Board.

“Just like the MWSS concessions, these two are headed for international arbitration in Singapore. Such provisions for international arbitration have been an important part of risk mitigation. It would be most desirable for the credibility of a country, especially its PPP program that arbitral awards are complied with promptly. However, as we have seen in the MWSS case this has not been so.

“As the Philippines moves from projects with attractive real estate plays and/or with an existing cash flow as in the case of a toll road extension or a mass transport operation, into those that require availability payments like prisons, hospitals, schools, the issue of reliability of government payments come into greater play, especially for a country where the budget appropriation is an annual process, without multi-year obligations.

“The credibility, and hence the success, of a PPP program hinges on government’s track record in complying with their contractual undertakings. A perception of uncertainty in that respect constitutes the essence of political risk. It is therefore to a substantial extent within the control of the authorities to make sure that such risks do not materialize. However, in an imperfect world, both the public- and the private-contracting parties should recognize pragmatically the merits of ‘just-in-case’ protective measures.

“There are a wide range of insurance products that are available to cover country and political risks.

“Private commercial insurers would offer great flexibility and speed, albeit at rates reflecting market perceptions of the specific country risk, which may be overly pessimistic. Bilateral risk coverage programs are available in many countries (but seldom in emerging market countries) in support of their nationals. Rates may be to some extent subsidized but coverage is often conditioned by national commercial or political priorities.

“The Multilateral Investment Guarantee Agency (MIGA), where I have been involved in the negotiations of the Charter in the ’80s, is the major international agency operating in this field and has rather unique characteristics. Being a member of the World Bank Group, its coverage is available to nationals of all member countries, with the only exception of local investors in their own country. Rates and coverage products are in line with the market, but its distinctive feature is the cooperative relationship with the host member country, which defuses the political dimension (often confrontational) inherent in bilateral insurance programs, and has been very effective in anticipating and preventing problems. In the case of disputes taken to arbitration, MIGA would cover the non payment of arbitral awards arising from not honoring contract obligations with immediacy.”

Romeo Bernardo was Finance Undersecretary in the administrations of Corazon C. Aquino and Fidel V. Ramos. He is also a Board Director in the Institute for Development and Econometric Analysis.

romeo.lopez.bernardo@gmail.com