Ill-conceived, half-baked tax policy won’t do

The author is the coordinator of Action for Economic Reforms. Thispiece was published in the Yellow Pad column of Business World, 09 August 2004 edition.

“The time for change is well past due. This time, let me say, let’sjust do it.” This is the most cited, most applauded phrase of GloriaMacapagal Arroyo’s (GMA) first State of the Nation Address (SONA) asthe 14th President of the Philippines.

Yet, days have passed, and she has wasted precious time in her attemptsto tackle the most serious problem—the fiscal deficit and the swellingpublic sector debt.

Despite enumerating several tax measures, the GMA administration hasnot firmed up the package, and along the way, it has flip-flopped onsome proposed policies. During the campaign period, GMA promisedcontinuity. Whether we agree with GMA on her economic program is besidethe point, but it is reasonable to expect a smooth policy transition toher new administration. Seen in this context, it is astonishing thather administration is stalling.

The signs of confusion and inertia are unmistakable. She sendscontradictory messages. On the one hand, she wants to replace the valueadded-tax (VAT) but on the other hand, her spokespersons propose anincrease in the VAT rate. Earlier, she floated the proposal to tax cellphone text messages, which she immediately withdrew in the face ofwidespread public opposition. Further, she has not appointed apermanent Secretary for the Department of Finance (DoF).

Of course, all this can be explained by politics. That is, GMA isconsolidating her power as she tries to return favors to her supportersand appease the many who doubt the credibility or the outcome of therecent elections. And although the tax measures boil down to apolitical choice, there is no way that politicized decisions cansatisfy the taxpayers. That all tax measures are painful is obvious.The only acceptable route is to adopt policies, in which the pain canbe transformed into gains.

In this regard, GMA’s catchy slogan—”let’s just do it”—is misleading.”Let’s just do it” presupposes the soundness of the proposed measures.Unfortunately, the tax menu that the administration offers is ahodgepodge of bad, if not highly questionable, proposals and a few goodones.

Let us first cite the few good proposals, namely the rationalization offiscal incentives, an additional tax on petroleum products, and theindexation to inflation of the “sin” products (i.e., cigarettes andalcoholic beverage). These measures pass the standards for fairness andefficiency and the promotion of public goods. Moreover, they can easilygenerate hefty revenues. Yet, even these positive measures have tohurdle formidable obstacles.

The demand to rationalize fiscal incentives has been fully articulatedfor so many years. It is a position that has obtained an intellectualconsensus. Reformists, even some radicals, and neo-liberals are all onein saying that over-generous fiscal incentives are not a key variableto spur investments and growth. In fact, many of those who have availedthemselves of the fiscal perks belong to the high-growth industries(think of Smart and Globe); in short, investments would have been madeeven without the incentives. Yet, these incentives have resulted insubstantial foregone revenues. The DoF estimates that the foregonerevenues amount to PhP102.2 billion.

Despite the many studies that support the reduction of fiscalincentives, outside the statements of broad principles, theadministration has not identified which laws or executive orders thatneed to be repealed or which industries that have to be stricken offfrom the incentives list. Partly, this stems from the lack orincoherence of the government’s industrial and technology policy.

An additional excise tax on petroleum is indeed politically difficultto do. Oil pricing has always been a politically sensitive issue, andthe current soaring of the international price of crude oil compoundsgovernment’s dilemma in adopting such a tax. Still, a petroleum tax canbe absorbed by the car-owning middle classes and the rich, who, afterall, are the main consumers of gasoline. Government can designinnovative measures to insulate the poor and the low-income workersfrom the price effect of the tax. For instance, it can put in place avoucher system for public means of transportation.

Another positive aspect of the petroleum tax is that it addresses negative externalities, specifically pollution and traffic.

The indexation of the sin products is “well past due,” to borrow thewords that GMA used in her SONA. She should have done the indexationmuch earlier, but she and other politicians were more concerned aboutwinning the 2004 elections than pursuing tax reforms. Now, we need toknow the answers to the following questions: Is GMA willing to risk thebreak-up of her alliance with Danding Cojuangco and Lucio Tan—whosebusiness interests include the manufacture of sin products? And are thelieutenants of Cojuangco and Tan in Congress willing to undermine theruling political coalition by defying a Malacanang wish to legislatethe indexation of sin products?

The rest of the tax measures, as earlier noted, are bad, if notdownright silly. The silliest of them all is the proposed adoption ofthe minimum gross income taxation of corporations and self-employedindividuals. The intelligent criticisms against this proposal, comingfrom the broadest spectrum of society, are too many to cite. Suffice itto say that the untested proposal is practically impossible to enforce,thus creating bigger opportunities for corruption and tax evasion totake place. It is indeed frustrating for tax reformers to confront afoolish idea that refuses to die. Adding to the frustration is theirony is that the main proponent of this idea that is bereft of soundfiscal principles is the President, a formally trained economist with aPhD degree from the country’s premiere school.

The proposed tax amnesty must likewise be shot down. Tax amnestiescreate a moral hazard problem; the government, after several amnestyprograms, unwittingly informs tax payers that they can get away withtax evasion.

The proposed windfall tax on telecommunication companies in the form ofa franchise tax, equivalent to a fixed percentage of gross income, isanother bad idea. The franchise tax assumes that the telecommunicationindustry is a monopoly. While the allegation that Smart and Globe areengaged in oligopolistic pricing might be valid, the same cannot besaid of the small players. In truth, a franchise tax handicaps thestruggling companies and likewise serves as a barrier to entry toothers.

And finally the VAT. The proposal to replace the VAT with the sales taxhas not been knocked off. The return to the sales tax is veryregressive. While both the sales tax and VAT both have a regressivecharacter, the former is worse because of its cascading effects. Thesales tax, too, is more complicated than the VAT. To be sure, the VATis far from perfect, especially in a setting in which the undergroundeconomy is prevalent. But this imperfection applies to other taxes aswell.

The wind, though, is now blowing towards the option of having atwo-step increase in the VAT, which is an increase in the rate by 2percent for two consecutive years. And while it is acknowledged thatVAT is superior to the sales tax, the increase in the VAT rate is adifferent story. Being an indirect tax, the VAT hits the poor most. Theproposed hike in the VAT rate has to be applied to all goods andservices covered by the VAT; hence the general population, especiallythe poor consumers, will bear the biggest burden of the increase. Saidanother way, the proposal is insensitive to equity concerns. Whatdrives the administration to push for this kind of policy is that it iseasy to collect, never mind that it hits the poor.

And from an efficiency perspective, the rate increase will only magnifythe distortions in the present VAT, arising from the so manyexemptions. A DOF study estimates that the VAT evasion rate is as highas 50 percent. It is more prudent for government to address the leakageproblem in the VAT than to increase the rate.

All told, the tax package that GMA offers is disappointing. A fewmeasures deserve to be supported, despite the political hurdles, butmany of the proposals do not pass the test of efficiency and equity.

On top of all this, perhaps the most difficult question that GMA mustanswer is: How can she credibly convince the taxpayers to support eventhe good proposals, when she is seen, even by those who elected her, asa party responsible for the current fiscal crisis?

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