Ms. Hazel Jean Malapit is a Research Associate of Action for EconomicReforms.  This article was published in the Yellow Pad column ofBusinessWorld, 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 ofthe sectors that may have to bear the burden of new taxes – that is, ifCongress approves the government’s proposed tax measures.

One wonders, however, how a tax proposal that does not requirelegislation and yet can generate sizable revenues has not been takenseriously by the administration. If indeed generating revenues in theshort run is our most urgent fiscal challenge, what’s not to like aboutan import surcharge?

Taxing foreign producers

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

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

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

To maximize its employment effect, additional taxes on imports are bestimposed on goods to which locally produced substitutes exist. In theseindustries, we expect domestic producers to benefit from the increasedprotection. On the other hand, an additional tax on imported goods towhich we have no locally produced substitutes simply results to higherprices, without any job-protecting or job-generating effect.

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

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

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

The only caveat Dr. Manasan cites in her paper “The fiscal reformagenda: Getting ready for the bumpy ride ahead,” is that an importsurcharge may be inflationary. This can occur directly, through thehigher 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 toits consumers, any tax can increase consumer prices and contribute toinflation. This is true for the VAT. This is most certainly true forthe petroleum tax.

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

A matter of necessity

The truth is, the proposed solutions to our fiscal problems inevitablyerode the competitiveness of our domestic industries. Barraged withrising potential costs – from the higher VAT, higher petroleum tax, andhigher power rates, just to name a few – local industries are in dangerof losing their business to cheaper imports, and creating massiveunemployment.

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

From this point of view, an import surcharge is no longer a matter ofchoice. It in fact complements all the other painful measures that willhave to be implemented to address the fiscal situation. Offering somemarginal protection to local industries is the least the government cando 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?
Calling a spade, a spade

In general, reservations to the import surcharge are rooted in theabsolute confidence towards a liberalized trade policy. But asHarvard-economist Dani Rodrik noted in his 2001 article, “Thedeveloping countries’ hazardous obsession with global integration,” anysuccessful trade liberalization program requires a laundry list ofprerequisites.

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

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

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

Let’s be practical

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

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

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

While legislators are busy digging into GOCC salaries and wrestlingwith line-item budgeting, the President can – if she wanted to – issuean 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?