The passage of the first package of the proposed Comprehensive Tax Reform Program (CTRP) in the Lower House of Congress last week is credit-positive for the Philippines because it will address the government’s weak revenue generation, credit ratings agency Moody’s Investors Service said.
The Philippines has a ‘Baa2 stable’ rating from Moody’s.
Dubbed the Tax Reform for Acceleration and Inclusion (TRAIN), the CTRP’s first package was approved by the House of Representatives by a 246-9 vote with one abstention on May 31 before the Congress’s adjournment. The proposed TRAIN Act is now pending at the Senate for approval.
The Act aims to lower income taxes and make up for the consequent revenue loss by plugging tax leakages, limiting value-added tax (VAT) exemptions and adjusting excise taxes on fuel, among other measures.
The TRAIN is a consolidation of the original tax reform bill—House Bill 4774—with 54 other tax-related measures.
“The TRAIN bill will boost revenue and improve the government’s debt affordability, as measured by interest payments as a share of revenue,” Moody’s Vice President and Senior Credit Officer Christian de Guzman said in an article from Moody’s Credit Outlook released on Monday.
De Guzman said in the outlook that while the government revenue has improved by nearly 2 percentage points to 15.2 percent of gross domestic product (GDP) in 2016 from 13.4 percent in 2010 on administrative measures that improved tax compliance, the Philippines still collects less revenue than most investment grade Baa-rated peers.
Its revenue collection is higher only than that of Indonesia (which has a Baa3 positive rating), whose revenue was equivalent to 12.5 percent of GDP in 2016; Colombia (Baa2 stable) at 14.9 percent; and stands well below the developing country Baa-rated median of 22.9 percent, he said.
However, de Guzman also pointed out that although changes reflected in the approved bill from the original bill will erode revenue, they are more than offset by additional taxes on items such as automobiles, fuel and sugar-sweetened beverages.
The latest estimates by the Department of Finance (DoF) showed the government may generate P130 billion in potential net revenue in the first year of implementation of the proposed measure, 17 percent down from P157.2 billion the economic managers originally estimated under HB 4774, where 95 special laws that would be repealed were listed.
The original version did not include the tax on sugar-sweetened beverage, but provided for the indexation of fuel excise taxes to inflation after a three-year period.
It also provides for a five-bracket tax scheme for automobiles, compared with the DoF-endorsed four-tiered structure. It will be implemented on a two-year staggered basis starting 2018, instead of the original proposal of full implementation in the first year.
“Official estimates of the tax reform’s revenue effect are still forthcoming, but we expect that the debt affordability ratio will fall to less than 13 percent by 2018 from 24.4 percent in 2010, should the bill pass into law later this year,” de Guzman said.
Crucial in narrowing deficits
De Guzman added that the TRAIN bill awaiting Senate approval is also crucial to maintaining narrow fiscal deficits since the administration of President Rodrigo Duterte intends to ramp up infrastructure spending over the course of its term through 2022.
The government aims to spend P847 billion on infrastructure development this year, covering projects in all regions, including small-, medium- and large-scale ventures. In the six years to 2022, the government intends to spend P8.4 trillion on infrastructure.
“The TRAIN bill will also help to keep fiscal deficits in check as the government’s plans to increase expenditures gradually to 20 percent of GDP by 2020 from the budgeted target of 18.3 percent this year. Over the same period, the government expects to increase infrastructure spending to 7.1 percent of GDP in 2020 from 5.3 percent in 2017,” he said.
But in the absence of tax reform, the Moody’s official warned that fiscal deficits could widen beyond the 3 percent of GDP level currently envisioned in the government’s projections for the years to 2022, potentially reversing the debt consolidation trend that started in 2010.
Govt capacity for reforms
De Guzman also stressed that the passage of the tax reform bill also demonstrates the capacity to implement reform amid the political controversies around the government’s focus on security and the war on drugs.
Since last year, President Duterte’s administration has been mired in various controversies related to his focus on security and the war on drugs. As a result, strained relations with some factions in both houses of Congress threatened to detract attention away from the reform agenda, particularly those related to economic and fiscal matters.
“Nevertheless, Mr. Duterte has maintained high approval ratings among the electorate, as well as a coalition comprising a strong majority in the House of Representatives, and has leveraged his political capital to push the TRAIN bill through the legislature,” he said.