Sta. Ana is Coordinator for Action for Economic Reforms. This article was published on July 28, 2008 in the Yellow Pad column of the BusinessWorld, pages S1/4 to S1/5.

There is no shortage of measures, some of them controversial, to ease the problem arising from the skyrocketing prices of goods, especially of food and oil. The proposals cover a wide range: government subsidies for the poor, higher minimum wage, higher level of income tax exemption, and lower tax rates.

The government’s move to spend and undertake populist measures is not simply driven by compassion and sensitivity to the poor.  For Mrs. Gloria Arroyo, it’s mainly a question of political survival.  Consequently, government spending favors some more than others. Much of the spending, for example, goes to major cities where the agitated urban poor can be easily organized and mobilized.

But the target of appeasement includes the articulate and mobile middle class. A scenario that Mrs. Arroyo dreads is an alliance of the middle class, the workers, and the urban poor spilling out into the streets and blaming the government for their misery. And so, the measures or proposals to provide relief through fiscal tools extend the benefits to the middle and upper classes.

An example of a proposal that will principally benefit the rich and middle class is the call to remove the value-added tax (VAT) on oil.  The 2006 Family Income and Expenditures Survey (FIES) contains a breakdown of the total oil consumption by income bracket. The poor’s share is 5.4 percent.  On the other hand, the share of the rich and upper middle class is 40.3.  The lower middle class has the biggest share of oil consumed, accounting for 54.3 percent.

To illustrate how the VAT on oil affects the masses, take the case of the worker who rides the jeepney to go to work. At the time that the minimum fare was PhP7.50, the amount of VAT he paid was PhP0.03 (based on the rule of minimum gross receipts).  For comparison, we can estimate that a private car owner, driving the same distance that the jeepney charges for minimum fare, would have to shell out about PhP1.50 for the VAT on unleaded gasoline.

Let’s summarize the problems when the VAT on oil is removed.  Certainly, it will shrink revenues considerably. It will weaken the principle of tax neutrality. It may likewise create administrative problems in tax collection.  Note that in the VAT system, the taxable entity will deduct the tax paid at the preceding stage of production (the business entity can recover the input VAT).

And from an equity perspective, it penalizes the poor and benefits those who have the ability to pay.  Of course, everyone benefits from the removal of the tax.  But let’s not forget the tradeoff.  The non-payment of taxes that are mainly paid by those who have the ability to pay will mean a diminished capacity to spend for essential services that have a bigger marginal impact on the poor.

The appropriate intervention is to use the revenues to protect the poor.  This is what Raul Fabella calls “collect [revenue] for targeted subsidy.” Well-designed, well-targeted subsidies, including additional subsidy on public transportation such as the introduction of vouchers, address the pro-poor concern without dissipating revenues.

One version of the proposal to remove the VAT on oil is the bill filed in Congress that replaces the VAT with a specific tax.  But delisting oil products from the VAT coverage distorts the VAT process and weakens the system’s over-all efficiency. Moreover, the specific tax can result in a substantial loss of revenues over the medium term. A specific tax is a fixed amount, independent of the price or value of the item being sold. Based on how it has been applied with respect to the excise on sin products, expect Congress to come out with a specific tax that is not indexed to inflation.

Notwithstanding this argument to retain the VAT on oil, some reformers outside government propose to reduce the VAT rate for all products from 12 percent to 10 percent.  The Philippine Finance Institute of the Philippines (PFIP), chaired by former Finance Secretary Bobby de Ocampo and steered by former Finance Undersecretary Nene Guevara, favors this position.

The PFIP believes that the loss of revenue from reducing the VAT rate for all goods can be minimized, if not compensated, by undertaking tax reforms that have been long overdue—tax administration, the indexation of the excise tax on sin products, and the rationalization of fiscal incentives.

The PFIP draft statement reads: “We do not believe that oil products should be exempt from the VAT.”  But at the same time it says:  “What we advocate is a reduction of the VAT rate on ALL commodities. The increase in the VAT rate from 10 to 12 percent was an exigency measure when the threat of an unmanageable budgetary deficit threatened fiscal stability. Since 2006, government should have put adequate measures to improve tax administration. We are afraid that continuous reliance on exigency measures would ease the pressure on collecting agencies to perform their responsibilities with utmost integrity and competence…. Exigency measures would continuously mask the fiscal problems that we have in tax evasion, avoidance, corruption, and proliferation of incentives.”

One can likewise hasten to add that a significant portion of the taxes we pay do not really redound to the country’s development.  In spite of the higher taxes, this government, perceived by many as illegitimate, has under-spent on essential services and has used billions of pesos to abet corruption, patronage, political gimmickry, and imprudent populism.

The PFIP has introduced the concept of the revenue curse, similar to the resource curse in which the endowment of natural resources becomes a liability to a nation’s development.

Thomas Paine—the American freedom fighter, republican, and liberal—said it well: “What at first was plunder assumed the softer name of revenue.”