Tax policy reform - it's time

Business World
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.

Having recently attended a tax policy forum with representatives of multilateral institutions, government officials (current and past), academics, representatives of business organizations and civil society members as participants, I am more convinced than ever that somehow the new administration will need to lead the nation to accept adjustments in some taxes. The sooner, the better.
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.

Tax policy reform - it's time

Business World
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.
Having recently attended a tax policy forum with representatives of multilateral institutions, government officials (current and past), academics, representatives of business organizations and civil society members as participants, I am more convinced than ever that somehow the new administration will need to lead the nation to accept adjustments in some taxes. The sooner, the better.
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 leveling 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.

Investors await policies, action on RP's problems

Business World

A relatively smooth elections and the speedy release of results may have improved the market's view of the Philippines but actual investments will depend on the new administration's policy agenda, economists yesterday said.

Romeo L. Bernardo, a former Finance Undersecretary, said the outcome of Monday's exercise had put to rest market concerns of a failure of elections.

The election went smoother than expected. It seems the leading candidate has a clear mandate and we will not have dispute of proclamation, he said.

This removes the lack of certainty on succession.

But in the long term, said Mr. Bernardo, investors will be waiting for the composition of the new economic team and how the administration approaches problems such as the deficit and corruption.

Investors will want to see how cohesive his team will be in addressing these problems, he said.
HSBC economist Frederic Neumann, meanwhile, said investors would be taking a second look at the Philippines once a clear winner had been declared.

Despite worries, it went reasonably well, he said. Investors are going to be relieved that there is a clear winner, that there is certainty.

Citibank economist Francisco G. Trinidad, Jr. said that while the speedy count had bolstered the view of a credible elections, what is more important for the market is how the new administration sets the tone for policies.

Recent political developments have dispelled much of uncertainty prior to the elections but it will take familiarity with the new administration's policy agenda before we can ascertain the likelihood of the investment climate improving materially, he said.

Mr. Trinidad said investors would want the new administration to work on its fiscal position by improving tax administration and coming up with revenue measures.

[The] revenue side will be crucial to provide more cash flows to support anti-poverty programs and job creation, he said.

The government expects the deficit to hit P293 billion this year after reaching a record P298.5 billion in 2009.

As of the first quarter, the shortfall stood at P134.2 billion, higher than the programmed P110.9 billion due to higher expenditures and lackluster revenues.

Economic issues for next president

Business World
Introspective

The author moderated the discussion by a panel of economists in the 9th Ayala Corporation-UP School of Economics Lecture Series last April 14. The panel was composed of former Economic Planning Secretary Philip Medalla, former Budget Secretary Benjamin Diokno, former Agriculture Undersecretary Arsi Balisacan, and Raul Fabella, former dean of the UP School of Economics. Below is the continuation of the author's introductory remarks intended to frame the discussion:

B. Fiscal: How to generate resources needed for infra and social spending and to enhance private investment climate through sound macro.

1. Introduction: The new government will be coming in with debt to GDP levels quite high (57% vs. 35 to 45% for our neighbors), tax-to-GDP ratio close to historic lows (at 12. 7% vs. 15 to 16% for the region), erosion in revenues due to new measures passed over the last couple of years and for specific taxes, from inflation. At the same time it needs resources to address the large infrastructure and social spending deficit/backlog that is creating a drag on the country's future growth which can only get worse with time. Our infra spending is only about half the average for the region of 5% of GDP, and our education quality has slipped dismally over the years, and from being one of the highest among our peers, is now down the cellar.

2. Questions:
a. How much can the next administration depend on improving tax administration/plugging leakages to generating fiscal resources? How can this new administration generate sizeable increases in collection via improved administration considering poor track record of past administrations (and modest successes in other countries that yielded no more than 1% of GDP)?
b. Should the new administration look to new/additional taxes? VAT, excise taxes, especially on oil, text tax? How to generate public support for new taxes?
c. What reforms are needed in spending priorities to get more bang for the taxpayer buck? In budget and procurement processes?
C. Government Interventions in Imperfect and/or Important Markets. How should government intervene better in key sectors to generate inclusive sustainable growth?
1. Introduction: There are a number of key areas where there is serious lack of supply, despite clear demand, perhaps bordering on crisis proportions if unattended. Examples are in important infrastructure like power, water, and mass transport. Just to illustrate how market or government failure can lead to serious losses - consider the power crisis of 1991/92, resulting from failure to anticipate and build power plants and losses in growth and investment. Growths during those years were negative and only marginally positive, respectively, instead of what could have been at least the historic level of 4%. Even if we assume that the losses were confined only to those two years, putting aside losses from the fruits of lost investment and reputation damage, every 1% of growth forgone each year translates to P70 billion, $1.5 billion, the same price of as two Bataan Nuclear Power plants. Multiply this by 8 for the two years- that's what it cost the economy- that's P560 billion down a dark pit, lost forever. Presented this way, the losses of inaction for under provision of other important infrastructure - water, roads, mass transport, though perhaps not as staggering can be quite compelling.

2. Questions:
a. We are already seeing an increase in frequency and duration of power outages, perhaps driven by combination of factors - weather, inadequate reserves, breakdowns - what can the next administration do to prevent power crisis of the magnitude of the early '90s which is consistent with the EPIRA architecture and law? Or does the EPIRA need change?
b. In the other areas of water, mass transport, roads, how can government improve the investment climate for more public-private partnerships to augment its constrained budget for public works? Does the Philippines also need broader competition policy so that infra services become cheaper, for example in transport or power?
c. Is there a role for government providing fiscal incentives or production subsidies for particular industries or activities (say, SME financing, R and D, training) on a temporary basis until they can be competitive? What are the pitfalls to this strategy advocated by some?

D. Poverty Reduction: How can government make growth more inclusive?
1. Introduction: The Philippines now has one of the highest incidences of poverty counting over 20% of its population as having incomes below one dollar per day, higher than Vietnam, Indonesia, China. This is explained by limited dynamism of economic growth, which moreover has not translated to poverty reduction. There is likewise evidence of deterioration in the distribution of income. Factors identified by the World Bank as contributing to this deterioration include unequal, inadequate access to social services and social protection, leading to unequal sectoral and regional distribution of growth and barriers to factor mobility.

2. Questions:
a. What are the roots of poverty in the Philippines?
b. How might some of the barriers in factor mobility help reduce poverty, i.e., policy bias like legislated wages against low-skill employment, or biases vs. more efficient use of land due to agrarian reform? Too sensitive to embark on? Are there political feasible actions possible in these areas?
c. What improvements in social services and social protection are feasible, e.g., redeployment of NFA subsidies toward conditional cash transfers? What could be the possible political road map for doing this without raising obstacles on ground of food security, etc?
d. What are the other kinds of interventions should government embark in the areas of education and health, including reproductive health, that addresses the requirements of the poor that are politically feasible early on?

Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc. and managing director of Lazaro Bernardo Tiu & Associates, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.

Economic issues for next president (part 1)

Business World
Introspective

Last April 14, I was privileged to moderate a distinguished panel of economists in the 9th Ayala Corporation-UP School of Economics Lecture Series. The panel members were Dr. Philip Medalla, former Economic Planning secretary, Dr. Ben Diokno, former Budget secretary, Dr Arsi Balisacan, former undersecretary of Agriculture, and Dr Raul Fabella, former dean of the UP School of Economics. As our invitation said: most of them had to grapple with hard economic questions, not only as academics but as senior economic managers in four administrations, dealing in real time with difficult policy trade-offs, often against strong vested interests and working through weak, sometimes even compromised institutions.

Below are my introductory remarks intended to frame the discussion. Subsequent columns will cover what they said.

I met with them a week before, and agreed, on a common set of assumptions, like good economists, that will frame the discussion.

The key one is that by end of June, we will have a credibly elected president with the Congress and the public more or less behind him. Why this is something we need to state explicitly is perhaps best illustrated by a text I got this morning.

The Social Weather Stations says President Arroyo's net satisfaction rating is down a negative 53 percent - an all-time low. Because of the 'F' or failing grade she received from Filipinos, Mrs. Arroyo, a former student of the UP School of Economics, says this. 'I am more than willing to repeat'.

Proceeding further on our assumptions:
1. He has adequate skill set and incentive to govern well which are aligned with the nation's. He will have alter-egos/teams which are similarly placed. 2. The new president needs to set a tone for his administration in the first 100 days, and perhaps success or failure during the first two years will define the rest of his term. Needs to make a mark, score victories supported by the public, and build confidence within this period, using powers at his disposal, in most cases without new legislation.
3. Key question for the administration, and the country. How to achieve that which has eluded the Philippines for many years-inclusive, sustainable growth.
4. For our discussion flow, we framed/try to break up this question into four areas and assigned a panel member to take the lead in discussing these issues: These are - a) on the overall strategy, how to restore growth after the crisis, b) the fiscal challenges of finding the resources to raise investment and social spending, c) government interventions in imperfect and/or important markets, and d) how do we reduce poverty and make growth more inclusive.

A. Overall Strategy: How to restore growth after the crisis (both global and as one panelist said - Glorial.)?
1. Intro: From what has been one of the two most promising countries in the 1950s (together with Burma), the Philippines has become one of the laggards in our region. The lack of faster growth in the Philippines has been traced by the World Bank to low investment and slow structural transformation from low-productivity to high productivity activities, especially in the last decade. This manifests itself in agriculture and manufacturing stagnating, and services sector, primarily driven by remittances from overseas, and more recently BPO employment, generating what there is of growth, and job creation. Recent diagnostic studies point to key constraints as the culprits - a) a vulnerable fiscal situation, b) inadequate infrastructure, c) weak investment climate due largely to governance concerns.
2. Questions:
a. What should be the next president's development vision for the country, given the global environment, our resource endowments, and limitations? Should we still look at the East Asian models, relying more on manufacturing as the big driver. Or is India a more relevant model, i.e., very focused on services, or even Caribbean, i.e., remittances and tourism? Other models?
b. Broadly, what can be done to overcome these binding constraints identified above of fiscal situation, inadequate infra, and weak investments?
c. Why is corruption in the Philippines seen to be such a grave disincentive to investment and doing business and a deadly drag to growth (even as we see corruption in other countries with vibrant private sector investment taking place)? What can a serious new administration do to limit corruption and/or its most pernicious consequences? To be more specific, how can an incoming administration establish credibility in this area, which we all know will take a long time to fix?
d. Is there a case for more activist policies like production subsidies and incentives to promote faster industrialization as advocated by some economists?
e. Or keeping the exchange rate undervalued as China seems to be doing, as seems to have been recently suggested in Introspective columns in BusinessWorld.?
marginally positive, respectively, instead of what could have been at least the historic level of 4%. Even if we assume that the losses were confined only to those two years, putting aside losses from the fruits of lost investment and reputation damage, every 1% of growth forgone each year translates to P70 billion, $1.5 billion, the same price of as two Bataan Nuclear Power plants. Multiply this by 8 for the two years- that's what it cost the economy- that's P560 billion down a dark pit, lost forever. Presented this way, the losses of inaction for under provision of other important infrastructure - water, roads, mass transport, though perhaps not as staggering can be quite compelling.
2. Questions:
a. We are already seeing an increase in frequency and duration of power outages, perhaps driven by combination of factors - weather, inadequate reserves, breakdowns - what can the next administration do to prevent power crisis of the magnitude of the early '90s which is consistent with the EPIRA architecture and law? Or does the EPIRA need change?
b. In the other areas of water, mass transport, roads, how can government improve the investment climate for more public-private partnerships to augment its constrained budget for public works? Does the Philippines also need broader competition policy so that infra services become cheaper, for example in transport or power?
c. Is there a role for government providing fiscal incentives or production subsidies for particular industries or activities (say, SME financing, R and D, training) on a temporary basis until they can be competitive? What are the pitfalls to this strategy advocated by some?

D. Poverty Reduction: How can government make growth more inclusive?
1. Introduction: The Philippines now has one of the highest incidences of poverty counting over 20% of its population as having incomes below one dollar per day, higher than Vietnam, Indonesia, China. This is explained by limited dynamism of economic growth, which moreover has not translated to poverty reduction. There is likewise evidence of deterioration in the distribution of income. Factors identified by the World Bank as contributing to this deterioration include unequal, inadequate access to social services and social protection, leading to unequal sectoral and regional distribution of growth and barriers to factor mobility.

2. Questions:
a. What are the roots of poverty in the Philippines?
b. How might some of the barriers in factor mobility help reduce poverty, i.e., policy bias like legislated wages against low-skill employment, or biases vs. more efficient use of land due to agrarian reform? Too sensitive to embark on? Are there political feasible actions possible in these areas?
c. What improvements in social services and social protection are feasible, e.g., redeployment of NFA subsidies toward conditional cash transfers? What could be the possible political road map for doing this without raising obstacles on ground of food security, etc?
d. What are the other kinds of interventions should government embark in the areas of education and health, including reproductive health, that addresses the requirements of the poor that are politically feasible early on?

Power, interrupted

Business World
Introspective

The current electricity shortage in the country is stirring up memories of the power crisis in the early 1990s when daily blackouts of as long as 12 hours in Manila pushed investors to the exit causing economic output to contract.

I wrote a report a week back for GlobalSource, a global network of independent analysts, explaining how the current shortage differs from that of 20 years ago, noting that:

1. Power outages today are not due to an acute shortage of power generating capacities but have been triggered by an El Nino-induced drought, hence the surprising severity especially in Mindanao, which relies on hydroelectric plants for over 50% of its electricity needs.

2. Severe power outages have so far been limited to Mindanao; in comparison, power interruptions in Luzon, which depends much less on hydroelectric plants (about 10% and less than 1% in Visayas), have been intermittent and of much shorter duration.

Thus, in the near term, from a macroeconomic perspective:

3. Mindanao's less than 20% contribution to economic growth (vs. two- thirds for Luzon), while not insignificant, is not expected to cut into overall growth appreciably.

4. Despite the more than doubling of spot prices, the impact on electric bills are expected to be muted as utilities are allowed full recovery only on 10% of their purchases from the wholesale electricity spot market (WESM) while any excess purchases are recoverable based on time-of- use rates of the National Power Corp. (NPC).

The big picture
Still, beyond election and short-term macroeconomic risks, incidents of massive blackouts in a country that has a history of power shortage and where competitiveness is dragged down by high power costs, tend to undermine investor confidence further and raise the hurdle rate on investments. This risks underinvestment all around resulting in an inability to expand the country's growth frontier, thus bringing forward to the present the issue of long-term supply adequacy.

The Department of Energy's power supply and demand outlook does not provide much comfort. For Luzon, government estimates the critical period, when existing generating capacity will not be able to meet peak demand plus a 23% reserve margin, to come as early as 2011. Private industry estimates range from 2012 to 2014, which nevertheless also point to the need for capacity additions today.

Meanwhile, the critical period has come and gone for Visayas, which has been experiencing rotating blackouts for a couple of years already before the construction of a new baseload coal plant, expected on stream by the third quarter this year. Mindanao is also expected to face power shortages this year, albeit the current severity has not been anticipated.

In sum, the supply/demand outlook reveals the need for immediate new investments in power generating capacity, especially considering the three year lead time needed to get all the requirements and financing for building power plants. Indeed, industry experts are one in saying that shortages even in Luzon would have happened already had it not been for the following developments: (i) lower economic growth due to the global financial crisis, (ii) higher dependence of recent past growth on the services sector which is less energy intensive, versus the manufacturing sector which has been losing out to China, (iii) rehabilitation and better maintenance of privatized plants which have translated into higher energy sales, and (iv) functioning of the WESM with peak/off-peak pricing that encourages optimized energy dispatch to improve returns and spread out power demand.

Work in progress
To be sure, investor interest of late can be gleaned from successes in government auctions of existing assets - after much delay, over 80% of government's power generating assets is finally in private hands. It has been much more difficult to get them to put up new baseload plants without open access, where electricity buyers of a certain size can freely shop for suppliers.

Thus far, investors find simply buying existing public generating assets the easier route to participating in the local power industry. Moreover, the transition supply contracts that come with the plants help to ease the way into complete merchant plants that will operate in an uncertain regime.

The Energy Regulatory Board is expected to soon issue rules on open access on a voluntary basis, ahead of the Power Sector Assets and Liabilities Management Corporation (PSALM) achieving the threshold. It is hoped that this will help investors see the emerging landscape and make business decisions to address Luzon's power needs anticipatorily.

Also, the WESM, introduced in 2006, continues to have rules that undermine price discovery and is thus unable to telegraph shortages through price signals. Instead, it has been observed that WESM prices have tended to be artificially depressed due to the operation of government's must run plants whenever there are supply disruptions on the private side that results in spot prices not reflecting the true scarcity of electricity.

Unlike fiscal sustainability which boils down to a taxing problem, it is less clear to us, based on the economic platforms presented so far by leading presidential contenders, how the winning candidate will tackle power sector issues, which are in truth much more complex. Even if the next administration learned the lesson of 20 years ago, i.e., to be anticipatory and not wait for a crisis to happen before acting which imposes huge costs on the economy, rules have changed under the Electric Power Industry Reform Act (EPIRA). EPIRA now bars government, except with Congress's approval, from doing what the Ramos administration did in 1992- 93 to solve the power crisis then, i.e., enter into energy purchase contracts with independent power producers.

A worst case scenario, if the next administration dilly-dallies, will see a repeat of the end of Aquino administration power crisis that will seriously damage investor confidence, pull down economic output. and lead to expensive solutions that will affect the country's long-term competitiveness. A rough calculation, based on the $1-million-per megawatt rule of thumb for costing power plants, indicates that every foregone 1% of GDP growth translates into over P70 billion of loss per year for the economy, which is enough to pay for a 1500-MW power plant. When viewed in the context of a negative growth rate in 1991 and near zero in 1992, the losses can be quiet staggering if the next administration fails to avert another power crisis.

We remain optimistic though that with memories of the last crisis still fresh in the minds of people now holding decision-making posts, the next administration will have enough political will to iron out kinks in the present setup and do enough to give comfort by way of improved regulatory and macroeconomic environment to investors and lenders before reserves dwindle further in the main grid. If investors continue to shy away, we expect it to be able to find interim measures involving public provision that do not run afoul of the EPIRA, a far second best option though.

This was based on a report with the same title by Christine Tang and the column writer for Global Source, a network of independent analysts. 

Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc. and managing director of Lazaro Bernardo Tiu & Associates, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.

The good, bad, and somewhat stupid

Business World


In an earlier column, I wrote about The Fiscal Imperatives for the Next Administration (No Money, No Honey) focusing on tax policy reform needed to sustain macro-stability and provide the much-needed resources for infrastructure and social spending.

This time, allow me to talk about how our government uses, well or badly, fiscal policy tools to help members of society who need help, focusing on recent programs for the poor and the elderly.

The good: Conditional cash transfers

Learning from the successful experience of two dozen countries, notably Indonesia and Brazil, to get maximum bang for the taxpayer buck to help reduce poverty, the administration, with the full technical and financial support of the World Bank, launched its own conditional cash transfer program under the banner of Pantawid Pamilyang Pilipino Program (4 Ps). It provides a monthly stipend of up to P1,400 (P500 per household for health and nutritional expenses and P300 per child for educational expenses up to a maximum of three children) to the poorest households of a community provided the children are kept in school. The DSWD selects the beneficiaries based on the targeting system developed for the program.

Despite apprehensions that this may end up being no different from many past programs done in the name of the poor that have ended up at best as wasteful political showcases, this program is showing good early results. Children are going back to school and getting immunized, while their mothers are having pre- and post-natal care. What it can achieve at the end of the day is to break, for the next generation, the cycle of poverty - poor nutrition, poor health, poor education, and resulting unemployment and impoverishment.

The credit for this program goes to highly regarded DSWD Secretary Esperanza Cabral, and of course, the full support of President Gloria Macapagal Arroyo who clearly saw not just the economic soundness of the program, but also its political benefits. (A professor friend who served in the Estrada administration quipped that the appointment of the right person for DSWD secretary is one area where President Arroyo did better than his boss.)

The bad: Nfa

Ask any good economist what is the biggest waste of government resources in recent years and he will readily point to the NFA program of rice subsidies. As a subsidy program it fails the needs test since the subsidized rice is available to all, whether rich or poor. Indeed, studies have shown that less than 25% of the poor have access to NFA rice. Worse, it is quite likely that a large fraction - maybe more than half - of the rice is sold by the NFA at the official government price to some lucky people who repack the NFA rice and re-sell them at market prices. According to a recent World Bank study, it costs the NFA an estimated average of P5 to deliver P1 of subsidy to the poor, the big number reflecting the wastes, leakages, and the governance deficit in its administration. It does nothing for the poor farmers who especially at a time of high rice prices (like now) are deprived the benefits of a remunerative price. On a more fundamental level, it distorts market signals and misallocates resources in the agricultural sector and rest of the economy. Finally, it is very expensive: in 2008, NFA lost P37 billion per data from the Philippine Institute of Development Studies. According to the World Bank, this may have racked up to P63 billion in 2009 (coming from losses that averaged only P5 billion annually in earlier years).

Many studies have been written on why NFA needs to be re-engineered, and how better off consumers and farmers would be if funding is redirected as targeted subsidies to poor consumers and invested in productive assets like rural infrastructure to help farmers. (You can view the most recent one in the November quarterly report of the World Bank - Towards an Inclusive Recovery at http://siteresources.worldbank.org/INTPHILIPPINES/Resources/PHLQuarterly November2009FINAL.pdf) Indeed, generations of technocrats in NEDA, Finance, and the Department of Agriculture, assisted by multilateral and bilateral institutions, have tried to push for reform without success. The vested interests are just too entrenched, and the rents too much.

Contrast the cost of NFA with the cost of the conditional cash transfer. The P10 billion this year under the 4Ps program will benefit around 3.5 million people. Consider what this means: If we had shut down NFA last year and diverted the P63 billion to a conditional cash transfer program, we would have been able to cover 100% of the country's poor (against the 25% with NFA), with each household receiving 7 times the benefits!

(The next president, whoever he may be, can't do better than reappoint Secretary Cabral to see this program move to a higher level, perhaps refined to include conditions covering other socially desirable objectives like reproductive health. NB. I have never had the privilege of meeting Dr. Cabral.)

The somewhat stupid

Despite strong recommendation from the secretary of Finance for her to veto it, the President recently signed into law a bill that would give exemptions from VAT for purchases of senior citizens for restaurant food, medicines, transportation, and movies. Like many tax exemption bills, one cannot find fault with the objectives - in this case to help the elderly, most of whom no longer receive current income. Indeed one can even argue that the amount of tax leakage is not that large, at least compared to NFA deficits, only P1.68 billion per DoF estimate; so it is not that bad from a fiscal standpoint.

However, it is somewhat stupid. Why? Because there are so many other ways of helping the elderly without reaping the unintended consequences of creating a loophole in the VAT system that create a compliance and administration nightmare, or be vulnerable to abuse by crooked traders and BIR agents. The most straightforward way is the one suggested by the Department of Finance: simply raise the discount from 20% to 30%, thus restoring the savings to the elderly that the VAT law is supposed to have deprived. The stores will simply recoup this additional expense from sales to other customers.

This will also keep the integrity and efficiency of the VAT system, one which is self policing - somebody's credit is somebody else's payment - and does not create precedence for others to clamor for the same. (Doesn't society care for the young? Why not exempt children's medicines and baby milk from VAT? How about purchases of the handicapped? Or of our soldiers, teachers, or OFWs?)

If we want to help the elderly poor, how about conditional cash transfer for them? Isn't this much better than this prime example of poorly thought out, politics of pander, VAT exemption for seniors that subsidizes in proportion to one's purchases, to the richer, the more subsidy and for the poorest, nada?

More fundamentally, if we are to improve revenue collection and maintain macrostability, we need to make our tax system - already complicated, full of discretion and loopholes - simple and easy to administer. Let us not overburden it further. Let us instead use expenditure policy to help the poor and the elderly, or for that matter all other sectors asking special support like industries seeking/enjoying fiscal incentives. This way, it is transparent, targeted and needs based, and subject to annual evaluation if still deserving, all under the discipline of a budget process.

Mr. Romeo Bernardo is Global Source Philippine advisor and board member of The Institute for Development and Econometric Analysis, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.