YearEnder: Budget freebies come with revenue challenges in 2017

By Prinz Magtulis (The Philippine Star), December 29, 2016

MANILA, Philippines – A few days after the 2017 budget was signed into law, Finance Secretary Carlos Dominguez gave both an assurance and a warning on government revenue prospects for next year.

“We are confident that the deficit will remain within three percent of gross domestic product,” Dominguez told The STAR in an e-mail.

“(However), a delay in tax reform will result in delays in infrastructure projects,” he said.

That could serve as a dose of reality as people in and out of the government cheered all the “freebies” that come with the so-called budget for “real change” worth P3.35 trillion. The public applauded three new welfare programs, amounting to P18 billion, dangled by Budget Secretary Benjamin Diokno.

On Jan. 1, 2017, the budget will give P8.3 billion for free college education in state universities and colleges for the first time, expand the free hospitalization and medicine program with an allocation of P7 billion to cover not only poor families, but also non-indigent ones, and provide irrigation to farmers at no cost through a P2-billion funding program.

“We need to invest in the education of our youth…free irrigation is intended to boost the agriculture which is both pro-poor and pro-growth. Universal healthcare will be truly universal as it covers 100 percent of potential beneficiaries,” Diokno said.

But just like Dominguez, Diokno did not answer directly how revenue would catch up with the new government’s planned budget pump priming, which for now looks balanced on welfare and infrastructure, but may slide more into becoming populist in the coming years if government revenue falls short.

“Welfare spending assumes a lot of tax revenues and moderate borrowing to sustain,” said Alvin Ang, economist at Ateneo de Manila University, in an e-mail.

Hard to take away

The 2017 outlay, up around 11 percent from this year, embodies President Duterte’s promise – that of making years of strong economic growth felt by most people.

That has been the global trend last year. Duterte was being lined up with the likes of US president-elect Donald Trump and UK Prime Minister Theresa May, who both ran on the platform of responding to people’s need for better services, which they felt were neglected despite years of economic prosperity.

“It really depends on the priority of the sitting government,” Ang said.

But for Maria Fe Villamejor-Mendoza, dean of the National College of Public Administration and Governance at the University of the Philippines, people’s expectations should still be “managed” to properly allocate the government’s meager resources.

Sustainability of welfare programs could be difficult, she said, which would partly explain why Dominguez warned of a cut on infrastructure spending instead. “That’s easier to take,” she said.

“It’s really hard to reduce or take away all the free stuff because these become entitlements, meaning, people feel they are entitled to them,” Mendoza said in a phone interview.

“I think for some programs, like free college education, people’s expectations should be managed in a sense that you make them realize that not all are bound to benefit,” she said.

For instance, Mendoza said emphasis should be given on the fact that free tuition in SUCs would be subject to stringent qualifications of students. The Commission on Higher Education (CHED) had said it is drafting implementing rules for the P8.3-billion funding which would be shared by 113 SUCs with around P73 million each.

Diokno agreed. “DBM and CHED will tighten rules on scholarships in SUCs,” he said.

Qualifications may likewise be needed for free irrigation services, which Mendoza said had been naturally contentious in recent years. “That was always the question. You are providing water and farmers cannot pay it, yet the government also has limited resources, so who should pay?” she said.

On the other hand, universal healthcare, which was started by the previous administration, is similarly under threat from populist measures. A bill that aims to reverse a 2012 law that generated roughly P40 billion in additional revenues every year just passed the House of Representatives and will now be heard in the Senate. The law channeled the bulk of incremental revenues to healthcare.

House Bill 4144 aims to retain the two-tier excise tax on cigarettes, which the Department of Finance said would widen disparity on tobacco products and prompt manufacturers to shift to cheap cigarettes to prevent paying higher taxes. That will come on top of possible health repercussions.

“Legislating unpopular tax policies to fund populist programs will be the biggest challenge to this administration,” Bank of the Philippine Islands lead economist Emilio Neri Jr. said.

“The populist spending programs could lead to a return to our profligate past or a failure to stick to our deficit targets,” Neri said.

Dominguez admitted “tax administration is quite difficult” if a two-tier tax system is retained, but said there is no stopping the unitary rate under Republic Act 10351 of 2012 from taking effect next year, for now.

Higher interest rates

As if that was not enough, interest rates tied to government borrowings used to bridge the budget gap between revenue and spending, are bound to rise next year, National Treasurer Roberto Tan said.

Theoretically, revenue increases every year as the economy expands. The only period when revenue declined recently was during the global financial crisis. In recent months, however, revenue agencies had been underperforming, which may leave the government no choice but to borrow more.

Take the Bureau of Internal Revenue, for instance. For the first five months under President Duterte, average growth rate hit 6.4 percent, slower than the economic growth of 6.9 percent in the third quarter.

The Bureau of Customs, meanwhile, had performed better, even beating its collection target for November. But that came on the back of a weakened peso that slumped more than P2 against the dollar from 47.06 to $1 in 2015. Earlier, Diokno said every peso depreciation earns the government P9.2 billion.

“The Treasury is confident that we will be able to successfully navigate market conditions and raise necessary funding for government’s program,” Tan said.

“Even though there is upward pressure in interest rates, the Treasury, as in the past, is equipped…to minimize the effect or rising borrowing costs,” he said.

Indeed, borrowings are programmed to decline 9.2 percent next year, although no law stops the government from borrowing more as needed. It fell below its borrowing plan for 2016.

Neri said revenue challenges could impact the country’s credit ratings.

“Our sovereign ratings are at stake and a downgrade could make public infrastructure financing far more challenging for the government and higher cost of credit less supportive of private sector capacity expansion,” he warned.

Both Neri and Ang agreed the landmark tax reform should be passed to help raise additional revenues. The first package of the reform, poised to generate P200 billion, had been stuck unnumbered at the House ways and means committee.

The plan was to originally pass it at the committee level this year. The package will cut personal income taxes and exchange this with higher excise tax in oil and removal of some value-added tax exemptions.

Dominguez said it “remains on track.” But committee chair Dakila Cua said the current version would not get enough support, prompting him to draft a “compromise” measure that would divide into phases the planned oil tax hike into three to five years, delaying potential additional revenues.

“We are still finalizing (it),” Cua said.