Mr. Sta. Ana is the coordinator of Action for Economic Reforms(AER).  This article was published in the Yellow Pad column ofBusinessWorld, March 28, 2005 edition, p. 23.

Policy reformers – politicians or technocrats – often have to strugglewith how to treat a compromise. In a liberal democratic setting wherecompeting, conflicting interests negotiate and bargain, compromisesbecome the norm.

This is a difficult and tricky question. Take the piece of legislationpassed during the Fidel Ramos administration that shifted the taxationof sin products from ad valorem to specific. On paper, an ad valoremtax is superior to a specific tax in the sense that the former is basedon value and hence captures any price increases.

The move to a specific tax was intended to stop the tax evasion underthe ad valorem system, in which the manufacturer would pass on anartificially lower price to a dummy.

Hence the value of the product would be lower and lead to less taxes paid.

A specific tax is based on quantity. The tax remains, fixed, and it hasto be adjusted periodically, unless the law contains a provision forautomatic adjustment to inflation.

Alas, the law that Congress passed did not stipulate an indexation toinflation. The whole idea of generating bigger revenues in asustainable manner did not happen. What the reformers thought was asignificant gain in tax policy turned out to be a ruinous victory.

Recently, policy makers attempted to correct this glaring weakness inthe law. The indexation of the tax on sin products was a prioritymeasure.

But again, there was a compromise. In the end, the law that Congresspassed is not an indexation to inflation. The computation of the newrates is based on old prices. Thus, the additional revenues to begained are far less than the optimal. The optimal amount would havebeen about P24 billion, but the compromised law would fetch less thanP9 billion.

The response of the few reformers in Congress to the compromise wasmixed. Representative Lorenzo Tanada III, for one, had some seriousreservations, but he opted to vote for the compromised version, fearinga rejection would have meant loss of revenues. On the other hand, therepresentatives of the progressive party Akbayan took a principledstand by voting against the compromise.

The proposed legislation on the value-added tax (VAT) is likewiseheaded towards a heavily compromised revenue measure. The VAT proposalhas two main features – an increase in the VAT rate from 10% to 12%,and a broadening of the coverage of VAT.

Reformers are divided over this issue. Mainstream economists havecalled for the rate increase to stem the fiscal crisis. Their argumentis simple: the VAT, among the proposed tax measures, has the capacityto generate the biggest amount of revenues. A two percentage pointincrease in the VAT rate is equivalent to P25 billion in additionalrevenues.

However, a VAT rate increase shifts the burden of taxation to the poorand the low-income groups. Action for Economic Reforms (AER) opposesthe rate increase, but it supports the removal of VAT exemptions. AERhas recommended other revenue measures that will be sufficient tonarrow the public sector deficit, even without an increase in the VATrate.
AER argues that the VAT is insensitive to the equity criterion. Theconsumption pattern of the poor includes goods covered by the VAT, suchas processed food. It is easy to see that sardines, noodles, margarine,and the like have penetrated even the remotest barrios, with the poorrelying heavily on such processed food.

Aware of how the VAT can adversely affect the poor, other reformerssuch as the group of Milwida Guevara, Solita Monsod, Roberto de Ocampo,et al. propose a temporary increase in the VAT rate. They favor areturn from the proposed 12% rate to the 10% rate, once the VAT’scontribution to gross domestic product (GDP), or the VAT-GDP ratio,reaches 4%.

Supposedly to protect the low-income groups, the House ofRepresentatives has come out with a version that contains different VATrates, with goods consumed by the poor having a lower rate. The problemwith this is that it only makes the VAT system more complex anddifficult to administer. Multi-tiered rates create distortions andinefficiencies.

It is very disturbing to note that the different VAT measures endorsedby the Senate and the House of Representatives are riddled withmeasures that are inequitable, arbitrary, or hard to enforce. Asidefrom the multi-tiered rates, the versions of both Upper and LowerHouses contain exemptions that favor powerful but narrow interests. Inthe Lower House version, the importation or lease of aircraft engine,equipment, and spare parts of airlines is exempted from the VAT. In theSenate version, international airline and shipping companies enjoyzero-rated VAT: Not only are they exempted from the VAT payment but caneven claim tax credits for VAT inputs.

Cooperatives, already privileged with an exemption, get an additional favor of having lending operations exempted from VAT.

The Senate version (in particular, the bill of Sen. Ralph Recto) isconvoluted. For one thing, it contains a provision to reduce the excisetax rates on diesel, naphtha, fuel oil and unleaded gas. This is plainpopulist opportunism. On the contrary, there is a strong argument foran increase in the excise tax on gasoline, notwithstanding the currenthigh prices of crude oil. A tax increase is justified to address thenegative externalities – traffic and pollution – arising from theconsumption of gasoline. Besides, compared to prices for the rest ofthe world, the price of Philippine gasoline is cheap.

For another thing, the Recto bill wants to increase the corporateincome tax from 32% to 35%. At first blush, it looks progressive. Butgiven the harsh reality of a culture of tax evasion and a revenuecollection agency that is prone to corruption and inefficiency, saidproposal would not result in substantial revenue gains.

In sum, the VAT measures from both Houses fail the test of simplicity,equity, efficiency and non-arbitrariness. The proposed VAT amendmentscannot even be considered second-best options. They deserve to betrashed.