Core
Business World, 12 April 2016
Without question, it is the economically smart thing to do. Any presidential candidate who promises not to reform the Philippine tax structure does not understand the enormity of the country’s economic problems and is not getting honest and competent advice from his or her economic experts.
It would be a monumental mistake to assume that there is nothing wrong with the way the present administration is managing its fiscal affairs. It is wrong to assume that the way the budget is prepared and implemented, which is characterized by underspending and opaqueness, is the right thing to do.
It is wrong to assume that there is no need to fix the present tax system, despite the fact that it is too complex, economically inefficient, unfair, and does not generate enough revenues to finance essential public needs.
It is wrong to assume that tax effort — defined as taxes as percent of GDP — can be increased without raising taxes or broadening the tax base. It is wrong to assume that the government can do what is expected of it simply by improving tax administration.
The harsh reality is that with ASEAN integration, and with the rising clamor for tax harmonization in the region, the Philippine tax system is not aligned with its ASEAN neighbors.
At a time when the Philippines desperately needs more foreign direct investments (FDIs), the statutory and effective rates of its personal and corporate income taxes are too high compared with its ASEAN counterparts.
But why do our national leaders continue to believe that the status quo is the appropriate public policy? “Why fix it when it isn’t broken?”, those who don’t want to reform the tax system might ask. But precisely the tax system is archaic — it is 19-years old. It has not kept up with inflation. It is not harmonized with our ASEAN neighbors (see graph).
Since EDSA-1, there were only two episodes of tax reform: first, Cory Aquino’s 1986 tax reform program and second, Fidel Ramos’ 1997 comprehensive tax reform program.
Tax effort reached its peak (15.3%) in 1997, a result of the 1986 tax reform program. The reform was a successful one because it was comprehensive and was done during Mrs. Aquino’s first year in office. The VAT concept was introduced for the first time to replace a myriad of indirect taxes.
It helped that tax reform program was crafted and passed under a Revolutionary government, that is, when Mrs. Aquino exercised both executive and legislative powers.
By contrast, the Ramos comprehensive tax reform program was a failure. It was not comprehensive. It was long-winded rather than swift. VAT base was narrowed rather than expanded. Specific measures were acted upon separately.
The timing of the reform was poor: it took place towards the end of the Ramos presidency and nearing the next Presidential elections. Consequently, the tax reform became an opportunity for compromises and accommodations by politicians running in the 1998 elections. Congress passed, and President Ramos, approved a watered-down version of the original proposal. As a result, tax effort deteriorated.
After four years of large budget deficits, Mrs. Arroyo was forced to amend the VAT law. The tax base was broadened and the VAT rate was increased from 10% to 12%. As a result of this stand-alone measure, tax effort rose from 11.8% in 2004 to 13.7% in 2006, Mrs. Arroyo’s peak rate.
From the very start, President Aquino was adamant that there would be no new taxes. I assume his tax advisers convinced him that he could pursue his dreams for the country without passing new taxes and by just focusing on better tax administration. Or, perhaps, he was convinced to the core that no new taxes were needed.
As expected, improved tax administration has limited effect on the tax effort, especially in a regime where the tax system is complicated and the tax administrative machinery is corrupt. I argued then, and I continue to believe, that improved tax administration might, at best, increase tax effort by one percentage point.
Well, tax effort indeed grew by 1.6%, from 12.1% in 2010 to 13.7% in 2015.
THE ILLUSION THAT HIGHER GROWTH MEANS A BETTER LIFE
Our national leaders are caught in the illusion that there is no need to change the tax system since the Philippines is one of the fastest growing country in Asia. However, it could be argued that the country is growing faster than its ASEAN-5 neighbors simply because it is starting from a low base.
To put it more bluntly, despite its above average economic growth in recent years, the Philippines remains to be the poorest among its ASEAN-5 counterparts. Let’s focus on ASEAN-4 (Indonesia, Malaysia, Philippines and Thailand), leaving Singapore out of the analysis. After, all Singapore is a class of its own. It has long graduated into a developed nation, now a member of the Organization of Economic Cooperation and Development, an organization of industrialized countries, and focus on ASEAN-4 (see table).
Among ASEAN-4 countries, the Philippines has the lowest per capita income: $2,900, compared to Malaysia’s $9,743, Thailand’s $6,635 and Indonesia’s $3,347. Again, it is easier to grow faster if one is starting from a low base.
Despite the Philippines’ higher growth rate, it experiences extreme poverty the most, where extreme poverty is defined as $1.9 per day in 2011 purchasing-power-parity prices.
Gini-coefficent, a measure of income inequality, is the highest for the Philippines, that is, income inequality is the worst among ASEAN-4 nations.
Income and mortality are positively related. Rich people, judged by income per head, tend to survive to higher ages. Not surprisingly, Filipinos have the lowest life expectancy at birth (68.6 years), compared to the Malaysians (74.8), Thais (74.2) and Indonesians (70.6).
It is the responsibility of the incoming President to understand the challenges that lie ahead for the Philippine economy and society. He has to invest heavily in public infrastructure and human capital. He needs to modernize agriculture. He needs to invest in public health care and social protection. He needs to strengthen the police and the military. He has to reduce the cost of doing business in this country.
In the process, he needs to increase the capacity of the government to finance the public needs of a modern, progressive, and humane society. He needs to reform the tax system to make it high-yielding, economically efficient, fair, and simpler to administer
