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By Dave L. Llorito, Research Head
First of 3 parts
Wholesale failure of the revenue effort —
that’s the simplest way to explain the worsening fiscal deficit.
However, probing deeper into the budget mess will reveal the rough
print of a flawed tax policy that is being implemented in the worst
of times.
At first glance, the budget problem may appear
as a mismatch between revenue and spending (Table 1). It may appear
that economic managers are spending beyond what the country can
afford to pay for. That observation may contain a grain of truth. In
the last 10 years government spending has been growing about nine
percent in current terms and revenue by eight percent. The bad
financial behavior has simply caught up with the country’s weak
finances (See Figure 1).
But if the various components of the country’s
revenue and expenditures were converted into a percentage of the
gross domestic product a “revenue problem” would emerge.
As shown in Table 2, total revenue is composed
of tax and non-tax measures.
Almost 80 percent of tax revenues are brought in
by the Bureau of Internal Revenue from taxes on income and profits,
excise taxes, sales and licenses, and other domestic taxes. The rest
of the revenues come from the collections of the Bureau of Customs
that are essentially import and export taxes, and collections of
other government offices. Non-tax revenues include fees and
charges, income of the Bureau of Treasury, the sale of government
assets, and grants.
It is essentially a revenue problem because
since 1995, government spending has always been within the range of
18-19 percent of the GNP, while revenues have been shrinking since
the Asian currency crisis.
“Over time, expenditures have remained fairly
constant,” observes Dr. Rosario Manasan, economist and public
finance expert based at the Philippine Institute of Development
Studies. “But on the revenue side, revenue has been falling from
about 19 percent on average from 1995 to 1997 as a percentage of GDP
to 17.35 percent in 1998, to 16 percent in 1999, and finally to
about 15 percent of the GDP in 2000 and 2001. By 2002, the revenue
effort may further slide down to 13.93 percent.”
Manasan explains that the country’s revenue
collection is being affected by poor tax collection. Tax collection
as a percentage of the GDP had peaked at 16.98 percent in 1997 from
16.29 percent in 1995 and 16.94 in 1996 during the time of President
Fidel V. Ramos. By 1998, however, the tax effort suddenly dropped,
to 15.63 as a percentage of the GDP. That was the time Joseph
Estrada assumed the presidency. Since then, the tax effort has been
constantly declining: 14.5 percent in 1999 and 13.91 in 2001.
In early 2001, Estrada resigned over issues of
massive corruption and presidential involvement in illegal gambling.
The tax effort never recovered since then. Manasan projects that the
tax effort will further deteriorate to 12.14 percent by the end of
2002.
Manasan explains that non-tax revenues have also
been down but not as bad as those of tax revenues. Non-tax revenues
averaged 2.36 percent of GDP from 1995 to 1997. It went down to 1.72
percent in 1998, and further down to 1.57 in 1999. Since 2000,
however, it appeared to be recovering from 1.65 percent of GDP in
the same period to two percent in 2001.
She attributes the overall decline in non-tax
revenues to the drop in income of the Bureau of Treasury resulting
from slipping domestic interest rates. This is because the interest
rate is no longer used to prop up the exchange rate, she says.
“It is really the tax revenues that have been
consistently going down,” she says.
Figure 2 seems to confirm that all tax revenues
are indeed dropping particularly since 1997, indicating a gradual
unraveling of the tax collection effort since that period. From 1995
to 1997, the tax effort has been generally on the rise, averaging
16.74 in the period. BIR collections as a percentage of the GDP
averaged 12 percent while that of BOC average 4.61 percent.
Things started to turn bad after 1997-1998 when
the entire region came in the grip of a financial crisis. From 1998
to the present, the average tax effort as a percentage of GDP slid
to 15.67 percent. BIR’s share went down to 11.87 percent of GDP
while Customs’ share plummeted to 2.74 percent.
What brought about the current budget mess?
Manasan lists three factors: a flawed tax policy, the change
in economic structure, and massive tax evasion.
Manasan explains that tax evasion has always
been a major headache of the government. Based on studies she made
two years ago, tax evasion rates for individual income taxes range
from 61 percent to 65 percent. In simpler terms, it means that only
about 41 centavos are collected for every peso of collectible taxes
from individuals. Non-payment of the value added tax also ranges
from 63 percent to 67 percent. However, the change in tax policy
simply aggravated the tax evasion problem and created more tax
leakages leading the current fiscal crisis.
Manasan explains that Customs revenues have been
consistently dropping since 1996. In 1995, Customs collection as
percentage of GDP was 5.12 percent. It has not recovered since: from
4.81 percent in 1996 to 2.64 in 2001. Manasan says that it may even
dive deeper this year to 2.43 percent of GDP.
“That is due to largely to trade
liberalization,” says Manasan. “That has been programmed; it is
something that should have been anticipated (by the country’s
economic managers). Because of the reduction in tariffs, collections
will decline even if you are importing the same volume of goods.”
Nevertheless, Customs collections account for
only about 19 percent of the total tax take. Hence, the bigger
problem lies with the deteriorating performance of the BIR.
BIR collections as a percentage of GDP have also
been declining every year particularly since 1997. But if one looks
at the collections from incomes and profits that contain individual
and corporate income taxes, one may notice that there has been a
one-shot decline in 1998. That has been the prevailing situation.
Manasan attributes this trend largely to the
passage of the Comprehensive Tax Reform Package that went into
effect in 1998. The CTRP reduced the corporate income tax rate
from 35 percent to 32 percent and provided greater tax exemptions to
individual taxpayers. Manasan says this proposal is sound
considering that the country has the highest corporate income tax
rate in the Asean region. “The individual income taxpayers bear
the brunt because they have largely been bearing the bigger portion
of the tax revenues,” Manasan says.
The problem lies with BIR’s inability to
collect from the self-employed and the professionals (e.g. lawyers,
doctors, engineers, among others). Close to 80 percent of
collections from individual income taxes comes from compensation
income. In fact, BIR collections from compensation income are five
times bigger than the tax take from business and professionals.
Manasan explains that the problem really lies
with the fact that CTRP that was passed by Congress has been a
watered down version. As originally proposed, the CTRP as a
comprehensive package contained both “revenue-losing” and
“revenue-gaining” components. The revenue- losing components are
the reduction in corporate and the individual income taxes. The
revenue-gaining components are the rationalization of fiscal
incentives that has been a major source of fiscal leakages reaching
more than a hundred billion of worth of foregone taxes. In 2000, for
instance, the total revenue foregone due to fiscal incentives
reached P148.52 billion.
“However, when CTRP was proposed to Congress,
for some reasons, legislators broke the reform package into two —
one for revenue losing and the other for revenue gaining,” Manasan
says. “At the end of the process, what emerged was a law that
contained only revenue losing components.”
Another major source of the leakage are excise
taxes. These are taxes slapped on goods produced in the Philippines
for domestic consumption, in addition to VAT. Some of the more
common goods affected by excise taxes are tobacco and cigarettes,
beverages, and petroleum.
From 1995 until 1997, the excise tax averaged
2.38 percent of GDP. Since 1998, its ratio has been consistently on
the decline, reaching 1.61 percent of GDP. Again, Manasan relates
this problem to the CTRP that provided a shift to specific tax from
ad valorem tax. Under ad valorem taxation, the tax slapped on
certain commodities is based on its value. Under the specific tax
system in the CTRP passed by Congress, the tax is based on the peso
value per volume and is not indexed to inflation. This has become a
major source of revenue losses for the government.
“Under the original CTRP proposal, the
specific taxes are indexed to inflation,” Manasan says, explaining
that indexation would mean that the tax take should rise with the
overall increase in the prices of goods. “But this was not carried
in the version that became the law. In the end, it became also
revenue losing.”
The other bill to rationalize the fiscal
incentives has also not taken off the ground. This is because of the
disagreement between the Department of Finance and the Board of
Investments. The DOF says that it’s a big revenue leakage but the
BOI says the fiscal incentives are needed to attract investments.
This policy paralysis has led to government foot-dragging on the
revenue-gaining component of the original tax reform package.
“In the end, nothing has been done about
it,” says Manasan. “The entire CTRP law became revenue
losing.”
What aggravated the problem is the fact that
CTRP took effect in January 1998, at the height of the Asian
financial crunch. That crisis started in May 1997 with speculative
attacks on the Thai currency. The Thai government initially tried to
shake off the attacks by defending its currency. Three months later,
the Thais lost much of their reserves, forcing them to float the
baht. This move immediately led to the rapid depreciation of the
Thai baht, dragging down other Asian currencies including the
Philippine peso.
By the end of 1997, it became a full-blown
financial crisis, battering stock and real estate markets as well as
financial institutions throughout Asia. As investors lost
confidence, economies went into recession. The Asian Development
Bank says that for many countries, the economic difficulties it
spawned equaled the Great Depression of the 1930s.
Since then, life for the Philippines has never
been the same. It didn’t help that the Estrada Administration that
took power in 1998 were regularly wracked with charges of corruption
and sheer ineptness until it succumbed to popular protests in early
2001.
When President Macapagal-Arroyo took the reins
of power, the economy, particularly the industry sector, was
listless (See Figure 3), battered by political instability and
terrorism. All these events have led to a change in the structure of
the economy, which according to Manasan, is another factor for the
low tax intake.
During the Ramos presidency, the foreign media
referred to the Philippines as another “Asian tiger,” impressed
by a five- to six-percent economic growth rate. A vibrant
industrial sector then was a major linchpin of that high growth
rates. Since the Asian crisis, the country’s GDP has been
hovering at three to four percent, kept afloat largely by the
resilience of the agricultural sector and the increasing flow of
remittances from overseas workers. Save for the last two quarters
where the industry sector grew at an average of five percent, the
industrial growth has been flat at an average of 1.3 percent.
There’s really nothing bad about agriculture
lifting the economy on its shoulders, except that this sector is the
least taxed among the various components of the economy. This also
translates to lower tax collections.
With Kristine R. Payuan, Researcher
Part 2
| Conclusion
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