Yes, New Taxes 3: A reform program for the new administration

Posted on May 22, 2016 07:54:00 PM

In two earlier columns (“Yes, New Taxes”, 1 February 2016, and “Low Hanging Fruit”, 29 February 2016), I pushed for comprehensive tax reform to make the system fairer, yield more for infrastructure financing, and, at the same time, simplify for ease in compliance and administration, thereby making it less prone to corruption.

We offered some ideas for this both 1) administrative -- like use of technology for security marking, including on oil products, and 2) tax policy, such as a variable excise on oil products, tariffying quantitative restrictions (QRs) on rice with a 30% excise, and a rationalization of redundant incentives and unjustified exemptions.

Earlier this month, the Department of Finance unveiled a work in progress Comprehensive Tax Reform Package. Its elements (and the revenue impact for the first year) are as follows:

1) Lower income tax rate to 25% for individuals and corporations (minus P158 billion to P222 billion);

2) P1 million all-in income tax exemption for wage earners;

3) Fiscal incentives rationalization (P5 billion);

4) Excise tax increase on gas, diesel, and other oil (P132 bilion);

5) Expand VAT base (P80 billion);

6) Increase VAT rate from 12% to 14% (P82 billion); and

7) Tax administration reforms

-Make tax evasion a predicate crime to money laundering

-Repeal Bank Secrecy for BIR

-Remove BIR and BoC from salary standardization and civil service protection

-Allow BIR and BoC to retain 1% of their revenues as their budget for modernization and to fund personnel enhancement measures.

Some quick comments on the tax reform package.

First, it seems aligned with earlier reform proposals from within the DoF and by outside experts. My only regret is that this is being proposed at the tail end of this administration. Tax reform is best pursued early while an administration has abundant political capital, and so that it reaps fiscal dividends early. Nonetheless, it is commendable that Sec. Purisima and his team of mostly career professionals have taken the initiative to help the new administration get off on the right foot.

The personal income tax gives in the plan look fairly aggressive, though almost fully offset by the higher rate and expanded VAT. What will likely be said by critics is that VAT is not a progressive tax; and that we already have the highest VAT rate in the ASEAN region.

Reductions in the corporate income tax side are called for. It makes us more aligned with the corporate income tax rates in the region.

On the other hand, it is disappointing to see the estimated gains from rationalizing tax incentives at only P5 billion. I was hoping for more bite from this reform measure, not only for revenue grounds, but also because it would suggest needed guillotine of incentives and exemptions, and a more level playing field.

The proposed additional tax on oil and diesel was computed at P10 for gasoline and P6 for diesel, and of the rates to be indexed to inflation at 4% per year. I think more can be squeezed from this tax source. Not just via higher rates, but as observed in my second column (“Low Hanging Fruits”) by adoption of technology to flush out smuggling, now estimated at minimum of 20% of imports. President Duterte is well placed to demonstrate the people’s wrath versus smugglers, who have vexed us for decades.

Nothing was said in the DoF package about tariffication of rice QRs.

As observed in my earlier column, this will not only halve the price of rice and help address poverty and malnutrition, but can raise revenue amounting to P30 billion annually. Just as important, it will release wasted subsidies to NFA in the billions of pesos annually. This has accumulated to around P150 billion in unpayable national government guaranteed debt.

The World Bank estimates that for every P5 of spending for NFA, P4 are wasted leakages that provide no public benefit. (Please see recent statement of the Foundation for Economic Freedom on this “Let change come to the present rice policy: Liberalize ride importation” in fef.org.ph )

The tax administration elements in the program pose high risks. Both in getting these highly sensitive legislation passed, and in actual implementation.

It will take very skillful navigation by new administration to get support by legislators on a law that will repeal the bank secrecy for BIR. Same with a bill to make tax evasion a predicate crime to money laundering. The argument that the Philippines is only one of two countries (the other being Lebanon) in the world where tax evasion is not a predicate crime and only one of three (Lebanon plus Switzerland) that do not allow tax administrations access to bank deposits has not swayed Congress so far. I think we can all guess why.

Exemptions of BIR and BoC from salary standardization and civil service protection will also not be easy -- this is a reform that earlier administrations have tried to push without success. Often it is the employees of the bureaus who lobbied Congress against the lifting of civil service protection.

Choosing the right people to head these two agencies is critical -- with the requisite technical background and experience, but perhaps even more important, the temper and skills to introduce and manage radical reform. They should be fully trusted by, and accountable to the Finance Secretary. The President needs to give him the say on these appointments.

As I said earlier, these reform proposals are not new, but failed to pass or be implemented. We can only hope that under a President who is known for resolute action, we shall see greater demonstration of skill in pushing through the mill and of political will to summarily execute (wink!).

Romeo L. Bernardo is vice-chairman of the Foundation of Economic Freedom and a GlobalSource Partners advisor. He was formerly undersecretary of Finance during the Aquino1 and Ramos administrations.

romeo.lopez.bernardo@gmail.com

Political economy of reform, take 2

Posted on April 24, 2016 09:42:00 PM

(I stumbled across a column I wrote in this space [July 26, 2010]on lessons learned on the political economy of reform during President Ramos’s term, as documented in a World Bank Growth Commission working paper written with Christine Tang. Excerpts and my current thoughts as Nota Bene, are below.)

At a recent forum organized by the IMF-UP School of Economics-Philippine Economics Society, four speakers -- one IMF economist, two UP professors (Philip Medalla and Ben Diokno) and I -- were asked what we thought were needed to raise potential growth for the Philippines.

IMF Resident Representative Dennis Botman summarized these solutions quite well: a) raising the tax effort, b) increasing public investment, and c) reducing the cost of doing business by improving governance.

I would like to try to answer the corollary question, how to get it done politically, in a complex free-for-all democratic setting like the Philippines.

Some reflections based on the political economy of reform during the Ramos administration, a case study for the World Bank Growth Commission. (http://goo.gl/HovqWM)

We looked at what it took the Ramos administration to successfully push for reform in telecom demonopolization, water privatization, and oil deregulation working against strong special interests (including from affected businessmen, labor constituencies, political ideologues) and using instruments, both formal and informal, at the disposal of the presidency in an environment of weak, lethargic, or sometimes obstructive, and compromised institutions.

Even though the three reform case studies were on specific initiatives done during the Ramos administration, the basic reform agenda was a continuation or, if you will, a fuller articulation and execution of the framework of stabilize, privatize, and liberalize as a way to improve growth performance adopted during the time of President Cory Aquino (the Aquino 1 administration).

While the Aquino 1 government in 1986 had the advantage of having the Filipino people geared up for wide-scale political, economic and social reforms, with the President clothed with full legislative powers early in her term, it also had to contend with the task of rebuilding democracy.

(In comparison the), Ramos government, because of the President’s background, and an orderly succession that was the lasting legacy of the Aquino 1 administration, was not fettered by coup challenges, but rather the normal challenges that a presidency faces such as pushing for laws to a Congress where the President’s party was not the majority.

Below are lessons we took from the reform experience.

1 ARTICULATING A VISION.

The Ramos administration’s vision had been to pursue reforms that would create a Philippines 2000, a carefully crafted strategic vision that brought coherence to his government. Policies like ‘leveling the playing field’, dismantling monopolies, privatizing state assets and services, embracing liberalization and globalization, forging peace agreements with the Moro National Liberation Front (MNLF) and the rightists, etc., were adopted to make the country an Asian economic tiger, or at least a tiger cub.

2 SCORING EARLY SUCCESS

A new president has six years to make a difference and needs to score early wins to build confidence for future reform efforts.

During the Ramos administration, the immediate problem, and opportunity, was getting the economy on track after debilitating outages that saw the GDP contract by 0.6% -- to put the lights back on both literally and in terms of business confidence. This was achieved in a record of 15 months, thanks to Mr. Ramos’s no-nonsense leadership and empowerment of known achievers such as Energy Secretary Del Lazaro and National Power Corp. President Sonny Viray. Such a victory set the stage for reviving  investments and rallying public support behind other reforms to improve global competitiveness.

There is no one thing as dramatic as putting the lights back on this time around, but it is clear that this administration is aware of the importance of early wins:

My candidates for demonstration of resolve and early success are topped by the following:

a). Getting the wasting NAIA Terminal 3 operational for international air traffic. This structure otherwise stands as an almost decade-old national monument to folly, corruption and, for failing to find a solution on how to use it, stupidity.

(N. B. Six years hence, alas still a work in progress.)

b). More train cars in MRT-3 and fewer buses along EDSA to decongest traffic. The economics or even just common sense of additional cars with little incremental costs for a system that is already in place is so compelling. (N. B. Go figure. )

c). Taking steps to scrap the National Food Authority (NFA). The NFA lost P37 billion in 2008 and P63 billion in 2009. According to a World Bank study, it cost the NFA an estimated average of P5 to deliver P1 subsidy to the poor, reflecting the wastes, leakages, and governance deficit in its administration. (N. B. Not to mention cost of rice to our people -- twice to thrice that of our neighbors, contributing to poverty and malnutrition, wage uncompetitiveness, and lost jobs). Start by having leadership in Department of Agriculture and NFA that understand and can be committed to such a long overdue reform measure. (N. B. Go figure 2.)

3 POLITICAL WILL

Reform requires a lot of political will on the part of the leader.

For example, in the case of the telecom demonopolization, the situation in 1992 was perhaps best captured by a remark attributed to then PM Lee Kuan Yew -- The Philippines is a country where 98% of the residents are waiting for a telephone line, and the other 2% are waiting for a dial tone. An estimated 800,000 applicants, 75% of the country’s capital (Metro Manila), were then queuing for a telephone.

The PLDT, which owned the nationwide transmission backbone, was a virtual monopoly, controlling over 90% of the country’s telephone lines. Its controlling shareholder, the Cojuangco family, was politically well connected, its influence extending across the three branches of government as well as media.

Nevertheless, the Ramos administration proceeded to pry the sector open with various tactics. These ranged from encouraging the formation of consumer groups that took to the streets and clamoured for change, to boardroom battles where the President replaced government’s representatives in the PLDT board, to behind-the-scenes maneuvers to increase the concerned parties’ receptiveness to reform.

As a result, twin executive orders that the President issued within six months of each other in 1993 (i.e., within one year of his assumption of office) opened the floodgates to investment in the sector. This was followed by pushing legislation to insulate the reform from reversal. (N. B. Thus laying the foundations of our BPO industry, together with remittances, our fundamental growth driver. )

Similar demonstrations of political will were evident in the largest water privatization at that time, which required raising water rates prior to selling and reducing the Metropolitan Waterworks and Sewerage System (MWSS) work force, and in pursuing oil deregulation despite ideological opposition and a nullification of the first law by the Supreme Court.

In light of relative weaknesses of Philippine institutions, where the system of checks and balances put in place to stem abuses is often exploited by those opposing reform to block or at least delay it, carrying out the needed changes would have been very difficult if not impossible without the President’s vision and strength of conviction.

4 EFFECTIVE COMMUNICATION AND CONSTITUENCY BUILDING

This entailed establishing a Legislative-Executive Development Advisory Council (LEDAC) where the Executive met weekly with leaders of Congress, pacifying militant elements of society by granting amnesty to rebel soldiers, repealing the law that outlawed the Communist Party, and launching peace talks that led to the 1996 peace agreement with the MNLF.

This also included a penchant for summitry, which earlier annoyed me as a finance undersecretary since I sometimes found little by way of substantive output from them. That was my sentiment until I began to appreciate that the most important output at the end of the day was the process. It allowed stakeholders to participate in and understand what government had in mind and to buy into what government was trying to do.

5 THE REFORM PROCESS -- OPPORTUNISTIC TIMING, PRAGMATISM, JUDICIOUS HASTE, PERSISTENCE

Compared to the resolution of the power crisis, the three reforms discussed may be considered elective surgery, i.e., mending a non-crisis situation. Therefore, they demonstrate better the reform process in a democratic setting where the leader himself has to generate the impetus for reform through his vision and persuasion and to craft the approaches that are politically feasible. The case studies show that the Ramos administration had to address the problems in each area in ways that were possible given the timing, the window of opportunity, conditions prevailing, and other prospects available.

These considerations are perhaps useful in weighing the timing for pushing tax policy reforms needed for fiscal sustainability, immunizing the economy from global financial turbulence, and generating needed resources for social and infrastructure spending. (N. B. Up to now, this is a key governance issue, as discussed in my previous two columns -- “Yes, New Taxes!” 1 and 2)

I have argued that the best time to push for this is early in the administration -- while the government is at the height of its trust and popularity rating and some of the responsibility for needed, possibly unpopular, reform measures can still be rightly laid at the doorstep of its predecessor, and where the new administration can earn credibility dividend from the financial markets that translates into front-loaded savings. One can argue that such an opportunistic approach was observed with the Ramos reforms.

While I can appreciate the reluctance to pass laws on new taxes, I cannot see why some of these measures cannot be pushed as refinements and broadening of the tax base to make it fairer or even as plugging the loopholes. I would easily put in this category the rationalization of fiscal incentives which leads to an even playing field in business.

One can even push the argument further that a retroactive indexation of sin taxes, say, on liquor and tobacco, does not mean new taxes but simply a restoration of the real value of taxes eroded by inflation (even if these two items will not really yield much, tax adjustments are clearly called for on health grounds).

(N. B. Congratulations to the PNoy administration on getting this done two years ago!)

Sooner or later, government should also push for correcting the relative undertaxation of oil products, a more robust progressive source by far, either as a stand-alone or with proceeds earmarked for spending to ease public acceptance.

The best timing for pushing such an increase in oil taxes measures and other difficult measures coupled with a decrease in income taxes is a political call the leader and his economic managers and Congress team will need to make. Waiting too long to do tax policy reform and relying only on administrative measures, however, run the risk of having a fiscal crisis dictate non-elective surgery. Or if we are not too unlucky, muddling through several more years of unremarkable (and un-inclusive) economic performance.

Romeo L. Bernardo is board member of The Institute for Development and Econometric Analysis, Inc., and a GlobalSource partners advisor. He was formerly undersecretary of Finance during the Aquino 1 and Ramos administrations.       

PIDS: Bridging the gap between knowledge and power

Posted on March 27, 2016 09:19:00 PM

Outside of beauty contests and boxing, there are few lists where the Philippines takes top place. Thus, it is a source of particular pride for me to banner in this column that the Philippine Institute for Development Studies (PIDS) was recognized once again as the top social policy think tank in Asia and among the top 50 in this field globally. This high recognition was given by the University of Pennsylvania’s Think Tank and Civil Societies Program (TTCSP).

            

Commenting on this recognition, PIDS President Dr. Gilbert Llanto observed: “Despite having only a handful of researchers compared to other better endowed research institutes in the region and in the Philippines, PIDS has consistently made significant contributions and influence on Philippine development policy through its active and close collaboration with government agencies, academic and research institutions, and international organizations.”

Its current board includes Planning Secretary Emmanuel Esguerra as ex-officio Chair (succeeding now Competition Council Chairman Dr. Arsenio Balisacan), Dr. William Padolina, Atty. Rafael Perpetuo Lotilla, UP President Alfredo Pascual (incoming Trustee), and Dr. Llanto, who succeeded Dr. Josef Yap. PIDS was first recognized by TTCSP under Dr. Yap’s watch.

I congratulate President Llanto, his predecessors, and the PIDS Trustees, Fellows and staff over four decades of its distinguished life. Its establishment trace back to the vision of Dr. Gerardo Sicat, then Planning Secretary, who saw the need for a think tank to help government planners and policy makers in the executive and legislative branches of government address broad issues of development. While it is a state-funded think tank, PIDS’ fathers imbued it with some independence by giving it a corporate structure and some measure of fiscal autonomy. Moreover, under its charter, its Trustees are not appointed by the Philippine President but are self-electing with staggered terms.

PIDS Fellows are known experts in their fields, and include not just economists in different areas of specialization, but also sociologists, public health specialists, demographers, statisticians, lawyers, etc. who individually and collectively contribute to its rich body of independent evidence-based research, as well as respond to the need for quick policy briefs of officials.

In recent times, PIDS Fellows have appeared, and made their mark in various Senate and Congressional Committees that deliberated on the following: cabotage law, competition policy, taxation of incomes, sin taxes, CCT, SUC’s and scholarships, budget planning, customs and tariff modernization, a bill now awaiting the President’s signature.

It has a rich trove of literature, 1000 completed studies, on these and other areas built over the years, straddling a wide field -- macroeconomics, public finance, trade and industrial policies, health economics, foreign direct investment, housing finance, urban development, governance, agrarian reform, food security/rice policy, just rattling off items I have in the past researched on. (You can find more about PIDS and its research library in www.pids.gov.ph)

Under Dr. Llanto’s watch, it has done several impact evaluation studies on the effectiveness and impacts of key government programs and projects to ascertain whether they are achieving their intended objectives and to ensure that government resources are used wisely. It has likewise trained a large number of bureaucrats on the art and science of impact evaluation.

In the coming years, Gilbert is focusing on doing studies on easing the regulatory burden in various sectors. PIDS researchers are also looking at the supply chain of tuna, a major export industry, and other sectors in manufacturing to follow. In transport, they will be examining the regulatory burden in the land transport sector. This year’s annual public policy conference will focus on the need to build resilient systems -- economic resilience for example in the face of interconnected global risks and external shocks.

As I finish my two terms as a PIDS Trustee with pride and gratitude, I recall what James McGann said about think tanks. “Think tanks seek to bridge the gap between knowledge and power. The role of think tanks is to link the two roles, that of policy maker and academic, by conducting in depth analysis of certain issues and presenting the research in easy-to-read condensed form for policy makers to absorb.”

Globally recognized PIDS has achieved this and through its active live public policy engagements in conferences, Congress, media, even more.

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)

romeo.lopez.bernardo@gmail.com

Yes, New Taxes 2: Low Hanging Fruit

Posted on February 28, 2016 08:28:00 PM

In the first installment of this column (“Yes, New Taxes,” Feb. 1), we emphasized the need to raise revenues to cover catch-up infrastructure, to offset revenue gives for equity reasons in favor of low to middle-income salaried workers, and to align our corporate income tax regime with our peers to attract investments and create jobs. Moreover, we also need to provide for advance commitments of the administration that go beyond 2016, notably increases in government salaries over the next three years.

 

Where can all these come from? Let us do some math on how much this would cost.

For simplicity, expressing these in percent of Gross Domestic Product (GDP).

1. Additional spending for infrastructure to raise it to a minimum of 5% of GDP, same as our neighbors, from the present 2%-3%. Needed: additional 2%-3% of GDP or around P200 billion-P300 billion each year.

2. Adjustment in personal income tax exemptions to correct for “bracket creep,” the bloating of income due to inflation that does not reflect real purchasing power. Needed: 0.5% of GDP.

3. Reduction of corporate income taxes to 25% (same as Indonesia and Malaysia) from the current 30%, the highest in ASEAN. Needed: 0.6% of GDP

4. Salary increases under EO 201, Needed: 0.5% of GDP every year for the next three years. Or a total of 1.5% by 2018.

When this is totaled, the required amount ranges from P450 billion to P500 billion, or roughly around 5% of GDP every year. This does not even count other new expenditure claims like the modernization of the AFP and the indexed increases in the pensions of soldiers.

Early in its term, the next administration needs to think about its fiscal program so it can pursue its investment and expenditure program confidently and responsibly without courting macro instability and a credit downgrade. While there is headroom to increase debt due to historic low levels of debt to GDP, credit markets look at the medium term. Unless there is clarity that the medium term fiscal program is sustainable, interest rates will rise, crowding out government development spending and dampening private investment.

Secretary Cesar Purisima, recently deservedly recognized Best Finance Secretary for the sixth time, is cited as saying there is no need to impose new tax measures in order to boost collection -- “I think we need to continue to use technology to make sure that we improve the efficiency of tax collection.” (Phil Star, Feb. 26 -- “Incoming government does not need to impose new taxes” -- Purisima ).

Indeed, improving collection efficiency should be government’s first resort. At the same time, we call attention to the limits of administrative measures, as evidenced by experiences of many countries that this is at most around 0.5% of GDP per year.

In the last 5 years, despite heroic, some would say excruciatingly painful, efforts of the BIR, tax to GDP only rose from 12.1% in 2010 to estimated 13.8% in 2015. If one takes out the effect of the increase in effective tax rates on sin taxes (see Part 1 of column), the net effect of administrative measures over the entire five years is only 1% of GDP. Of course, the figure is a conservative estimate since there were other moving parts that brought down collection -- for example the drop in oil prices that reduced the base. But clearly, 1% is nowhere close to the 5% of GDP we calculated as needed over the medium term.

We do agree with Sec. Purisima that there are ample opportunities for using technology to improve collections. As discussed in Part 1, how BIR/DoF used security stamp taxes to ensure that smuggling and evasion do not rise with the higher sin taxes in cigarettes -- and coming soon in alcohol -- is a model case study on smart and resolute use of technology.

A logical extension on use of technology is plugging smuggling in oil products -- a problem that has vexed our country for decades.

It has been estimated by industry experts, investigative journalists, and a variety of government officials over the past few years that at least 20% of all diesel and gasoline sold at retail in the Philippines has been smuggled into the country -- which means that the government is unable to collect a large portion of the tax that should be paid on these fuels.

In a paper published in October 2015 by the Asian Development Bank, the bank encouraged governments to institute sophisticated fuel marking programs as a proven way to increase government revenues, improve fuel quality and combat criminal activity.

Fuel marking can be the parallel to the successful security stamp program the government instituted here last year.

A well-run fuel marking program puts a high-tech marker (in effect -- a tax stamp) in all legally imported and locally refined fuel before it is distributed. Just like with a cigarette tax stamp, when fuel is then tested throughout the country at retail and commercial sites, any fuel that is found not to have the proper fuel marker is illegal -- and thus subject to confiscation, and the illicit trader is subject to fines, closure and if necessary, criminal prosecution. Deterrence that fuel marking creates has been proven in many countries with similar problems.

Still in the area of oil taxes, the very sharp decline in oil prices provides an opportunity to capture some of it by imposing a variable tax that goes up when oil prices are low, and down when prices are high. This is can also correct for the erosion in the real value of the excise taxes on oil. Just like tobacco and alcohol products until two years ago, oil excise taxes are not indexed to inflation, and thus steadily dropped from 1.1% of GDP in 1997 to only 0.1% of GDP currently. (See graph)

At this time when our thoroughfares sometimes look like giant parking lots during rush hour, a good way to package this variable oil tax is as short-term response to reduce traffic, while at the same time addressing the traffic problem at the roots by earmarking collections for building and upgrading of mass transport and road systems.

The savings of the country from the global oil price drop is around $6 billion annually. If only a third of this is captured via a variable oil tax, we can have $2 billion incremental revenue collection -- around 1% of GDP, thus also restoring oil excise tax to GDP ratio to its 1997 level.

The next installment of this column will talk about other potential revenue sources, rationalizing fiscal incentives, reducing unnecessary exemptions, and tariffication of quantitative restrictions on rice.

The last measure, will not only bring down the cost of rice, historically twice to thrice our neighbors’, but can bring new revenues of P25 billion to P30 billion every year, and save government P4 billion from annual budget subsidy and stem further explosion in unpayable NFA debt (around P 150 billion) guaranteed by the Republic.



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)

romeo.lopez.bernardo@gmail.com

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

Sunday December 06, 2015 

Reduce regulatory burden!

Posted on December 06, 2015 08:50:00 PM

Foreign direct investments (FDI) into the Philippines were once again the lowest among the ASEAN-6 (Association of Southeast Asian Nations) in 2014, at 5% of total Asean-6 FDI flows, only half of the proportionate share of the Philippines to the entire ASEAN-6 economy. Our investments to gross domestic product ratio at 20% is also well below the 25%-35% range in the other ASEAN-6.

 This unhappy state of affairs of underinvestment by both domestic and foreign players persists despite unprecedented low international and domestic interest rates arising from high global liquidity and excess domestic savings from remittances and business process outsourcing. The investment response to surplus funds and improved credit rating has been relatively weak. What gives?

Analyst studies and global competitiveness surveys have pointed to three factors to explain this: (a) poor infrastructure, (b) unfriendly investment environment -- restrictions on foreign investments in the Constitution and certain laws and government policies, such as failed agrarian reform and rice policy, and (c) regulatory uncertainty and red tape. The first two have been well covered in earlier columns of my Introspective fellow columnists, Chikiamco, de Dios, and Fabella, and me. Allow me now to focus on the third. (See graphs)

Let me first cite some examples.

The 2016 Ease of Doing Business of the World Bank ranked us 103rd out of 189 countries; we are the second to the lowest among the ASEAN-6. To open a business, it takes 16 steps and 29 days. Best performing Singapore and Malaysia take 2.5 and 4 days, respectively. Even Vietnam, until recently a centrally-planned economy, is better at 20 days.

These surveys are based on what it takes to establish a small or medium enterprise. I don’t know whether we should take comfort that big companies suffer as long. I have seen a chart prepared by a major power industry player on the number of signatures it takes to get a power plant started, around 200. No wonder it takes twice as long to build a power plant here vs. elsewhere -- contributing to thin reserves and high cost power.

In the latest World Economic Forum Global Competitiveness report, 2015-2016, “inefficient government bureaucracy” climbed to the top spot as the most problematic factor for doing business in the country, from last year’s fourth place. Moreover, “complexity of tax regulations” ranked fourth, whereas elsewhere in the ASEAN it is not in the top 5 concerns.

I’m told that under Revenue Memorandum Circular 7-2014, tricycle operators, farmers, fishermen and sari-sari store owners are now required to issue Bureau of Internal Revenue-registered receipts and sales invoices without any “de minimis threshold.” The World Bank has earlier warned that “Certain tax policy regimes are both inefficient and detrimental to job creation. Enforcing the current weak tax design may yield more revenues but will have adverse impacts on jobs” (World Bank, “Philippine Economic Update,” 2014).

Then there are the big disputes arising from sudden idiosyncratic reinterpretation by regulatory bodies of contracts after more than a decade of being implemented and celebrated as successful examples of public-private partnerships. I refer to the two water concessions of the Metropolitan Waterworks and Sewerage System, the Shell-Oxy Malampaya project, and the Manila North Tollways Corp.; all are now or about to enter international arbitration initiated by the private parties against government for non-implementation of contracts in amounting to several tens of billions of pesos.

I cannot recall there being so many concurrent international arbitrations at one time.

How can Public-Private Partnership (PPP) projects for infrastructure, in the platforms of all of the Presidentiables, take off unless government can provide greater regulatory clarity and stability?

Recognizing the importance of effective and sound regulations, other countries have pursued government-wide action in improving regulatory quality. Countries belonging to the Organisation for Economic Co-operation and Development (OECD) have adopted an explicit “whole-of-government” approach to regulatory reform, which requires stakeholder engagement in extensively reviewing regulations, use of regulatory impact assessment (RIA) by oversight bodies for an evidence-based policy-making, and conduct of effective ex-post evaluation of policies.

In our region, Vietnam has made great strides in overhauling its administrative procedures. They call this reform process “regulatory guillotine.” Vietnam, in 2007, established a “Project 30” unit in their government, with the goal of simplifying administrative procedures and reducing administrative costs by at least 30%. It is no surprise then that Vietnam has continued to be ahead of us in the Ease of Doing Business rankings and has received 50% more FDIs than us.

Malaysia, in 2013, launched the National Policy for the Development and Implementation of Regulations, and has started implementing reforms in regulatory practice, such as requiring RIA for all new regulations.

Also South Korea, which was able to review over 11,000 regulations, in the process eliminating almost 50% of them, all within the span of 11 months. Over 1 million new jobs and $36 billion in FDIs were projected to be the economic gains of such regulatory cleanup.

To keep in step with our neighbors, a comprehensive regulatory package must be part of next administration’s reform pillars.

In a recent Philippine Institute for Development Studies seminar (for more information, visit http://goo.gl/l2hvCj), NEDA Deputy Director General and University of the Philippines Professor Emmanuel F. Esguerra identified elements from OECD and ASEAN for best practices for good regulation. These are: internationally recognized processes, systems, tools and methods for improving quality of regulation, a system for implementing public consultation and stakeholder engagement and impact analysis of regulations to achieve desired policy objectives.

Beneath technocratic language is the political reality of bureaucratic inertia and entrenched interests in the status quo labyrinth that must be overcome.

Hopefully, our next leader will have the vision and political will and skill to take on this difficult but necessary task for the Philippines to truly travel the “tuwid na daan” to inclusive investment-led growth.

Romeo Bernardo is a Trustee of Institute for Development and Econometric Analyis and of the Philippine Institute for Development Studies.

http://www.bworldonline.com/content.php?section=Opinion&title=reduce-regulatory-burden&id=119736