On the import surcharge: What’s not to like?

Ms. Malapit is a Research Associate of Action for Economic Reforms.  This article was published in the Yellow Pad column of BusinessWorld, 4 October 2004 edition.

At this point, to tax or not to tax is no longer the question.

With all the public discussions stirred up by the UP 11 fiscal alarm,
there has been widespread recognition of the need for new tax measures.
The key issue now is who to tax.

Who should bear the burden of increased taxes? Smokers and drinkers?
Texters? Telecommunications service providers? Foreign investors?
Car-owners? Commuters? Consumers in general? These are just a few of
the sectors that may have to bear the burden of new taxes – that is, if
Congress approves the government’s proposed tax measures.

One wonders, however, how a tax proposal that does not require
legislation and yet can generate sizable revenues has not been taken
seriously by the administration. If indeed generating revenues in the
short run is our most urgent fiscal challenge, what’s not to like about
an import surcharge?

Taxing foreign producers

An import surcharge is simply an additional tax on the value of
imported goods, on top of whatever tariffs are currently applied. An
additional tax on imported products will raise prices of these goods
and precipitate a shift of demand towards locally produced substitutes.

Since practically every sector in the economy will be vulnerable to
higher taxes, why should foreign producers be exempt? They’re not even
Filipinos, whose livelihoods and incomes the government should take
every care to preserve. If Filipinos buy less imported goods and more
locally produced goods, even at slightly higher prices, it is the
domestic industries and the Filipinos they employ that will benefit
from these higher prices.

Compared with a higher VAT, which takes away some disposable income
from all of us, an import surcharge takes away some disposable income
from all of us and passes part of it on to our domestic industries.
Even if both measures yield the same tax revenues, the import surcharge
is clearly more favorable considering the jobs it can protect and even
create locally.

To maximize its employment effect, additional taxes on imports are best
imposed on goods to which locally produced substitutes exist. In these
industries, we expect domestic producers to benefit from the increased
protection. On the other hand, an additional tax on imported goods to
which we have no locally produced substitutes simply results to higher
prices, without any job-protecting or job-generating effect.

For practical purposes however, an across-the-board import surcharge is
the second-best solution. By leaving no room for discretion, it
minimizes the opportunity for “rent-seeking” or accommodation of vested
interests. So long as the rates are small, say 2% or 3%, adjustment
costs need not be substantial.

Also, imposing this surcharge uniformly across industries maintains the
relative protection of industries. Whether the current levels of
relative protection are worth keeping, however, is another story.
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Revenue yield, not peanuts

Moreover, the revenue potential of an across-the-board import surcharge
is considerable. Dr. Rosario Manasan of the Philippine Institute of
Development Studies (PIDS) estimates that a 1% across-the-board import
surcharge can generate about P8 billion in revenues. A 2% surcharge can
yield roughly P16 billion, more than her estimated yield of P14 billion
for a two-percentage point increase in the VAT. The potential revenue
yield of a 3% surcharge rivals the most aggressive estimates of the
two-percentage point increase in the VAT, and even exceeds savings from
scrapping the entire pork barrel.

The only caveat Dr. Manasan cites in her paper “The fiscal reform
agenda: Getting ready for the bumpy ride ahead,” is that an import
surcharge may be inflationary. This can occur directly, through the
higher domestic prices of imported final goods, as well as indirectly,
through the higher costs of imported inputs or intermediate goods.

But then, depending on the ability of producers to pass on the tax to
its consumers, any tax can increase consumer prices and contribute to
inflation. This is true for the VAT. This is most certainly true for
the petroleum tax.

But why should the inflation generated by the petroleum tax or the VAT
be acceptable, and the inflation generated by an import surcharge be
unacceptable? Does this preference stem from a true fear of the
magnitude of inflation (no estimates have been cited thus far), or
simply from an “ideological reflex” as others might call it?

A matter of necessity

The truth is, the proposed solutions to our fiscal problems inevitably
erode the competitiveness of our domestic industries. Barraged with
rising potential costs – from the higher VAT, higher petroleum tax, and
higher power rates, just to name a few – local industries are in danger
of losing their business to cheaper imports, and creating massive
unemployment.

As it is, even before any new tax measures are implemented,
unemployment already stands at an alarming 13.7%. How much more of the
growing labor force can the domestic industries absorb, once the new
taxes kick in?

From this point of view, an import surcharge is no longer a matter of
choice. It in fact complements all the other painful measures that will
have to be implemented to address the fiscal situation. Offering some
marginal protection to local industries is the least the government can
do to restrain another burgeoning crisis – a crisis of unemployment.

After all, what good is it that prices of consumer goods are low, if one does not earn enough income to buy those goods anyway?
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Calling a spade, a spade

In general, reservations to the import surcharge are rooted in the
absolute confidence towards a liberalized trade policy. But as
Harvard-economist Dani Rodrik noted in his 2001 article, “The
developing countries’ hazardous obsession with global integration,” any
successful trade liberalization program requires a laundry list of
prerequisites.

Ask any World Bank economist what makes for successful trade
liberalization, he says, and they would provide the following list of
counterpart measures: “tax reform to make up for lost tariff revenues;
social safety nets to compensate displaced workers; administrative
reform to bring trade practices into conformity with WTO rules;
credibility enhancing institutional innovations to quell doubts about
the permanence of the reforms; labor market reform to enhance labor
mobility across industries; technological assistance to upgrade firms
adversely affected by import competition; training programs to ensure
that export-oriented firms and investors have access to skilled
workers; and so on.”

That the Philippine government has provided all these counterpart
measures to ensure the success of its trade liberalization program in
the past is questionable. But as to whether it can continue to do so –
assuming it has in the past – given its current fiscal constraints? At
the very least, our present situation raises very serious doubts that
it can.

What then is so objectionable with increasing effective protection
through an import surcharge when our economy is ill-equipped to take
advantage of trade liberalization? After all, we have more than ample
room to maneuver our trade policies given that our applied tariffs have
been way below the bound rates imposed by the World Trade Organization
(WTO). At the same time, it can generate much-needed revenues for the
government, and protect jobs.

Let’s be practical

Unpalatable as it may sound to some, this crisis is a time for setting
aside preconceived notions and considering all our options with an open
mind. Let’s be practical and accept proposals on the basis of
reasonable trade-offs.

Admittedly, an import surcharge is not a win-win situation. As in any
tax measure, there are of course, sectors bound to lose. But compared
with other proposals, we have argued that an import surcharge delivers
trade-offs we can live with.

What is both sad and puzzling about our entire fiscal predicament is
that the administration is merely sitting on a viable option – an
option that is quick, easy, and hefty.

While legislators are busy digging into GOCC salaries and wrestling
with line-item budgeting, the President can – if she wanted to – issue
an Executive Order to implement this measure.

What better way to zap our creditors with a “credibility shock,” as Rep. Joey Salceda calls it, than with decisive action?

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