Business World, 19 March 2012


The clamour from public-transport groups, mass organizations, a few politicians, media columnists, and—surprisingly—even some academics to reduce the VAT on oil products has now become so insistent that the government may just be tempted to cave in.

Doing so would be a big mistake.

It is hard to justify on first principles just why or how a solution to high oil prices should involve a reduction of the VAT on fuel. The VAT, after all, is based on the idea that all consumption must be uniformly taxed—that is, taxed at the same rate. Without good reason, the tax system should not itself be responsible for making some goods more or less expensive than others. Hence, if without taxes the price of a can of corned beef was, say, twice that of a bar of bath soap, then it should still be worth twice as much after a 12-percent tax is imposed on each. (Note that the ratio of X to Y is the same as the ratio of X(1.12) to Y(1.12).) That relationship is unchanged whether the uniform VAT is set at 5, 10, or 12 percent, as long as the rate is the same across all goods. (My colleague Ben Diokno has even seriously proposed that the VAT rate be raised to 15 percent in lieu of high income taxes—although he has curiously been reported as supporting a cut in the VAT on fuel.)

To argue that the VAT rate should be reduced for some products but not for others is to privilege the consumption of those products. But why should gasoline and diesel in themselves be more vital to consume than other goods? Why is a peso spent on fuel socially more important than, say, the peso a family spends on electricity or water? Or the toll paid by a bus using the NLEX? Or what a student pays for a cheap sandwich? Or a professional’s hard-won savings to purchase a laptop? Or more meritorious than a farmer’s purchase of fertiliser, pesticides, and farm tools?  What entitles petroleum products to this special treatment?

If the answer given is that petroleum products are “consumed by the poor”, that’s not exactly true either. It is vehicle owners, both private and commercial, who consume petroleum-based fuel—and few of them are poor. Indeed if the government were to cut the VAT on fuel, it would help not only jeepney- and bus-operators but also owners of BMWs, Benzes, Pajeros, and Fortuners. The effect would be to privilege heavier users of auto fuel—poor or not.

Tax-tinkering is fraught with danger, and its deleterious effects should by now be evident in our experience with an already-existing fuel subsidy (which everyone seems to have forgotten), namely, the decades-old privilege given to diesel fuel. For starters, note that there is no inherent physical reason that diesel should be cheaper than gasoline. Indeed, from a pure cost perspective, diesel is more costly to refine, so that before any taxes, it is likely to be more expensive than gasoline. In the US and the UK, for example, where the two fuels are taxed uniformly, diesel is more expensive than gasoline; in Germany and Canada they cost virtually the same. So if only the 12 percent VAT were applied to both—say, at landed cost—gasoline would probably still be cheaper than diesel.

It is not the VAT but the lower specific tax on diesel—at only one-third of that applied to gasoline—that makes the latter more expensive by more than 20 percent. This low tax, which has been in place since time out of mind, was always meant as a concession to public transport, the predominant user of auto diesel.

And where has this discriminatory policy taken us? First, it has only deepened the country’s reliance on diesel fuel. It has discouraged any search for or shift to alternative fuels on the part of public transport. On the contrary, it has enticed an increasing number of private vehicle-owners to shift to diesel fuel themselves. The latter, of course, is a completely unforeseen consequence and embarrassingly gives the same “pro-poor” diesel tax privilege to a jeepney driver and a Mercedes Benz owner. It’s basic Slutsky: cheapen something in relative terms and you divert consumption towards that thing. Similarly, lowering the VAT on fuel will do nothing but deepen the country’s dependence on all petroleum fuels.

The second effect is more pernicious. Cheap diesel—combined with the lax franchising of everything from buses to jeeps to pedicabs—has created an overcrowded and über-fragmented urban transport sector. A 2007 World Bank volume reports that Manila had 13,375 public transport vehicles per million people, compared to only 1,890 for Bangkok and 1,807 for Hong Kong. (Guess where the public is better served.) Philippine public transport today is dominated by numerous and fragmented small operators kept alive only by artificially cheap fuel.

Transport groups routinely blame high fuel prices for their woes. Underappreciated is the fact that their own uncontrolled proliferation—which leads to cutthroat competition, congestion, and dangerous road rage and warfare—is the main reason for their low incomes. This proliferation of bit-players has itself been unwittingly brought about by the policy of subsidised fuel (diesel). Ultimately, however, this kind-hearted approach has only hurt the poor by depriving them of cheap, clean, and efficient transport. For just as large developers will be discouraged by squatters occupying a property, the transport sector’s pre-emption by an inefficient and fragmented small sector precludes the entry of firms with larger capacities and more efficient technologies, all of which could have led to better service.

Lowering the VAT on fuel addresses none of these problems. On the contrary, it would only perpetuate them. The country is better served by confronting the real problems of urban transport. Government time, imagination, and effort are better directed at encouraging higher capitalization in the transport sector, larger capacities, more fuel-efficient technologies, and less reliance on imported fuels whose prices are volatile. The initiative to field large numbers of natural gas-powered and electric buses is a promising start. Unlike the transport sector, the power industry weaned itself from imported oil many decades ago, and electric power now is largely sourced domestically and therefore largely immune to the price–gyrations of world oil markets. Using more electricity for transport is the more effective way to insulate the country from the speculative activity that characterises world oil markets. The same goes for natural gas, which is something the country itself produces.

The sooner the petroleum-dependency of public transport can be reduced, the better it will be for the country—including its poor. For that, the most urgent and bold actions are clearly warranted. But as for the demand to reduce the VAT rate on petroleum products—effectively undermining and distorting hard-won legislation for the sake of a temporary exigency—the best response is clearly inaction. And if there are those who choose to call this indolence, indifference, or “Noynoying” (the latest meme), if some critics cannot see the difference between a placebo and real medicine, between palliatives and real reforms—then the president would do well to pay them no heed.

He should simply—igNoy them.