The weakest link of the Gloria Macapagal-Arroyo (GMA) administration is
the widening budget deficit. To be precise, the main problem is the
declining revenue collection. Tax administration reforms are necessary
but not enough to increase the revenues to finance growth and
development. Tax administration reforms have to be accompanied by
unpopular tax increases.

The growing budget deficit is probably the weakest link of the Gloria
Macapagal-Arroyo (GMA) administration. But the real problem lies in the
declining revenuecollection— resulting in the bigger budget deficit.

In fact, the current budget deficit as a proportion of GDP (gross
domestic product), in itself, is not that alarming. For 2002, the
government's targeted budget deficit is 3.3 percent of GDP. The ratio
can go higher, if the trend of weak revenues continues.

Some quarters in the GMA administration have tried to justify the
deficit as a case of deficit spending to finance growth. We can concede
that deficit-spending is worthwhile at this juncture so long as it
satisfies two conditions, namely:

  1. Tax reform measures are pursued, and revenue collection targets are accomplished
  2. The revenues are used to finance growth and poverty reduction
    (e.g., human development and infrastructure as defined in its broad

The first is essential for at least two reasons. First, it prevents a
runaway budget deficit, making the deficit manageable. Second, it is a
signal to investors that despite the deficit, the government is
committed to achieving fiscal discipline. In a word, increased revenue
collection as a result of efficient collection and other tax
administration reforms is one essential condition for long-term growth.

The second condition also directly contributes to long-term sustained
growth. In particular, increasing public spending to strengthen human
capital is a priority. Human capital together with democratic and
strong governance is the key to freeing the Philippines from the
shackles of underdevelopment. But a closer scrutiny of the 2002 budget
shows that public spending is barely enough to cover the minimum
development needs.

At any rate, all the talk about deficit spending or pump-priming the
economy is imaginary. The government does not have a strategy for
deficit spending. At the outset, it has been more concerned about
having a balanced budget at the soonest possible time. We can only
surmise then that a spin master has used the jargon of deficit spending
to cover up the inability of the administration to meet its own fiscal

The latest pronouncement from the economic policymakers is that they
are standing by their original target with respect to the budget
deficit. They see the problem of the missed target for the first
semester of 2002 as a challenge that has to be met.
Brave words, indeed. It would however be more prudent for the
policy-makers to exercise flexibility regarding the budget deficit but
maintain firmness and be relentless in the collection of revenues,
especially taxes.

It is crucial to define weak revenue collection as the principal
problem. To address the concern over the widening budget deficit, the
focus must be on increasing revenues, especially tax revenues, and the
attendant need to enhance tax administration.

In the first place, there is not much to cut in public expenditures in
the short term. Across-the-board reduction of public spending would
adversely affect programs and projects that are geared toward long-term
growth and human development.

To be sure, we can always find items in the budget that can and should
be cut. Some, for example, have proposed the abolition of non-essential
government agencies. However, this solution, which is more appropriate
for the medium term, is not sensitive to the immediate issue.
Especially in a democratic setting, a radical move to abolish
government agencies and their personnel would have to go through a long
process of debate. Closure of government offices and retrenchment of
public workers moreover entail costs—including the political
transaction costs (i.e., "side-payments")—that in the short term
compound the budget deficit.

Clearly, then, in responding to the budget deficit, government must
devote its prime attention to the deficiency in tax collection. Time
and again, we must remind ourselves of the perennial problem of weak
tax effort resulting from inefficient tax collection.

Corporate income tax and individual income tax are the biggest internal
revenue earners. However, actual collection for both is far from
approximating the tax potential. A policy paper from the Department of
Finance (DoF) estimated that for 2001, the leakage (actual collection
as proportion of the potential revenue) from the individual income tax
was 72.27 percent. For the corporate income tax and the minimum
corporate income tax, the leakage was 39.86 percent and 87.75,
respectively. In short, the tax leakage is very high in relation to
direct taxation. But evasion is also high with regard to indirect
taxation. The DoF paper calculated that the leakage in the value-added
tax in 2001 was 49.94 percent.

The Bureau of Internal Revenue (BIR) has correctly identified that its
priority is reforming tax administration. It seems, however, that in
practice the BIR is more engrossed with an exercise that is for the
long-term—specifically its advocacy of the "corporatization" of the
BIR. We can debate about the pros and cons of "corporatization," but it
surely is not the panacea to the chronic problem of tax inefficiency.
In addition, it does not address the immediate and urgent problem of
increasing tax revenues now.
The BIR must devote more time and attention to tax administration
reforms such as the presumptive taxation on hard-to-tax income groups;
full computerization of the BIR; and the prosecution of big-time tax
evaders and corrupt high-level revenue officials.

Nevertheless, most of the gains from reforming the tax administration
will not be reaped immediately, either. In this case, tax
administration reforms have to be accompanied by more controversial
measures such as selective tax increases to achieve the goal of
financing development and reducing the budget deficit to a manageable

Increasing taxes is always unpopular, but there are indirect taxes that
enhance the principle of progressive taxation. One example is a tax on
petroleum, the main consumers of which are the rich and the middle
class. To protect the workers and the poor, a mechanism such as tax
rebates to mass transportation cooperatives can be worked out.

Recently, some legislators have accused BIR commissioner Rene Bañez of
conniving with businessman Manny Pangilinan to defraud government of
billions of pesos in revenue. The serious allegation has to be proven
convincingly. However, Mr. Bañez can blunt the attack by demonstrating
his independence from Mr. Pangilinan, who heads the Philippine Long
Distance Telephone Company. For example, the BIR
Commissioner should impose a tax on long-distance calls using pre-paid
telephone cards. This is not arbitrary; in fact it upholds equity. Long
distance calls through fixed landlines are subject to a 10 percent tax.
The use of pre-paid cards to make domestic and international
long-distance calls has been used to avoid taxes.

Another bold measure is to sharply reduce the fiscal incentives. The
huge fiscal incentives are foregone revenues. The strongest argument
against liberal fiscal incentives is that they are not the main
determinant of investment flows.

The real challenge, then, is whether the GMA administration— at this
time that its policies are being constrained by its desire to win the
forthcoming national elections—is willing to undertake the
controversial and unpopular measures.