TRAIN, inflation, and competitiveness

Business World Introspective
By Romeo Bernardo
March 11, 2018


The government’s Tax Reform for Acceleration and Inclusion (TRAIN) began to make an impact on inflation this January and February, with a spike of 3.9% under the revised series. In line with international practice, the consumer price index (CPI) series is rebased periodically by the Philippine Statistics Authority to ensure that the prices in the basket of goods being measured stay relevant and representative.

Though this was not unexpected, Finance Undersecretary Karl Chua explained that other factors were the bigger contributors to inflation than TRAIN. These include higher corn, fish, tobacco, and personal transport prices, all of which grew double digits. Interestingly, the spike in tobacco prices are driven by the success of the government in compelling Mighty,now under Japan Tobacco, Inc. (JTI), to pay the right taxes. The larger part of the increase in oil prices are due to the increase in global crude prices and the peso depreciation.

Allow me to excerpt from a statement presented by the Foundation for Economic Freedom (FEF) at a Senate Hearing in February that puts this price hike in perspective.

“FEF believes that TRAIN has safeguards in place to mitigate any inflationary effects which as estimated by the Department of Finance to result to 0.7 percentage point increase in inflation for 2018 with food prices rising by .03 percentage points and transportation by 0.1 percentage points.
These include:

1. Built-in cash transfer programs in TRAIN which have to be implemented effectively by the Government to benefit the poor;

2. The TRAIN has provisions for reaching informal sectors which currently do not pay income taxes. This broadens the tax base which helps reduce the fiscal deficit and inflationary pressures. Many in the informal sector are not poor, but are exempted by self-election from any income taxation. It is only fair that they pay their share of taxes;

3. It is not accurate to look at TRAIN’s impact solely from the tax side without reference to expected increase in public expenditures for education and health, which are very progressive; and

4. The higher infrastructure spending will likewise have a positive impact on the country’s medium to long term growth path and will lift the poor out of poverty.

Further, over the past long years of significant economic reforms which achieved fiscal consolidation, the restructuring of the central bank, and the creation of an independent central monetary authority, foreign exchange liberalization, and flexible exchange rates, the Philippines today benefits from a monetary policy framework that gives monetary authorities effective tools to pursue inflation targeting to ensure that inflation and inflation expectations are properly anchored.

The Bangko Sentral ng Pilipinas (BSP) has the instruments to anticipate any possible build-up of inflationary pressures from TRAIN beyond what is warranted from current inter-industry structure of the economy.”

Speaking before the Management Association of the Philippines (MAP), BSP Governor Nestor A. Espenilla, Jr., reinforced this message. Correcting the misimpression of some market players that the reduction in the reserve requirements represented an untimely easing in monetary policy, he stressed that the BSP is just executing an operational adjustment, part of phased reduction in our ultra-high reserve requirements with ensuing liquidity to be replaced by open market operations, with neutral effect on monetary policy.

Moreover, he reassured that the inflation impact of TRAIN is expected to be transitory, and that government has enough tools to properly anchor inflationary expectations. I made the observation as the forum moderator that liberalization of the rice trade can do much to lower rice prices, and lessen price volatility induced by government’s monopoly, an advocacy of the FEF. He said that the BSP strongly supports this reform effort.

Moving now to TRAIN 2, allow me to excerpt from a forthcoming letter to the Secretary of Finance from the leadership of MAP.

“The Management Association of the Philippines (MAP) respectfully submits this expression of support for the government’s TRAIN 2 program.

“We agree with the Department of Finance that TRAIN 2, as a package, will help the country become more competitive with the rest of the world by lowering the corporate income taxes from the current 30%, the highest among our ASEAN peers.

“We agree with the need to rationalize and modernize the tax incentive system to make incentives time-bound, performance based, and not excessively complex with far too many different, even overlapping laws, rules, and regulations.

“It is necessary to widen the tax base and enforce better compliance. The relaxation of our bank secrecy laws, coupled with proper safeguards against abuse, is an essential tool in doing that. It will also encourage more to avail of a general tax amnesty, which we support.

“We think that lowering the optional standard deduction (OSD) of 40% to 20% will only make taxpayers revert to the itemized deduction and to avoid paying correct taxes. The 40% should be retained.

“We believe it is important to commit to a definite timeline for the reduction of income tax rates to have predictability that can help decision making on investments and business plans. But we suggest starting in 2019 rather than 2020. Our ASEAN neighbors are contemplating even further reductions in their income tax rates — making this an important step. And, raising the need to go beyond 25% to 20%, even 15% as soon as it can be afforded.”

Romeo L. Bernardo is a Fellow of the Foundation for Economic Freedom and a Governor of the Management Association of the Philippines. He was Finance Undersecretary during the Corazon Aquino and Fidel Ramos administrations.