[Professor Rosa Alonso i Terme’s views on tax effort and tax reform were extensively covered in an article by Amado Mendoza, Jr. writing for the news site, Interaksyon.com. The link to the original article can be found here.]

Reversing the downward trend: PH needs new politics with a new tax culture at its core

by Prof. Amado M. Meondoza, Jr.

Interaksyon.com
6 October 2014, 12:56 p.m.

 

By several standards, the Philippines has fallen behind her East Asian neighbors and suffers from predictable consequences. It is often said (and bragged) that the per capita income in the Philippines was second only to Japan in the 1950s.

Rosa Maria Alonso i Terme, an economist from the World Bank who was also recently a visiting professor at the University of the Philippines School of Economics (UPSE), reported that almost 60 years later, in 2012 it had slipped down the rankings of the region behind all the by-now-developed countries, such as South Korea, Taiwan, and Singapore, and all the upper middle-income countries, such as China, Thailand, and Malaysia. In addition, Vietnam and Indonesia had overtaken the Philippines in education results (Program for International Student Assessment tests), and were fast approaching it in income levels.

This drop down the rankings is not unique to the East Asian context. I Terme also observed that the Philippines is now also below the income per capita level of almost all Latin American countries, ranking below Guatemala. The World Bank meanwhile noted that the country also exhibits the highest level of income inequality and the lowest rates of poverty reduction in East Asia during the 1980-2010 period. Even more worrying, despite increasing growth in the 2000s poverty increased steadily from 2003 to 2009 and only registered a statistically insignificant decline from 28.6 to 27.9 percent between 2009 and 2012. The country also exhibits the highest tuberculosis prevalence rate in the region, and infant and maternal mortality rates that are significantly higher than the region’s average.

PH economic indicators

At the heart of these failures is the country’s dismal tax effort (the ratio of tax revenues to gross national product, or GNP). Consequently, Filipinos suffer from the poor quality and inadequate supply of public goods ranging from police protection to defense of (claimed) national territory to roads, highways, ports, and airports.

Professor i Terme argues that the Philippine state’s performance is key. In particular, fiscal policy and governance failures explain weak accumulation of human capital, especially in the poorest 50 percent of the population, as well as low levels of public and private capital investment. According to the World Bank’s World Development Indicators, all combined, gross fixed capital formation in the Philippines is over 10 percentage points of Gross Domestic Product (GDP) below that of regional comparators, and in 2012 it was 8 points of GDP below its own 1990 level. The Bank’s Public Expenditure Review (PER) finds that the (largely declining) path of public spending since 1997 mirrors that of public revenue. It argues that shortcomings in the size of public spending compared to other countries in the region are at the core of the relative weakness in education, health, and infrastructure outcomes in the Philippines. These gaps are estimated at between 5 and 7 per cent of GDP.

Tax effort in the Philippines is very low and has been declining over the past 10 years. By 2011, the tax-to-GDP ratio had fallen to a meager 12.3 percent, 4.6 percentage points below the pre-1997 level and well below the regional average.

The decline in 4.6 percentage points in the tax to GDP ratio, according to i Terme, is due to the following: two percentage points are the result of a drop in collections from excise taxes, which are not indexed to inflation; one percentage point has been lost due to a decline in corporate and income taxation (0.5 points each) due to a combination of lower tax rates and increased tax exemptions; Value Added Tax (VAT) collections declined by a 0.4 percentage point because power transmission was exempted and the 70 percent cap on input VAT crediting was lifted, as well as an overall weakening in tax administration; collections by the Bureau of Customs (BOC) declined by 1.2 percentage points due to lower trade taxes and increased smuggling.

It may be true that private individuals should not rely on government to provide everything they need, it is also true that only government can supply much-needed public goods. In fact, it is a duty of government to provide them so a national community cannot only be maintained but could also prosper.

It is accepted that one of the major reasons behind poor tax collection is a corrupt bureaucracy — tax collectors and spending agencies alike. The Bureau of Internal Revenue (BIR), Bureau of Customs (BOC), Department of Public Works, and Department of Education regularly appear in the list of most corrupt government agencies.

Taxation gaps

A corrupt government will not improve tax compliance among our people. Taxation involves an implicit social contract between a government and its citizens: we pay taxes and government must provide public goods in return. If tax revenues are siphoned into private pockets and the volume and quality of public goods suffers as a result, then citizens will not be so eager to pay their taxes. The situation is not helped any if well-connected persons can get away from paying taxes.

It is also well known that our upper classes do not pay their proportionate share of taxes due to legal favors extended by malleable politicians and loopholes courtesy of corrupt tax bureaucrats. For instance, the 14th Congress (2007-10) alone passed 13 revenue-eroding measures costing around 1.1 percent of GDP, and introduced six more which would cost a further 0.5 percent of GDP. Not a single revenue-enhancing measure was passed.

The role of Congress is supplemented by that of the investment promotion agencies such as the Board of Incentives, which grant tax incentives to an increasingly large number of businesses, economic sectors, and geographical areas (e.g. special economic zones, eco-zones). Most of the businesses receiving tax incentives are domestic and have an above-average level of profits. UPSE economist Renato Reside estimates these incentives cost the country an estimated 1 to 4 percent of GDP. Abundance of tax incentives for highly profitable firms leads to a high level of horizontal and vertical inequity of the tax system. According to IMF estimates, the Philippines is one of the countries with the highest gap (20 percent) between those businesses benefiting from the most tax incentives and those that do not benefit from any.

The tax system is also inequitable across employment categories. According to World Bank estimates, salaried workers pay around 80 percent of total personal income tax collections although they account for only 40 percent of total non-corporate sector net operating surplus. The self-employed and professionals pay only 20 percent despite a 60 percent share of total non-corporate sector net operating surplus. Moreover, the actual personal income tax payments of the top 10 percent in terms of income, at an overestimated 1.7 percent of their income, are negligible.

Simultaneous big and small government

The situation creates the ironical impression that government is too large and intrusive and small at the same time. To salaried workers, the State looms large as it is able to withhold income and impose all kinds of indirect taxes on the products they consume. At the same time, the state is puny, weak and compromised as it fails to provide needed public goods proportionate to tax collections given the tax exemptions enjoyed by the powerful as well as the leakages caused by corruption.

It is quite clear that our country cannot progress and be at par with our neighbors unless taxes are collected and spent properly for the public good. I am not advocating big and intrusive government; I am for a competent government imbued with legitimacy.

Tax compliance is a function of the capacity to apply tax laws equitably and equally without any sector or group enjoying all kinds of incentives or able to avoid or underpay taxes due as well as the legitimacy of the collecting government. Legitimacy meanwhile is a product of government’s fulfillment of its contractual obligations to provide high quality and adequate public goods.

We need a new politics, a developmental politics which has a new tax culture at its core. Tax compliance among our citizens will improve if political leadership improves. This new politics is actually not really new. It is the politics that we desired since we started the Philippine nation-building project early in the late 19th century.

It is the politics of leadership by example. It is the politics of competence. It is the politics of leaders committed to protect and advance the citizens’ interest first. It is the politics of concern. Of course, we cannot rely on the almost non-existent that our political leaders will become saints overnight. In fact, all of us are “sinners” — leaders and citizens alike.

Rules and systems matter. New rules must be so designed, adopted, and implemented so we can be saved from our sins and propensities to look only after our self-interests.