Timing is everything

Sometimes, the perfect opportunity to happen is a matter of timing. And in regards to tax reform in the Philippines it will have to now before next year’s midterm elections according to Ben Diokno.

From BusinessWorld Philippines

April 03, 2012

Tax reform, poor institutions

This early, political pressure is rising. Senatorial slates are starting to take shape as politicians gear for the May 2013 midterm elections. Yet, Congress is still in the midst of the impeachment trial of Chief Justice Corona. In the meantime, the legislative agenda has been stalled.

And the prospects for the passage of many game-changing legislation — for example, the reproduction health bill, public information act, tax reform which includes rationalization of fiscal incentives and higher excise taxes on “sin” products — are fading past.

The Congress is in recess and will reconvene on May 7, 2012. That would be exactly a year before the May 2013 midterm elections. By that time, it might be too late and too risky to push any significant reform in the tax system. Only a few brave souls would dare pass any meaningful tax changes such as rationalization of fiscal incentives, increasing tariffs on sin products. and widening the VAT base. By definition, real reforms require some pain: reforms that are painless are rare; most reforms hurt, and thus, politically unpopular.

Why has it come to this? Blame it to poor institutions and lack of political leadership. The lack of real political parties in the country does not allow incentives for politicians to vote along reasonable party platform (say, increasing public spending while assuring fiscal sustainability). Instead, a politician is guided by what he considers might maximize his votes rather than what would promote the common good. He would vote for a budget that guarantees his share of the pork, but would reject any new tax measure, no matter how meritorious.

Blame it also on the President who took the hard line that he does not need new taxes to finance his ambitious spending program. Or, put the blame also on his economic manager for advising him that he does not need new taxes, and that all that needs to be done is to improve tax administration.

But the harsh reality it that the present tax system is inefficient, inequitable, and low yielding. Tax effort (taxes as percent of gross domestic product (GDP), after heroic efforts by the Bureau of Internal Revenue director Kim Henares, has remained stuck at slightly above 12%. That is woefully inadequate.

The tax structure should yield a tax effort of 17% to be able to finance the requirements of government on a sustainable basis. The financing needs for the expanded basic education system (K+12), a better health care program, and a more sustained and higher public infrastructure program (modern airports, sea ports, mass transit system, expanded road network, irrigation, water systems, power plants, etc.) are massive.

Two recent studies — the World Bank’s “Public Expenditure Review: Strengthening Public Finance for More Inclusive Growth, June 2011,” and the International Monetary Fund’s “Philippines: Road Map for a Pro-Growth and Equitable Tax System, November 2011” — gave a long list of possible reforms to the Philippine tax system.

There is near unanimity among analysts that the tax incentive system needs a major revamp. The revenue loss could be as high as one percent of GDP (approximately between P40 to P50 billion). The widespread tax incentives result to horizontal inequities among taxpayers. Since a large majority of firms receiving tax incentives are among the largest and most profitable, the present incentive structure leads to greater vertical inequity.

The fiscal incentives rationalization proposal is a serious challenge to Mr. Aquino’s “new” politics. Some incentives are known as “pork barrel in the tax side,” given away by Congress and the President to favored firms in return for political support in the future. Not surprisingly, attempts to reign in fiscal incentives in the past have been answered by more grants of fiscal incentives.

The World Bank study finds the “wedge between the taxation of Philippine companies benefitting from the maximum tax incentives and those that do not — at 19.7 percentage points — is one of the largest in the world.” Put bluntly, the business field is shamelessly uneven: firms enjoying incentives, a virtual who’s who in Philippine business, are greatly favored compared to the other firms in the Philippines and the rest of the world.

There is a strong argument for lowering the corporate income tax rates to be in line with its Asian neighbors. But this measure depends on the ability of policy makers — congressional leaders and the President — to rationalize incentives.

There is a strong argument for reforming the personal income tax (PIT) system. Its progressivity has been eroded over time due to over-generous deduction allowances, poor tax design, and weaknesses in tax administration.

Major reforms in the VAT law are needed. There is a sound argument for increasing VAT rates with the accompanying cut in PIT rates. Taxpayers should be taxed on the basis of what they take away from society (consumption) rather that what they contribute to society (income). I find it unfair that the government takes away one-third of personal income. This is not such a bad idea since the VAT system in the Philippines, which exempts food in its original state, is mildly progressive.

The World Bank study proposed broadening the VAT base “by reversing the exemptions for senior citizens and power transmission.” It would generate more revenues and improve VAT administration.

Many excise taxes need to be increased in order to recover lost grounds since 1997. Excise taxes on cigarettes and liquor have to be increased upward. The indexation feature, introduced as part of the 1997 tax reform, was a monumental failure.

Higher excise taxes on soft drinks and text messaging should be considered.

The IMF study recommends reforming mining taxation. It says: “The existing fiscal regime on mining operations can be characterized as a regime that levies a high royalty rate (5% royalty rate plus 2% excise). Also additional national and local government taxes and fees are not conducive to the development of the mining industry as a source of growth.”

Our experience with tax reforms in the Philippines suggests that reforming the tax system is best done at the start, not towards the end, on any administration. Mrs. Aquino’s 1986 tax reform was a success, Mr. Ramos’s 1987 tax reform was a failure.

Mr. Aquino III’s window of opportunity for reforming the Philippine tax system is closing fast. By failing to reform the tax system now, he risks settling for a watered-down version of tax reform down the road and underspending for his major programs for the rest of his term.

Benjamin Diokno is professor of Economics at the School of Economics, University of the Philippines(Diliman). He was formerly secretary of budget and management in the Estrada Cabinet and undersecretary for budget operations in the Aquino 1 administration.

Article location : http://www.bworldonline.com/content.php?Section=Opinion&title=Tax reform, poor institutions&id=49467

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