Bye bye, Build Build Build?

The Tax Reform for Acceleration and Inclusion (TRAIN) has been billed as the administration’s flagship legislation for achieving sustainable seven percent growth, generating investments and jobs,and reducing poverty. If TRAIN is derailed — kiss Build, Build, Build, bye bye.

There is some concern that the Senate version of TRAIN passed two weeks ago, heavily diluted the original tax reform package proposed by the DoF. According to press reports citing the Legislative-Executive Development Advisory Council (LEDAC),the likely incremental revenue yield of the Senate bill is only around P55B, around 0.3% of GDP. Compare this to the target revenue yield of the original proposal of the DoF of P157B, (1% of GDP), or even the House version of P134B (0.8% of GDP). Or what the Philippine Development Plan aims: for infrastructure spending to ramp up to 7% of GDP by 2022 from last year’s 3.4%.

Moreover, as stressed by Foundation for Economic Freedom last Sept. 14, “Tax reform is particularly important in the face of new spending mandated by Congress — free irrigation, free tuition in SUCS (state universities and colleges), escalating pension benefits of uniformed personnel, and increases in SSS (Social Security System) pensions unmatched by increases in contribution.” The incremental yield of the Senate bill barely covers the estimated first year cost of the free tuition law. And with inordinate amount of earmarks to boot.

If government pursues its programmed five-year infrastructure spending on top of all these Congress-mandated new ones without the matching new revenues, the country courts an explosive public debt buildup.More immediately, we put at risk another “BBB” — the Philippines “investment grade” credit rating. Keeping an investment grade rating is essential. It makes the country attractive to investors and keeps borrowing cost low for both government and the private sector, including small businesses and first time homebuyers.

The major sources of dilution in the Senate version according to experts are —

1. Plugging VAT exemption loopholes. The Senate version only lifted 36 VAT exemptions from the 70 lines in the DoF bill. Moreover the Senate bill gives new exemptions to ecozones.

2. Fuel taxes, auto excise taxes were watered down and made more complicated.

3. The option to pay 8% on gross for all self-employed, in lieu of income taxes at the top marginal rate of 35%.

On the VAT exemption loopholes, the consequence of having too many holes is a VAT yield of only 4.3% of GDP, around the same as Thailand’s, even when their VAT rate is only 7%.

My favorite example of a bad tax exemption — seniors citizens’ VAT exemption on top of a legally mandated 20% discount. This is exceedingly regressive as government subsidizes in direct proportion to amount of spending, and gives minimal benefits to the needy elderly poor. Its other objectionable feature from a tax policy standpoint is the high administration cost, and its window for abuse by opportunistic taxpayers/establishments and crooked tax collectors. The DoF originally proposed to limit this exemption to medicines, and to instead provide annual cash transfers similar to the Pantawid Pamilya for the elderly poor.

There are dozens of similarly unmeritorious exemptions like this that the DoF tried to wholesale correct in their version of the bill. (At the same time, the DoF has shown flexibility in recognizing truly deserving cases. For example, with the BPO industry, one of two key drivers of the economy in terms of direct and indirect employment, foreign exchange, and economic activity. Both House and Senate versions provide for a formula that allows the industry to continue to significantly contribute to the economy in the face of anti-outsourcing rhetoric in the US, concerns of foreign clients over security concerns like Marawi/ISIS, and the accelerating negative impact of technological disruption/Artificial Intelligence.)

On the oil taxes,while the three versions converge to same rate after year 3, the Action for Economic Reforms has argued that the back loading, especially in the Senate version impacts on the ability of government to fund the compensating cash transfers needed in the early years.(Though one can also argue that timing actually dovetails with the J curve ramp up in infra spending, given government’s absorptive capacity/execution limitations.) There is also the risk to the planned revenue increase for the outer years due to the 2019 election.

Finally, on item 3 — the revenue losses from the overly generous eight percent gross option for the self-employed (initially only for smaller establishments), has been estimated by the DoF/AER to be upwards of P20 billion. While its Senate sponsors have argued that there will be more taxpayers who will pay with the much lower rate, I doubt that tax evaders now paying zero will find virtue just because the tax rate is lower. Especially since, surfacing previously hidden income stream may expose them to charges of evasion on past income.

Moreover, this measure severely fails the test of horizontal equity — as salaried people, especially at the higher tax brackets, will be subject to three to four times the burden of the self-employed.

In order to make up for the huge gap in revenue yield, the Senate version introduced new items that were originally programmed for future packages by the DoF. They have thus not been subject to full consultations. Some quick notes on these new items:

1) Increase in taxes on dividends and on FCDU dollar interest income to 20%.

Premature and piece meal in light of a comprehensive review being undertaken by a team of experts commissioned by the DoF/ADB for reform of capital income taxation (interest, dividends, capital gains) across institutions and financial instruments. The objectives of this capital income tax reform (package 4) include greater neutrality, fairness, simplicity, and efficiency — to be supportive of government’s capital market development efforts.

2) Coal tax dubbed a carbon tax.

The Senate bill proposed doubling the coal tax from the current P10 per ton. While even this higher level seems modest compared to what is being pushed by alternative fuel interests,this tax should have been left for fuller study under the DoF’s package 5, taxation of products with negative social externalities (which also includes tobacco and alcohol).

Advocates have argued for a much heavier tax on coal based on coal’s higher per unit contribution to global Co₂ vs. alternative fuels. They fail to consider that the Philippine Co₂ footprint is just 1% of world total,the lowest in ASEAN. Moreover, the renewable energy component of our power mix at 35%, is way above global average — thanks to forward looking investments done over decades in efficient hydro and geothermal plants.

The question we need to ask in levying higher taxes on coal is — given the country’s aim to promote manufacturing investments and job creation, can we afford to further add to our high electricity costs? Such have been made higher recently by compounding feed in tariffs subsidies for wind and solar.

3) Cosmetic surgery (or cosmetic products) tax. This and other similar small yielding tax measures are just administrative burdens.

One is tempted to say, purely cosmetic. But nonetheless valid considerations in Philippine politics, especially bearing in mind 2019 midterm elections. I trust that the bicam and Congress as a whole will find the right balance between short term politics and our country’s long term development imperatives.

Romeo L. Bernardo is a board director of the Institute for Development and Econometric Analysis. He was undersecretary of Finance during the Corazon Aquino and Fidel Ramos administrations.

romeo.lopez.bernardo@gmail.com