Internally inconsistent

The Aquino III administration’s objectives of achieving 7-8% growth, reducing the budget/deficit to GDP ratio to 2% by 2013, and not reforming the tax system are internally inconsistent. Achieving two objectives may be done simultaneously but not all three. Achieving inclusive growth-oriented fiscal consolidation requires reforming the tax system. And reforming it now rather than latter is the best strategy.

This is the core of my presentation during a panel on Growth-Oriented Fiscal Consolidation in a forum sponsored by the Bangko Sentral and the International Monetary Fund last week.

In order to achieve a sustained growth of 7 to 8% for most of the years of Aquino III, the investment rate should be approximately 25%, with public infrastructure accounting for 5% of GDP. That amounts to P450 billion to P500 billion annually. Clearly not all of that sum could be spent through public-private partnership, the preferred option of the Aquino III administration.

Inclusive growth means taking care of the poor and providing jobs to the unemployed — and the one million workers who join the labor force every year. Recent labor numbers show that the economy is not growing fast enough to absorb the growing labor force.

The incidence of poverty has basically remained unchanged since 2000. One of three Filipinos is poor. And poverty has likely worsened in 2009 owing to the world economic crisis and the devastating typhoons Ondoy and Pepeng.

While poverty is everywhere, there are more poor people in rural communities than in urban centers. This means government should pay attention to agriculture, rural development, agricultural modernization, and public infrastructure that would link rural areas to urban areas. This means rural roads, rural electrification, small irrigation projects, rural water systems, and similar projects. These are crucial public infrastructure that are not susceptible to public-private partnership arrangements.

Show me the money

In the forum, I argued for the need to reform the tax system in order to raise resources needed by the government to finance its growth-oriented agenda and later achieve lower budget deficit. I argued that, at best, the improvement in tax administration may yield an additional one percent of GDP (about P90 billion).

Improved tax administration can only do so much. A change in design that would simplify administration and higher tax rates for some goods can do much more.

Here’s the list of my favorite tax measures. First, eliminate corporate welfare by discontinuing redundant tax incentives. So much taxes are foregone by favoring certain privileged sectors of the economy. Greater political resolve is needed to complete this two-decade long reform goal.

Second, increase taxes on cigarettes, liquor, and petroleum products. These products are considered socially ‘bad’ and the demand for which do not change as much as prices increase. Compared to other countries in the world, these products are considered not taxed adequately. This reform measure is a no-brainer if only Aquino is willing to use his political capital to fight well-known business personalities.

Third, raise the VAT rate from 12 to 15% and gradually reduce personal income taxes. The government should tax people on the basis of what they take away from society (consumption) rather than what they contribute to society (income and wealth). It is not true that the VAT, in the Philippine context, is regressive. The poor, whose food consumption accounts for about 60% of their budget, are essentially exempted from the VAT, since food in its original state is VAT-exempt.

In the meantime, by lowering the personal income tax rate, which at its highest marginal rate is about one-third of taxable income, most fixed earners would be benefited. They would then have the option to spend or save or invest the their additional take home pay.

Fourth, impose a nationwide one percent tax on real property on top of what local governments collect. This is the redistributive part of the tax reform. The proceeds of the additional real property tax may be set aside for the expansion of basic education from 10 to 12 years. Initially, the proceeds may be earmarked for kindergarten classes to be conducted nationwide. Educate the young at their formative years. That’s excellent investment in human capital. And it’s also equalizing.

When to do the reform?

A question from the forum participants is when to do the tax reform. A Finance undersecretary argued that it ought to be done after exhausting all efforts to improve tax administration or after two years. I disagree. I say, do it now, two and half years before the midterm elections, and while President Aquino’s approval rating remains high. Have all the needed reforms introduced early next year, have them approved by Congress before summer of 2011, but make all the tax changes effective January 2012. Expectedly, Aquino III may have to use a lot of political capital. But this is an investment for the future worth fighting for.

A startling question came from another senior official from the Department of Finance: How do you persuade the President to change his mind and agree to reform the tax system? The task of convincing the President has to come from his economic managers, but principally from the Finance secretary. If one takes a long-term view of the challenges ahead, this task should not be a difficult one. –Core — By Benjamin E. Diokno, Businessworld