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

The author is the coordinator of Action for Economic Reforms. This piece 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’s
just do it.” This is the most cited, most applauded phrase of Gloria
Macapagal Arroyo’s (GMA) first State of the Nation Address (SONA) as
the 14th President of the Philippines.

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

Despite enumerating several tax measures, the GMA administration has
not firmed up the package, and along the way, it has flip-flopped on
some proposed policies. During the campaign period, GMA promised
continuity. Whether we agree with GMA on her economic program is beside
the point, but it is reasonable to expect a smooth policy transition to
her new administration. Seen in this context, it is astonishing that
her administration is stalling.

The signs of confusion and inertia are unmistakable. She sends
contradictory messages. On the one hand, she wants to replace the value
added-tax (VAT) but on the other hand, her spokespersons propose an
increase in the VAT rate. Earlier, she floated the proposal to tax cell
phone text messages, which she immediately withdrew in the face of
widespread public opposition. Further, she has not appointed a
permanent Secretary for the Department of Finance (DoF).

Of course, all this can be explained by politics. That is, GMA is
consolidating her power as she tries to return favors to her supporters
and appease the many who doubt the credibility or the outcome of the
recent elections. And although the tax measures boil down to a
political choice, there is no way that politicized decisions can
satisfy the taxpayers. That all tax measures are painful is obvious.
The only acceptable route is to adopt policies, in which the pain can
be 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 a
hodgepodge of bad, if not highly questionable, proposals and a few good

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

The demand to rationalize fiscal incentives has been fully articulated
for so many years. It is a position that has obtained an intellectual
consensus. Reformists, even some radicals, and neo-liberals are all one
in saying that over-generous fiscal incentives are not a key variable
to spur investments and growth. In fact, many of those who have availed
themselves of the fiscal perks belong to the high-growth industries
(think of Smart and Globe); in short, investments would have been made
even without the incentives. Yet, these incentives have resulted in
substantial foregone revenues. The DoF estimates that the foregone
revenues amount to PhP102.2 billion.

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

An additional excise tax on petroleum is indeed politically difficult
to do. Oil pricing has always been a politically sensitive issue, and
the current soaring of the international price of crude oil compounds
government’s dilemma in adopting such a tax. Still, a petroleum tax can
be absorbed by the car-owning middle classes and the rich, who, after
all, are the main consumers of gasoline. Government can design
innovative measures to insulate the poor and the low-income workers
from the price effect of the tax. For instance, it can put in place a
voucher 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 the
words that GMA used in her SONA. She should have done the indexation
much earlier, but she and other politicians were more concerned about
winning the 2004 elections than pursuing tax reforms. Now, we need to
know the answers to the following questions: Is GMA willing to risk the
break-up of her alliance with Danding Cojuangco and Lucio Tan—whose
business interests include the manufacture of sin products? And are the
lieutenants of Cojuangco and Tan in Congress willing to undermine the
ruling political coalition by defying a Malacanang wish to legislate
the indexation of sin products?

The rest of the tax measures, as earlier noted, are bad, if not
downright silly. The silliest of them all is the proposed adoption of
the minimum gross income taxation of corporations and self-employed
individuals. The intelligent criticisms against this proposal, coming
from the broadest spectrum of society, are too many to cite. Suffice it
to say that the untested proposal is practically impossible to enforce,
thus creating bigger opportunities for corruption and tax evasion to
take place. It is indeed frustrating for tax reformers to confront a
foolish idea that refuses to die. Adding to the frustration is the
irony is that the main proponent of this idea that is bereft of sound
fiscal principles is the President, a formally trained economist with a
PhD degree from the country’s premiere school.

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

The proposed windfall tax on telecommunication companies in the form of
a franchise tax, equivalent to a fixed percentage of gross income, is
another bad idea. The franchise tax assumes that the telecommunication
industry is a monopoly. While the allegation that Smart and Globe are
engaged in oligopolistic pricing might be valid, the same cannot be
said of the small players. In truth, a franchise tax handicaps the
struggling companies and likewise serves as a barrier to entry to

And finally the VAT. The proposal to replace the VAT with the sales tax
has not been knocked off. The return to the sales tax is very
regressive. While both the sales tax and VAT both have a regressive
character, the former is worse because of its cascading effects. The
sales tax, too, is more complicated than the VAT. To be sure, the VAT
is far from perfect, especially in a setting in which the underground
economy is prevalent. But this imperfection applies to other taxes as

The wind, though, is now blowing towards the option of having a
two-step increase in the VAT, which is an increase in the rate by 2
percent for two consecutive years. And while it is acknowledged that
VAT is superior to the sales tax, the increase in the VAT rate is a
different story. Being an indirect tax, the VAT hits the poor most. The
proposed hike in the VAT rate has to be applied to all goods and
services covered by the VAT; hence the general population, especially
the poor consumers, will bear the biggest burden of the increase. Said
another way, the proposal is insensitive to equity concerns. What
drives the administration to push for this kind of policy is that it is
easy to collect, never mind that it hits the poor.

And from an efficiency perspective, the rate increase will only magnify
the distortions in the present VAT, arising from the so many
exemptions. A DOF study estimates that the VAT evasion rate is as high
as 50 percent. It is more prudent for government to address the leakage
problem in the VAT than to increase the rate.

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

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

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