Turning Crisis into Opportunity

Carlito Anoñuevo, Jessica Reyes Cantos, Jenina Joy Chavez, SylviaEstrada-Claudio, Alvin Firmeza, Margarita Gomez, Nepomuceno Malaluan,Hazel Jean Malapit, Cristina A. Morales, Rene Ofreneo, Rene R. Raya,and Filomeno S. Sta. Ana III

Several months have passed since the media first bannered the warningof the 11 faculty members of University of the Philippines School ofEconomics (UPSECON) about a looming economic catastrophe in the eventthat a worsening fiscal crisis is not arrested.

The good news is that everyone, from Gloria Macapagal-Arroyo (GMA) tothe man on the street, is aware of the gravity of the problem. TheUPSECON paper has generated a dynamic public discussion and debate. GMAherself has acknowledged that there is a fiscal crisis.

But the bad news is that the administration has not yet acteddecisively on the problem. Its actions to date are far from reassuring.The tax proposals that the administration has certified urgent areill-conceived or half baked. Government has likewise resorted to cheapgimmicks (the donation to the Bayanihan fund turns out to betax-deductible) and catchy but hollow slogans (on belt tightening,”live simply or simple leave”). Symbols have overwhelmed substance.

Identified priorities and even some proposed measures are wrong. Forexample, Congress has given priority to the tax amnesty bill. Thisbill, in fact, undermines tax reforms since an amnesty—which will begiven for the nth time—will only encourage further tax evasion.

Further, what should be a non-controversial indexation to inflation ofthe excise tax on sin products is being mangled. The bill that theHouse approved practically defeats the very purpose of indexation. Thetax increase is set at 20 percent, which does not compensate the lossesfrom inflation in previous years. The rate increases by a mere 3percent in 2005 and another 3 percent in 2006, again below theprojected inflation rate for both years. The deal brokered byMalacañang during a meeting with the top executives of cigarette firmsis even worse—a tax increase of 12 percent in 2005 and a nominaluniform increase of 40 centavos in 2006, to be followed by aninsignificant 3 percent annual increase till 2010.

We have expected all along that vested interests would do everything toundermine the sin tax. In the early phase, as part of multiple tactics,some legislators captured by vested interests advocated a return to thead valorem system, which is easily circumvented, in light of the weakstate capacity to monitor underpricing. Other legislators, also servingthe same vested interests, proposed to maintain different tiers in aspecific tax regime, which complicates tax administration. Either way,government loses substantial revenues.
On top of this, the imperative for government to be credible andaccountable—an absolute pre-requisite so that the public can at leastaccept the forthcoming painful measures—has suffered a serious blow,given the series of exposes of scandal and corruption involving themilitary, the Cabinet and Congress.
Against this backdrop of dissonance, incoherence, and backtracking, weneed to consolidate the struggle for key fiscal reforms and firm up theprinciples behind such reforms.

We stress that revenues have to be increased at the soonest possibletime through a combination of good tax administration and progressive,smart tax policy. We likewise stress that new taxes should be sensitiveto progressivity and equity even as the total package should yieldsubstantial and buoyant revenues. And we should also emphasize that thenecessary adjustments should harmonize with efforts to restructure thePhilippine economy in a progressive manner.

In this light, more important than quickly raising 80 billion pesos outof someone’s pocket, we must pay attention to whose pockets we aredipping into. From a moral standpoint, the poor, who certainly have theleast to do with this fiscal mess, should not bear the brunt. Themajority of the people have already sacrificed enough—religiouslycontributing to the government’s coffers through various indirect taxesand withheld income taxes.

And yet, because of the severity of the fiscal problem and the desireto avert the crisis within a narrow window of opportunity, one may betempted to go for tax measures that easily raise the much-neededrevenues but fail miserably in terms of equity. Some may even arguethat this crisis situation is enough justification to tax the poordisproportionately—if only because they are the easiest to tax.

True, there is no “simple, clever, or painless solution to theimpending crisis.” But even as we search for short-run solutions,government must never lose sight of its broader goals of equity andsustainable development. Government must see to it that its actions inthe short run do not exacerbate inequities over the long run. Failureto do so will only create new social problems that will have to beaddressed in the future.

The bias for a progressive fiscal policy should be applied to bothtaxation and spending. In practice, however, progressive taxes may bedifficult to administer (e.g. high evasion rates for the highest incomegroups) or may yield insufficient revenues (e.g. taxes on luxurygoods), justifying government’s reliance on indirect taxes. Aless-than-progressive tax structure can be cured by having aprogressive expenditure program in place to correct the inequitiescreated by regressive tax policies.
Guided by this framework, we call for the following reforms:

· Protect spending for essential social and economic services thatmostly benefit the poor and lay the basis for longer-term growth.

Even as the main strategy to address the fiscal crisis is toaggressively increase revenues, government must likewise consolidateits spending. But the fiscal deficit should not be used to justify anacrossthe-board reduction of government spending. Although there aremany undesirable budgetary items that should be cut, government haslikewise sacrificed spending for the most basic social andeconomicservices. For instance, we observe a significant decline inreal per capita spending for health and
education. On the contrary, despite the fiscal crisis, spending for essential services in real terms should be enhanced.

In short, austerity measures should be constrained by objectives that serve poverty reduction and give space to future growth.

· Push for the real indexation of the excise tax on tobacco and alcohol, and simplify the tax bracketing.

This tax measure has long been overdue. Special taxation of sinproducts is justified because its consumption negatively affectssociety through increased health risks. The revenues collected from sintaxes have been eroded by inflation over time, so that these productsare grossly undertaxed relative to 1997 levels. It is for this reasonthat we reject the diluted House version of the bill as well as theworse compromise brokered by no less than Malacañang.

The lesson we draw from this fatal compromise is that the call forindexation becomes an empty shibboleth without crafting the specificand appropriate design of the tax. Indexation, in fact, is not enough.At present, there are a number of tiers for different products based ontheir value. Products classified as high-priced are taxed more thanmiddle or low-priced categories. The more tiers we have, the more roomwe allow for misrepresentation of products and tax avoidance. Asimplification of the tax brackets must accompany indexation in orderto yield bigger revenues and promote horizontal

· Put in place a targeted petroleum tax.

We propose a differential taxation on petroleum. A well-designedpolluters’ tax can help alleviate traffic congestion and reduce urbanpollution. Similar to the argument for sin taxes, specific taxes onpetroleum have not been adjusted since 1997, and so it is alsocurrently undertaxed.

To enhance its progressivity, the tax on petroleum can be targeted atthe main consumers of gasoline—the car-owning middle classes and therich. This proposal is similar to the United Kingdom’s colored dieselscheme, where the taxed red diesel is intended only for privatevehicles, while the untaxed white diesel is intended for publictransport vehicles. To ensure compliance, spot checks can be organized,and hefty penalties imposed on private vehicles with the wrong-coloredfuel.

Still on the principle that polluters pay, the petroleum tax can besupplemented by a carbon tax, This means a tax is imposed on the carboncontent of power. Dirty power must be penalized through a bigger tax.In this manner, we can promote the diversification of energy sourcesand encourage the use of renewable energy.
•    Impose an across-the-board import surcharge.

Perhaps, the single most immediate tax measure that government canimplement is an across-the-board import surcharge. This measure doesnot require legislation—only administrative action—and adjustment islikely to be minimal for as long as the change is not too big.  Animport surcharge is relatively easy to administer and promises todeliver huge revenues as well. Moreover, in her paper “Fiscal ReformAgenda: Getting Ready for the Bumpy Ride Ahead”, Rosario Manasanestimates this measure to yield 16 billion pesos in revenues for a 2percent surcharge.  Even a 3 percent surcharge is reasonable.

What seems to have been underemphasized in public discussions is therole of the declining revenues from the Bureau of Customs (BOC) in thepoor tax effort. BOC revenues fell from above 5 percent of GDP in theearly to mid-1990s to only 2.4 percent in 2003 as a direct result ofgovernment’s aggressive trade liberalization policy, notwithstandingthe fact that the import oil levy was transformed into an excise tax in1997. In a similar vein, BOC’s share in total tax revenues in 1993, theyear before tariffs were autonomously cut, was 35.61 percent and wentdown to 28.42 percent in 1996.  By 2003, this further declined to20.09 percent.  Clearly, this drop in BOC revenues has contributedto the shortfall in government revenue. If we are consistent in usingthe argument that sectors currently undertaxed should be adjusted, wemight as well include imports.

Contrary to the UPSECON 11’s claim that “international commitmentsprevent significant tariff adjustments,” we in fact have sizeable elbowroom within which we can maneuver our tariff rates.  Our boundrates within the World Trade Organization (WTO), representing themaximum that we can raise tariff levels without violating ourcommitment to the WTO, are well above what we actually apply inpractice.  With regard to vegetable imports, for example, appliedtariffs are only 14 percent as against a bound rate or maximumallowable tariff of 40 percent; tariffs could be doubled and we wouldstill be 12 percent below the bound rate.  On the whole, while ouraverage bound tariff rate for the agricultural sector is a little over34 percent, our average applied tariff by the end of 2003 for the samesector was only 10.32 percent.  For non-agricultural products, theaverage bound tariff was 24.5 percent, while average applied rate wasclose to 2.9 percent.

It is likewise important to point out that practically all other taxmeasures being floated today will definitely have a dampening impact oneffective demand. Such dampening of demand will likely lead to furtherincreases in our already high unemployment.  Surely, with newtaxes and fiscal pressures on investment climate, domestic industriesand labor could very well use some additional degree, however small, ofprotection.

We acknowledge that an import surcharge, an indirect tax like thevalue-added tax (VAT), may also be regressive. However, unlike the VATwhich covers all sectors, an import surcharge will only cover importedfinal and intermediate goods. Moreover, any inflationary effect thatcan reduce consumer welfare will improve the welfare of domesticproducers, protecting jobs in the process.

In the end, the VAT, the import surcharge, and in fact any other taxmeasure will result in higher consumer prices. That is the tradeoffthat we have to accept to avert a full-blown crisis.  An importsurcharge, however, is unique in its potential to protect employment.
•    Limit industry coverage of Board of Investment’sInvestment Priorities Plan, and phase out special economic zones.

Too many and too generous fiscal incentives have resulted in hundredsof billions of pesos in foregone revenues.  In 2003, Department ofFinance (DOF) estimates that foregone revenues arising from fiscalincentives amounted to 174 billion pesos.  Of this total amount,the Philippine Economic Zone Authority (PEZA) accounted for 157 billionpesos, by way of income tax holiday and tax and duty exemptions.

Ideally, incentives should be designed to attract investments thatgenerate quality employment, transfer technology, have strong backwardand forward linkages in the domestic economy, and cultivate futurecompetitiveness. These incentives can be given to those industries thatare technologically strategic to sustain Philippine growth andemployment but by themselves will not attract investments without theincentives.
The regime of fiscal incentives in the Philippines, however, has beenbiased for those industries and firms that are already high-growthsectors and therefore do not need the incentives. (Smart and Globe, forexample, received generous tax perks for several years. Big foodmanufacturing firms like Purefoods, San Miguel, Swift Foods andVitarich are exempted from certain import duties, thanks to a provisionin the Agricultural and Fisheries Modernization Act.)

With a hundred laws granting incentives, four incentive-giving bodies,and no solid, coherent industrial policy, it is no wonder that ouruncoordinated regime of fiscal incentives has only served to attractfootloose investment, with very little sunk costs and no linkages tothe domestic economy.

An immediate measure government can undertake through administrativeaction is to limit the industry categories in BOI’s InvestmentPriorities Plan.  We caution, however, against restricting fiscalincentives to current exports alone. One of the goals of fiscalincentives is to develop industries with a potential for futurecompetitiveness. In rationalizing the industry priorities, we should beforward-looking and grant support for those sectors that have exportpotential in the medium- or long-term.  Rationalizing fiscalincentives, on the basis of an overarching industrial promotionstrategy, will give us more “bang-for-the-buck,” more benefit per unitrevenue forgone, than what we are enjoying today.

Government should likewise target special economic zones, which enjoythe biggest fiscal perks.  These special zones have no backward orforward links in the domestic economy.  They have only served asconduits for smuggling and corruption. But this action should becarefully phased and coupled with safety nets for workers, to minimizethe adjustment from lost employment.

•    Broaden the value-added tax (VAT) base.

The proposed hike in the VAT rate from 10 percent to 12 percent will bedisproportionately borne by poor consumers. Aside from being aregressive tax, this proposal is doubly unjust considering that theevasion rate is very high—estimated leakage for VAT ranges from 26 to38 percent. The most tantalizing feature of this proposal to increasethe VAT rate is its potential for huge revenues—even with substantialleakage.

From an efficiency perspective, the rate increase will only magnify thedistortions in the present VAT, arising from the many exemptions.Increasing the VAT rate penalizes the formal sector and may furtherdiscourage the already-poor tax compliance. This will also serve tofurther disadvantage legitimate businesses vis-a-vis smugglers and taxevaders, who already enjoy at least a 10 percent cost advantage, sothat even the income tax collections from legitimate businesses maysuffer.

Rather than increasing the rate, a more prudent move for government isto address the leakage problem in the VAT. This can be done by firsteliminating many VAT exemptions to ensure that the tax is uniformlyimposed across industries. This will also greatly improve theadministration of the VAT, by widening the audit trail. In addition, weencourage the Bureau of Internal Revenue (BIR) to pursue itsadministrative reform measures to address leakage arising frommisreporting. We likewise urge the public to demand receipts for alltransactions.
•    Broaden the overall tax base.

There are many ways to gather information about tax evaders; some ofthem do not even need legislation.  In fact, CommissionerGuillermo Parayno of the BIR has been able to widen the net throughcomputerization, third-party information, intensive mapping, BIR onwheels, and the like.

Presumptive taxation is also worth exploring.  As a simpleillustration, doctors with clinics at the Makati Medical Center or St.Luke’s Hospital or lawyers working at, say, the Firm or other Ayalaoffices, are presumed to have a high  average annual income andhence subject to  the top rate  on income tax.

Republic Act 9160 and RA 9194, respectively the Anti-Money LaunderingAct and the amendments thereto, could have provided the BIR with anexcellent tool for broadening the tax base.  Had tax evasion beenlisted as an unlawful activity under RA 9160, thus becoming a predicatecrime for money laundering, the Anti-Money Laundering Council (AMLC)would have then been given the responsibility and authority to lookinto the bank accounts of offenders and would have given the BIR theneeded information on the actual amount of financial assets an offendermay be holding.  As the bill progressed through the House ofRepresentatives and the Senate, its provisions were watered-down, andnow we have an Act with very limited coverage.
Again, this is lost opportunity to clamp down on tax evasion.

•    Promote progressive taxation through increasing taxes on luxury goods and real property.

These measures will improve the overall progressivity of the taxstructure. Increasing excise taxes on goods bought by the rich such asluxury vehicles, air travel, jewelry, high-end mobile phones, and thelike deserves support, even as we acknowledge that by themselves theycould not yield substantial revenues compared to other measures.
Not only luxury cars but all types of private motor vehicles should besubject to a higher excise tax.  After all, those who buy thesevehicles belong to the upper classes.  A higher excise tax and anincrease in registration fess of motor vehicles also serve to addressthe problem of negative externalities, namely pollution and traffic.
The real property tax is a tax on wealth and is therefore highlyprogressive. It is likewise a source of hefty revenues, In terms of thecontractionary and inflationary effects common to many taxes, the realproperty tax is probably the least damaging because of its limitedlinkages to the rest of the economy. In fact, a simple revaluation ofzoning values to current levels by the BIR effectively raises theproperty tax revenue, even without raising the actual tax rates.According to the BIR, many revenue districts are still using zoningvaluations based on 1997 and even 1995 property values, while the mostrecent valuations used are from 2002.
Being a local tax, this measure does not directly relate to thenational government’s fiscal position. However, it does provide asubstantial resource base for local governments to pursue progressivespending on social services and infrastructure.  The increase ininternally generated revenues by cities and municipalities alsotranslates into freeing a portion of the central budget that isallocated to local government units (LGUs).

•    Reduce and reform pork barrel funds.

As part of burden sharing, the pork barrel funds have to be cut. In the end, however, the reduction of pork may only be a realignment offunds, since the projects undertaken by legislators should have beenidentified anyway as national government projects. The gain fromreducing pork is greater transparency in the spending, by making fundsnon-discretionary.

We recognize that the pork barrel funds can serve as an incentive forlegislators to approve good laws, especially taking into considerationthat critical revenue measures need Congress’s approval. But as part ofreforming the budget, pork barrel funds must be used to financeprojects that have a clear and direct link to poverty eradication andlonger-term growth.

Most important, cut the biggest pork barrel of them all—the President’snon-transparent huge discretionary funds. To deny this public demandwill only erode whatever credibility the administration has left.

•    Link Internal Revenue Allotment (IRA) releases with counterpart local funds.

The proposal to cut IRA is a dangerous move, and could seriouslyundermine the delivery of basic social services. An across-the-boardcut will adversely affect the ability of many local government units(LGUs), especially those with a small local tax base, to providedevolved social services.

The UPSECON 11 paper, estimates that about 35 billion pesos can besaved by reducing the IRA from 40 percent to 30 percent of the nationalgovernment spending. There is already a de facto 5 percentreduction.  This is a result of the timing of IRA releases, whichare done very late in the year so that LGUs no longer have time to usethem.

On the other hand, it is also true that many LGUs are totally dependenton the IRA, not because of an inability to collect property and otherlocal taxes, but rather because of an obstinate refusal to do so. This is particularly true for cities and higher class municipalities(first to third class municipalities),  which have little excusefor their perennial dependence on IRA.  Addressing this problemthen necessitates the creation of an incentive mechanism for LGUs,especially the higher class units that have the ability to raise theirown revenues. The release of their IRA may be linked to a certainamount of counterpart funds.  To reiterate, we believe that themore prosperous LGUs can raise their own revenues through an increasein the real property tax.

In the medium-term,  a rationalization of the IRA has to includedevelopment concerns, apart from population, area and income, in theformula for allocation.
•    Arrest the bleeding of the National PowerCorporation (NPC) by junking populist policy and relentlessly pursuingthe renegotiation of  NPC contracts with independent powerproducers (IPPs).

NPC is the single biggest contributor to the rise in the consolidatedpublic sector deficit, and it accounts for a huge chunk of the debtstock assumed by the national government. In 2003 alone, NPCcontributed a staggering 81.4 billion pesos of the total 105.3 billionpesos in government-owned and controlled corporation (GOCC) deficits.

At the heart of the NPC problem are the IPP contracts. When GMA’spopularity plunged on account of the high Power Purchase Agreement(PPA) charges to cover the poorly-structured IPP contracts, she decidedto cap the PPA to 40 centavos per kilowatt-hour. This decisiontranslated to a loss for NPC of P0.85 per kilowatt-hour (kWh). Theballooning of NPC’s deficit from 21.7 billion pesos in 2002 to 81.4billion pesos in 2003 is directly linked to this decision.

Further, the government had the opportunity to mitigate its losses whenit undertook a review of the IPP contracts, pursuant to Section 68 ofthe Electric Power Industry Reform Act (EPIRA). Despite findings ofserious financial, technical and legal issues on the IPPs, therenegotiation of the contracts did not yield substantial results. ThePower Sector Assets and Liabilities Management Corporation (PSALM)estimates that the renegotiated terms yielded savings of 994 million USdollars in net present value.  Part of this, amounting to 383 USmillion dollars, is actually from the pre-termination of an IPPproject. The estimated total savings translate to an average reduction0.0908 centavos per kilowatt-hour on NPC’s  IPP obligation up to2011, hardly making a dent in overcapacity and overprice payments toIPPs.

The insignificance of the said renegotiation was to be expected from aconservative framework. The review and renegotiation were conductedwith the conclusive premise that the contracts were all entered intowith the requisite regularity. Given this, government’s proposal tomerely increase power rates cannot suffice, from a moral and politicalperspective.  Fairness requires that the review be reopened withthe view to a more equitable sharing of the burden among consumers andthe IPPs, and exacting accountability from responsible governmentofficials.

•    End the financial hemorrhage of the Metropolitan Waterworks Sewerage System (MWSS).

Starting in 2001 when Maynilad stopped paying its concession fees, MWSSbegan to post deficits of 3.0 billion pesos, 2.6 billion pesos, 3.2billion pesos, and 4.5 billion pesos for the years 2001, 2002, 2003,and 2004, respectively. The concession fees are secured by a 120million US dollars performance bond which MWSS has been unable to draw,first because of Maynilad’s legal maneuvers to forestall the draw, andnow because of MWSS’s unexplainable failure to do so despite theabsence of any legal obstacle. There is in fact a standing resolutionby the MWSS board directing its administrator to draw on the bond on 30July 2004 at the latest, but up to now remains unimplemented.

In addition to immediately drawing on the performance bond for the fullamount, the MWSS should now seriously consider other remedies availableto it outside of participating in Maynilad’s rehabilitation case inorder to stop its financial hemorrhage. We refer specifically to theright of MWSS under the Concession Agreement to initiate EarlyTermination Procedures.
We doubt that its reliance on the rehabilitation proceeding can producea result favorable to government. Aside from unduly delaying theresolution of MWSS woes, the proceeding in the past has only resultedin a compromise agreement, the infamous Amendment No. 2, which is ashameless bailout of Maynilad’s sponsors and grossly disadvantageous togovernment. The substitute rehabilitation plan to  replaceAmendment No. 2, submitted before the rehabilitation court, may be lessshameless, but a bailout nonetheless.

Such display of accommodation of vested interests undermines thecredibility of the GMA administration in leading a policy regime offiscal recovery.

The reforms that we have explained above are far from complete. They have likewise been articulated many times before.  This time,however, all these measures assume greater urgency.

In the very near term, government can easily implement several measuresthrough administrative action: the import surcharge, the limiting ofsectors in BOI’s Investment Priority Plan, and the immediate drawing ofthe Maynilad performance bond amounting to 120 million US dollars.Together, these measures can yield roughly 30 billion pesos in revenues.

Other priority measures that Congress should support include thereduction of the pork barrel funds, the genuine indexation of sintaxes, the targeted petroleum tax, the removal of VAT exemptions, andthe increased taxes on luxury goods. Medium- to long-term reformsinclude the continuation of tax administration reforms, the phase-outof special economic zones, the linking of IRA releases to counterpartfunds, and the review and renegotiation of NPC contracts with IPPs.

The resources that will have to be raised, either from increasedrevenues or expenditure cuts, are indeed enormous. Let us not be lulledinto a false sense of security by a piecemeal approach to fiscalreforms. In truth, there is really no magic number that has to beabsolutely reached.  What is more important is for government toshow its earnestness by immediately acting on the critical revenuemeasures.  Government has failed the initial test for allowingCongress to approve a diluted version of the excise tax on sin products.

Now more than ever, we need from our policy-makers sound tax laws thatwill correct the structural problems in our tax system. We need fromour policy-makers a realistic budget that reflects a progressiveexpenditure program, focusing on basic social services andinfrastructure.

In many cases, invoking urgency has become synonymous with quick-fixsolutions, and setting aside fairness for later. A practical tradeoff,some might call it. After all, if the crisis is not averted, it is thepoor who will suffer the most.  We reject this reasoning, forquick fixes result in worse economic and political consequences.
The great paradox is that while government desperately needs widespreadpublic support to push for new taxes, government cannot win the publicwithout being credible and being accountable.

How can the President convince the people to pay additional taxes whenshe contributed to the making of this fiscal crisis? How can governmentbe credible in asking for new taxes, when it has been irresponsible inusing taxpayers’ money?

The recent expose about massive, high-level military corruption hasfurther weakened government’s over-all credibility.  Of course,the perception is true that the scale of corruption in the military isno different from that of the rest of government.  The policy andinstitutional reforms must therefore tackle the bull by itshorns.  A less-than-ideal but practical approach is, to reformcorruption itself, as it were, making it tame and predictable.

The result of the 2004 national elections may have given theadministration a legal prop, but  as the surveys show, theadministration still lacks the political legitimacy and credibilityamidst the popular perception that GMA won through cheating.  Itwould be counterproductive to revive old debates between the warringparties. At this point, we have no choice but accept that the currentadministration must take on the responsibility of solving the crisis.

The GMA administration is at a crossroads. Solving the current crisisdepends on its capacity to build its legitimacy among the people. Conversely, the regime’s survival depends on whether it can solve thecrisis.  It has no choice but to take the steps necessary to gainpolitical and social legitimacy.  This requires that it turn itsback on the politics of corruption, patronage and subservience to thedemands of the powerful.

In the end, taxation becomes both a moral and political question. Onlywhen government truly and sincerely acts on behalf of the people willit earn its legitimacy and credibility—its very reason for being.

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