Posted on Wednesday, December 4, 2002

More tax incentives mean more losses for RP

By Dave L. Llorito, Research Head, and Kristine R. Payuan, Researcher

The first part of the report traces the roots of the budget crisis to three major factors namely massive tax evasion, change in economic structure, and flawed or incomplete tax policy that is being implemented in the worst of times.

WHY is the country suffering from a worsening budget crisis? 

It’s because the tax collectors cannot collect billions of taxes from citizens and businesses each year. It’s also because the country’s economic managers have decided not to collect billions worth of taxes from some business sectors each year.

In 2001, the country’s budget deficit reached P147 billion. In the same year, the total taxes that the country waived amounted to P187 billion, more than enough to cover for the money shortage. In 2000, total taxes waived reached P155 billion while the country’s treasury was short of P134 billion. In 1999, the tax collectors waived totaled P128 billion while the budget deficit was P112 billion. The total taxes foregone were rising while the country’s finances were sinking deeper.

The country did not collect that money because of the various fiscal incentives — income tax holidays, tax-free importation, tax credits, investment allowances — granted to local and foreign investors in the hope of attracting more of them into the country and to the poorest parts of the land. Some investments indeed came but at a very high costs to the economy.

Some policymakers wanted to do away with it, but they are scared of the outcomes as other countries are offering the same or even generous set of fiscal perks. In an effort to outdo the neighbors, the country’s economic managers and politicians offered even more generous perks, hoping that someday, somehow it will eventually pay off. Now, the giveaways have started to hurt and yet government cannot make up its mind.  Unmistakably, this is a symptom of what policy analysts call “the race to the bottom.”

“The BOI [Board of Investments] has been this — that we need the incentives because everybody in the [Asean] region are giving away incentives,” explains Rosario Manasan, economist and public finance expert at the Philippine Institute of Development Studies. “But it’s not static; it’s dynamic — one trying to outdo the other in giving away the incentives. You keep on chasing each other down until nobody collects the taxes.”

“It is quite clear that the Philippine budget is currently suffering the ill-effects of harmful tax competition,” confirms Nigel A. Chalk in a recent International Monetary Fund Study entitled Tax Incentives in the Philippines: A Regional Perspective. “The Philippines, like its regional competitors, is in the midst of a ‘race-to-the-bottom’ to offer the most generous incentives possible …”

He adds: “In order to remain competitive, and to some extent, compensate for the lack of competitiveness in other areas (such as corruption, infrastructure development, geographic location, etc.) the Philippines has been led to offer a broad array of fiscal incentives to entice inward investments and pursue the country’s development goals.”

The Philippines these days has one of the most numerous laws granting all sorts of perks to both local and foreign investments (Table 1). The history of its use dates back about 50 years ago in pursuit of various government objectives, including industrialization and regional dispersal of industries. Over time, such incentives have escalated and eroded the tax base. Thus, it has always been a controversial policy.

“In 1984, in an attempt to rationalize the use of incentives, all tax and duty exemptions were withdrawn by presidential decree,” recalls Chalk. “However, the decree allowed incentives to be restored through the Fiscal Incentives Review Board … and the situation quickly reverted to the previous proliferation of incentives.”

It’s a habit that prevailed even up to this day. As shown in Table 2, there are now at least 45 laws and regulations by which businesses could claim fiscal incentives. The most comprehensive is the Executive Order 226 issued by President Corazon C. Aquino in 1987 giving all sorts of tax and non-tax incentives. There are also the Export Development Act and the Special Economic Zones Act that provide another sets of incentives.

There are also other laws granting incentives for specific industries, sectors, and concerns: oil exploration, coal, hospital and medical equipment, geothermal exploration, iron and steel, hydroelectric power, importation of capital equipment by cooperatives, telecommunications, jewelry, food security, agricultural modernization, export promotion, rent control, among others. 

There are also incentives for specific agencies and private firms, including National Power Corp., Phividec Industrial Estate, Pilipino Telephone Corp., among others. The practice of giving all sorts of incentives seems to have gone wild that almost every business could now claim incentives.

For instance, there are tax credits and a myriad of incentives under various laws for the duty-free shops; energy contractors and operators; non-profit educational institutions; local government units; central bank; Channel 4; cooperatives; Government Service Insurance System; Social Security System; Radio Veritas; Philippine National Red Cross; Christian Era Broadcasting; Girl Scout of the Philippines; imports under the agricultural modernization, imports under the Commission on Higher Education; and imports of garments, planes, ships, and boats and many others.

While the government seems to have been giving away incentives to almost everybody, the process of choosing who deserves to get the incentives are also murky.

Observes Chalk: “… The selection of firms qualifying for incentives under the IPP [Investments Priorities Plan] (under the Omnibus Investments Code) for instance is somewhat discretionary … As a result, the process of granting the incentives is open to lobbying and political pressure … This can serve to undermine investor confidence and worsen the overall investment climate.”

The notion that the incentives system from more that three dozens of laws could be a source of “rent-seeking” is real. For instance, Chalk notes that since an investor is covered by various legislative acts and different incentives regimes provides that investor the opportunity to “incentive shop” or double-dip into the different incentive packages.

“That’s possible,” confirms Manasan.

This is especially so since most investments promotions body may not really have effective monitoring of firms registered with them.

Observes Chalk: “Companies in receipt of various incentives often do not comply with BOI regulations to supply information and financial statements and the BOI appears to have little resources to monitor and control the abuse of incentives …”

The possibility of abuse is real. Consider the Export Development Act that also offers incentives for exporters. The DOF operates a “one-stop shop” where exporters may file for their tax credit claims. In early 2000, the tax credit scheme were rocked by a scandal where textile firms were found to have received P4.5 billion in tax credit certificates under fraudulent claims for duties paid on imported inputs to exported goods.

It was a huge scandal but nothing was heard of the case since then. During that year, the country’s budget deficit reached P134 billion.

To be concluded

Part 1 | Conclusion