Core -- By Benjamin E. Diokno

Folly of ‘no-new-tax’ policy

Posted on March 31, 2011

What should President Aquino do when his "no-new-tax" policy gets in the way of meeting his administration’s goal of achieving sustained. strong, and inclusive growth? What should he do when this inappropriate tax policy gets in the way of creating the fiscal space needed to prepare the country for future crises and disasters? The sensible response is to reconsider -- quickly and decisively.

Most knowledgeable analysts agree that the President’s "no-new-tax" policy is getting in the way of his promised 7 to 8% economic growth. His administration simply does not have the resources to deliver on the needed public infrastructure (despite the promise of public-private partnership initiative), on social spending (K+12 basic education, universal health care, expanded cash transfer program, modern armed forces, and others).

The medium-term fiscal outlook is not promising. After a brief gain this year (largely because of a small budget that was asked by the President and approved by Congress), budget deficits are likely to soar in future years, reaching as high as 5 to 6% from 2012 to 2016.

I have done a first-order approximation of how the national government medium-term budget (from 2011 to 2016) would look like under conservative spending assumptions but with unchanged tax structure.

On the spending side, I assumed no real increase in salaries in wages, but with a 2% increase annually to take care of the growing population. I assumed increases in interest payments consistent with rising debt stock, rising interest rates, and widening deficits. I allowed maintenance expenses to increase by the rate of inflation. Public infrastructure spending to be maintained at 3% of GDP which is assumed to grow by 5% and annual inflation of 4%.

Tax administrative improvement initiatives

I know that the tax intake will not be unchanged. It is expected to increase with some initiatives undertaken by the Department of Finance.

Last Monday, I participated in a public forum sponsored by the Open Budget Partnership, where Finance Secretary Purisima and his top tax managers -- BIR Commissioner Kim and Bureau of Customs Commissioner Alvarez -- presented their programs to improve tax collection.

No doubt, their initiatives to improve tax collection are laudable and should be encouraged. But the merits of making more efficient the collection of an inefficient and unfair tax system are questionable.

I doubt, however, whether their best effort could raise tax-to-GDP ratio by more than 1.5% over five years.

Improvement in tax administration and tax reform are not mutually exclusive. Both are needed. Moreover, tax administration is a function of tax policy design. A simple tax system is easier to administer; a complex one is messier.

Tax effort, or tax-to-GDP ratio, has to increase by at least 5 to 7% in order to finance a big part of the needed infrastructure, investment in human capital, social protection programs, and rising pension requirements for the military and the police.

Managing the tax reform

For tax reform to succeed it has to be done now (actually, it should have been done six months ago). It should be done at the start of a new administration, but still years away from the next elections. The reform will surely be met with stiff resistance next year since it will be too close to the May 2013 elections. For demagogues, political survival comes first. Any reform done close to an election year is generally not real reform. Look at the 1997 tax reform.

For the reform to succeed, it has to be seen as part of a comprehensive tax-cum-public spending program.

Seen as a stand-alone measure, a proposal for a new or higher tax has very little change of surviving.

Thus a higher tax on cigarettes, liquor, and yes, soft drinks may be argued on efficiency grounds (less deadweight loss, in economic jargon) but also on the basis of negative externalities. This means smoking, liquor, and too much sugar are bad for one’s health. But the higher tax could be made more palatable by earmarking a big part of these "corrective" taxes for universal health care.

The rationalization of fiscal incentives could be accompanied by a cut in corporate income tax rates. This will make the Philippines a better investment destination for investors.

It will reduce revenues foregone because of redundant tax breaks. More importantly, it will enhance the fairness of the tax system. Under the present system. it so unfair for honest firms to pay 30% on their profits while their favored competitors enjoy tax exemptions through various tax incentives laws.

A nationwide real property tax piggybacked on locally collected real property tax may be imposed. This will force local governments to collect real property taxes from their favored constituencies. A mayor is less inclined to collect taxes if he owns half of the town.

It will also result in better allocation of resources. For example, if only half of the nation’s wealth which was invested in condos and office spaces in the Bonifacio Global City were invested in factories and modern farms, the Philippines would have been a better place for a vast majority of its people. There would be more jobs and prices of food would be more affordable.

A flexible tax on petroleum products may also be considered: an automatic cut in ad valorem taxes once the price of crude oil hit an upper limit (say. $120 per barrel) and an automatic surcharge once it hit a lower floor (say, $60 per barrel).

The government should not have a tax bonanza when the price of crude oil soars at the expense of the suffering public.

At the same time, consumers should constantly use this scarce, imported resource efficiently, even when it becomes artificially cheap.

These are only some of the new taxes that may be considered to help finance the development needs of a country that should be focused on developing its domestic economy.

A more vibrant domestic economy means more opportunities at home for its growing work force and less need for looking for jobs in foreign places.

Sadly, President Aquino’s "no-new-tax" policy is getting in the way of real progress for a majority of Filipinos.