Binding constraints: Corruption and limited fiscal space

By Pia Rodrigo and Filomeno S. Sta. Ana III

PRESIDENT Ferdinand R. Marcos, Jr. has entered the second half of his term with many promises to fulfill, but constrained by dwindling political capital, as shown by the administration’s performance in the 2025 midterm elections.

Although a recent OCTA survey (May 2025) said that President Marcos’ satisfaction rating is a high 68.1%, this does not translate into sufficient political capital. The political capital is necessary to pass difficult legislative reforms. For instance, a Senate that is mainly opposition, regardless of political color, will constrain the administration’s legislative agenda.

Further, the high satisfaction rating stands on shaky ground. Populist measures like the P20-per-kilo rice and different kinds of ayuda, make the masses happy. But this populism is fiscally unsustainable.

Nonetheless, if the President would like to leave a good legacy, he could use his high satisfaction rating to overcome the present major obstacles, introduce the durable reforms, and enable longer-term growth. His satisfaction rating should give him confidence that bold reforms can be done in the last three years of his term.

Thus, despite facing a few controversies, including the 2025 budget which was tagged by civil society as the most corrupt budget in Philippine history, President Marcos can still rectify the situation, move beyond business as usual, and adopt decisive reforms.

The administration must contend with what the World Bank describes as “weak Philippine growth until 2027.” The administration in truth has failed to meet its original growth targets. To save face, it has annually revised the targets downwards.

PROCESS OF IDENTIFYING BINDING CONSTRAINTS
As a first step, the Marcos administration needs to identify the binding constraints to private investments and growth. From there, determine the appropriate policy interventions. To undertake this, the growth diagnostics approach, popularized by Ricardo Hausmann, Dani Rodrik, and Andrés Velasco, is useful.

Examining low levels of investments and entrepreneurship, the diagnostics approach narrows the policy priorities through a decision tree, it explores possible causes, and picks out which constraints to investments are the most binding. To quote Hausmann et al., a growth and investment strategy must have a “sense of priorities” and targeting the most binding constraints “is likely to provide the biggest bang for the reform buck.”

Using the growth diagnostics approach, we then ask a series of questions, which would eventually lead us to the most likely binding constraints.

For example: Does an external shock like the US President Donald J. Trump’s high tariffs constitute a binding constraint? Analysts have pointed out that the Philippines is not as deeply integrated into the US and global markets, and hence the overall effect on our economy is rather “limited.”

Net, can the main obstacle be the high cost of finance? Globally, interest rates are stable or low. In the Philippines, the central bank has likewise pursued an easing of monetary policy. This August 2025, the central bank cut its benchmark rate by a quarter point. It has also signaled a further rate cut before the end of the year.

Or is the binding constraint attributed to low appropriability like high prices? At the start of Marcos’ term, post-pandemic inflation shot up because of supply bottlenecks, which in turn fueled inflation expectations. This became a barrier to investments,

It did not help either that import controls, low productivity, underinvestment, poor infrastructure, and oligopolistic market structure exacerbated the rise in basic food prices.

But general inflation in July 2025 stood at 0.9% (or a national average of 1.7% from January to July 2025). That said, food poverty and hunger persist, suggesting that the government must make food more accessible and affordable.

Is the binding constraint low human capital? The many persistent problems relating to education and health outcomes, their non-resolution will have a bigger economic impact in the future. But they have not seriously undermined current growth. In fact, labor productivity in the Philippines has improved in recent years. In 2024, it rose to 4.5% year on year. The problem is that workers are not even being given a fair share of the productivity gains, based on the data on huge wage markdown.

Is the binding constraint infrastructure? Poor and inadequate infrastructure used to be a most binding constraint. The Duterte administration addressed this by almost doubling government spending for infrastructure from 2.8% to 5.5% during its term.

CORRUPTION
The current problem is how the budget for infrastructure has become severely corrupted. To wit: The diversion of budget items to corruption-prone projects (e.g., flood control), the huge overpricing, the use of substandard materials, and even the existence of ghost projects. Most telling is the statement of Senator Panfilo M. Lacson that “sometimes less than 40% of project costs” is left for actual implementation. Outspoken mayors for good governance like Benjamin B. Magalong and Vico N. Sotto have likewise narrated stories about blatant corrupt practices.

Considering all this, BusinessWorld columnist Diwa C. Guinigundo wrote that “the biggest drag on our economic momentum is not inflation, nor interest rates. They have been tamed. It is corruption — plain, cruel, and devastating.” (See “Crawling beneath the bar of Caesar’s wife,” Aug. 29, 2025.)

Corruption has drained the public coffers and has deteriorated the government’s fiscal position. But other factors contribute to the worsening fiscal problem. The government has allowed inefficient, inequitable, and unsustainable expenditures like the different types of patronage ayuda and the inequitable health benefits that have not been subject to a technically rigorous assessment. It has abandoned the reform of the increasingly costly pension system for military and uniformed personnel; they do not contribute a single centavo to their pension fund. And it has rejected sound proposals to generate substantial tax revenues through, say, health taxes.

NARROW FISCAL SPACE
Thus, while the high degree of corruption has significantly contributed to the country’s shrinking fiscal space, the narrow fiscal space in itself is a most binding constraint.

For context, the government has yet to successfully unwind the deficit and reduce the debt burden from the COVID-19 pandemic, a time of understandable high deficit spending and borrowing. More disturbing is the fact that the trend for debt-to-GDP ratio, instead of going down during the post-pandemic period, has risen from 60.6% for the full year in 2024 to 62%, or nearly P17 trillion, as of March 2025.

Meanwhile, the projected National Government (NG) deficit for 2025 is equivalent to 5.5% of GDP, barely an improvement from the deficit of 5.7% in the previous year. Note that before the pandemic, the deficit stood at 3.4% of GDP.

Sadly, Finance Secretary Ralph G. Recto turns a blind eye to the fiscal problem. Secretary Recto maintains his position that the country’s fiscal position remains robust.

“Strategic measures were prepared to ensure fiscal sustainability and provide necessary buffers amid rising global economic uncertainty due to political tensions, prolonged higher interest rates, and unpredictable trade policies. But given our current strong fiscal performance, these are not needed at this time,” Secretary Recto said in an April 2025 statement. Further, Secretary Recto has adopted a firm stance of “no new taxes” until the end of the Marcos administration.

The Bureau of Treasury, in its 2024 Full-Year Cash Operations Report, reported that total revenue collections in 2024 reached P4.419 trillion, or 16.72% of the country’s GDP, the highest revenue effort since 1997.

NONTAX REVENUES
A closer look at some indicators will belie Secretary Recto’s statements. The seemingly satisfactory revenue effort is deceiving. Note that “better-than-expected” nontax revenue collections primarily drove higher total revenue collections. These nontax revenues included public-private partnership concession fees amounting to P30 billion, and notably, P167.2-billion transfer of funds from two government-owned and -controlled corporations (GOCCs), the Philippine Health Insurance Corp. (PHIC) and the Philippine Deposit Insurance Corp. (PDIC).

In short, the bulk of these non-tax revenues are regurgitated revenues — huge transfers from PHIC and PDIC. Moreover, the transfer of these “fund balances” has been challenged at the Supreme Court, with petitioners calling on the Court to declare the provision transferring the GOCC funds unconstitutional for being a rider to the General Appropriations Act.

Beyond the illegality of the act, citizens have been questioning the wisdom and morality of the transfers. The PhilHealth funds are social health insurance premiums of indirect contributors or the indigent population, persons with disabilities, and senior citizens. The PDIC’s mandate is to protect the funds of bank depositors.

At the root of the PhilHealth and PDIC fund transfers is massive corruption that led to bicameral insertions of pork barrel projects in the programmed appropriations. The pork barrel projects bumped off the development programs, which became unprogrammed appropriations (UA). In turn, the UA’s funding depended on the transfers from PhilHealth and PDIC.

It is a fluke to base overall revenue performance on nontax revenues. Nontax revenues like the transfer of PhilHealth and PDIC funds to the National Government are artificial, non-recurring, unstable, and worse deceptive.

TAX REVENUES
But even with respect to tax revenues, the recent performance is mediocre. Analyzing tax revenue collections shows that actual collections missed the target set by the Quarterly Fiscal Program by 0.51% in 2024.

Moreover, the tax revenue collection got a superficial, temporary boost from a change in the filing schedule from monthly to quarterly. The Bureau of Internal Revenue (BIR) reported: “The substantial rise in VAT collections resulted from collecting 12 months’ worth of VAT in 2024 compared to just 10 months’ worth in 2023.”

In addition, a bonus that will not repeat is the increase in personal income tax collections, “driven mainly by higher government employee salaries with the implementation of Executive Order No. 64 s. 2024.”

The fluke pertaining to the 2024 revenue performance, thanks to nontax revenues, will point to a shrinkage of almost half of projected revenue contribution in percentage terms to the fiscal balance in 2025. (Source: Budget Expenditures and Sources of Financing, FYs 2018 to 2025.)

STUBBORN FISCAL DEFICIT
In response to the stubborn fiscal gap, Finance Secretary Recto recently adjusted the borrowing plan to P2.6 trillion from P2.55 trillion. Worse, the government has consistently moved its targets after failing to reach them. Most recently, the Department of Finance (DoF) lowered the growth targets from 6%-8% to 5.5%-6.5%.

Said differently, the lackluster fiscal performance has sacrificed growth. The fiscal pressures have a constraining effect on investments and human capital development programs.

In June 2025, the national budget deficit shot up to P241.6 billion from P145.2 billion in May 2025 as spending continued to outpace revenue collections. Year-on-year Treasury data indicate that this is a 15.56% increase from the P209.1 billion deficit in June 2024.

In the first six months of 2025, the National Government’s budget deficit widened by 24.69% to P765.5 billion from the P613.9-billion gap last year. The BTr said the budget deficit remained relatively within target as it was 0.63% above the programmed P760.7 billion for the first half.

So far, the Marcos administration has only successfully legislated two tax reforms: the Value-Added Tax (VAT) on Digital Service Providers Act, which will collect P102 billion until 2029, and the Capital Markets Efficiency Promotion Act (CMEPA), which will collect P25 billion until 2030. Other reforms, including the motor vehicle road users’ tax (MVRUT), the excise tax on single-use plastics, and excise taxes on alcohol, vape products, junk food and sweetened beverages have been dropped.

Rather than pursuing fiscal consolidation, the administration has increased politically motivated, populist, and corruption-prone expenditures and pursued revenue-eroding measures.

Congress passed the CREATE MORE Act, which repeals the law that rationalized fiscal incentives, the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act. CREATE MORE destroyed the core of the CREATE reform: giving incentives based on rigorous, fair, performance-based, and transparent rules administered by the Fiscal Incentives Review Board.

Another threat is the continuing intense lobby of the tobacco industry to railroad a bill that will effectively lower tobacco tax rates. Although the attempt to pass the bill (House Bill No. 11360) in the last Congress was thwarted, expect the bill to be resurrected in the current 20th Congress. If passed into law, over the next 10 years, the said bill will result in over one million new smokers and P176.5 billion worth of lost government revenues.

Solving the fiscal space problem has two major features. On the spending side, the government must stop the corruption of the budget and do away with inefficient and inequitable spending. Here, President Marcos, Jr. has called out the corruption in the flood-control projects. Public anger and vigilance can likewise restrain corruption.

On the revenue side, given the stubbornness of Secretary Recto towards tax reforms, the President can come forward and tackle the bull by its horns. The President must get the assurance that some tax reforms that efficiently generate substantial revenues have popular support.

We refer in particular to health taxes. Raising taxes on alcohol, sugar-sweetened beverages, tobacco, and vape products is a win-win. They discourage consumption of harmful products that contribute to non-communicable diseases like cardiovascular disease, diabetes, and cancer while raising government revenues that will create fiscal space as well as finance health and nutrition programs.

Admittedly, it is most challenging to pursue reforms in the last half of the presidential term. But President Marcos has shown that he can express intense anger about corruption of the budget. We hope he will exhibit the same intensity to solve the intractable fiscal problem and, to quote his former Finance Secretary Benjamin E. Diokno, to avert a “fiscal collapse.”

For the Marcos legacy to happen, he must surmount the most binding constraints, namely corruption and the narrow fiscal space.

Pia Rodrigo is strategic communications officer while Filomeno S. Sta. Ana III coordinates the Action for Economic Reforms.