Reforming the National Tax and Expenditure System

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Reforming the National Tax and Expenditure System
Felipe M. Medalla Karl Robert L. Jandoc
4th Ayala Corporation-UPSE Economic Forum
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Good news and Bad news

• Good news
• After adjusting for inflation, the National
  Governments budget is in fact in balance (or
  even in surplus)
• Under certain assumptions, a 200 billion deficit
  that is reduced gradually in real terms by 2 per
  year is sustainable
• Tax administration has not really deteriorated as
  suggested by the Tax/GNP ratio

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Good news and Bad news

• Bad news
• Debt sustainability can be attained only by
• Significant reductions (relative to the past) in
  off-budget deficits
• Maintaining macroeconomic stability
• Preventing backsliding in the Tax effort
• Aside from the EVAT and nominal growth of GNP,
  fiscal balance has been achieved by compressing
  public expenditures

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On the taxation side

• Tax effort can be further improved using both
• obvious solutions that require only political
  will (periodically updating excise taxes for
  inflation and rationalizing fiscal and tax
  incentives)
• and out-of-the-box solutions such as
  substituting good indirect taxes for direct
  taxes
• Or restructuring the BIR and BOC, increasing the
  snooping powers of the tax police, and taxing on
  the basis on change in net worth when this are
  way out of line of declared income (this may even
  be less politically feasible than the above)

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On the expenditure side

• Because of the expenditure compression, both good
  and bad expenditures have been significantly
  reduced
• Given that there is global consensus among world
  leaders and international financial institutions
  for the need for concerted fiscal stimulus in
  nearly all economies, this may be a good time to
  decompress public expenditures

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Important social and political question

• Can we decompress only the good expenditures?
• Can we find a process of achieving social and
  political consensus that succeeds in
  decompressing only the public expenditures that
  contribute to increasing economic growth and
  reducing poverty?

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Is the official deficit THE real problem?

• The official deficit is a potential red herring
• Provided that peso depreciation and the
  official deficit are the only sources of debt
  growth (i.e., the official deficit is the true
  deficit), there will be decline in the Debt/GNP
  ratio over time

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Is the official deficit THE real problem?

• Indeed even if economic growth rate is modest,
  the Debt/GNP ratio will still fall given a
  deficit of 200 billion
• The simple reason for this is that after
  adjusting for inflation, the 200 billion deficit
  shrinks by 75 percent

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Conditions under which an official deficit of 200
billion per year is sustainable

• The official deficit is the true deficit
• Government Expenditures/GNP will not go out of
  control
• Modest growth in Tax/GNP ratio
• No large jumps in interest rates and exchange
  rates
• The economy is growing
• Bond and foreign exchange markets do not panic

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In summary

• Even if the budget is not balanced, falling
  Debt/GNP can still be achieved through
• Macroeconomic stability
• Good quality public spending
• A gradual increase in Tax/GNP ratio
• A buoyant tax system
• The challenge To make the official deficit the
  true deficit, increase tax effort, improve the
  buoyancy of the tax system and decompress only
  good public expenditures

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The official deficit versus the true deficit

• The true deficit accounts for only about 48 of
  the actual increase in debt from 1990-2007
• Off-budget deficits figure heavily in debt
  accumulation

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The official deficit versus the true deficit

• Half of the 18 years from 1990 account for the
  cumulative difference between the actual debt
  stock and the debt stock with the true deficit
• Most of the deviations were greater than 150
  billion pesos
• 3 years (2002, 2003 and 2004) accounted for 40
  of the deviations
• No off-budget deficits have been recognized in
  the last four years Is this a new trend or a
  lull before another downpour?

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The official deficit versus the true deficit

• Rounding up the usual suspects?
• NAPOCOR, DBP, PNB and the old Central Bank
• Other possible sources of off-budget deficits?
• Have we seen the end of off-budget deficits?
• Contingent liabilities in the power sector
• Bank failures
• NFA, NDC and other government corporations
• Pension funds (GSIS, SSS, Special funds for
  retired Military personnel)
• Management of contingent liabilities and
  off-budget deficits is as important as the
  improvement in tax or revenue effort.

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Explaining the decline in the Tax/GNP ratio

• Is the decline in BIR Collections/GNP ratio due
  to weak tax administration?
• There is no drastic decline if we benchmark BIR
  revenues to Gross sales of the Top 1000
  corporations
• If excise taxes were excluded, one would even
  conclude that there is a slight improvement in
  revenue collection over the pre-Asian Financial
  Crisis period

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Explaining the decline in the Tax/GNP ratio

• All of the major BIR revenue components lagged
  behind nominal GNP growth after the Asian
  Financial Crisis

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Explaining the decline in the Tax/GNP ratio

• Only excise taxes have been deteriorating if we
  use Gross Revenues of the Top 1000 companies as
  the benchmark
• Most BIR revenue components have recovered from
  their pre-Asian Financial Crisis levels

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Explaining the decline in the Tax/GNP ratio

• Corporate income tax collections closely follow
  the business cycle
• Correlation between Profit of Top 1000 companies
  and Corporate income tax revenue is very strong
• The behavior corporate profits is much more
  sensitive to where the economy is in the business
  cycle than to the official GNP and GDP growth
  statistics

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Explaining the decline in the Tax/GNP ratio

• Weak BOC collections due to
• Reduction in tariffs
• Import compression
• Increase in share of non-taxable or non-dutiable
  imported inputs to total imports
• Decrease in the share of consumer goods in total
  imports

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In summary, the decline in tax effort (as
measured by the Tax/GNP ratio) is due to

• Changes in methodology for computing GNP and GDP
• The business cycle and structural changes in the
  economy
• Governments trade and liberalization policy
  (which should not be reversed)
• Failure to index excise taxes to inflation (which
  should be addressed ASAP)

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Moreover

• Tax administration cannot be entirely blamed for
  the slide in Tax/GNP ratio
• Significant increase in revenue will come from
• New taxes (or substitution from one tax for
  another tax)
• a RADICAL restructuring of the BIR and BOC

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New Sources of Revenue

• Which kinds of taxes are needed?
• Effect on consumer prices (direct vs. indirect
  tax)
• Progressive? (Individual Income Tax)

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New Sources of Revenue

• Making the tax system more equitable
• More snooping powers for the tax police?
• Substitution of good indirect taxes for direct
  taxes
• Weaning cities away from IRA towards other tax
  handles such as an increase in real estate tax
• Main Challenge Selling Tax Reform
• Making the poor less vulnerable by expanding
  social safety nets
• Selling the tax reforms to the middle class

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Urgency of good quality public spending
Source Social Weather Stations (SWS)
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(No Transcript)
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Good quality public spending

• Public spending should focus on
• Projects that support growth (e.g.
  infrastructure)
• Programs that address poverty (massive
  conditional cash transfer CCT programs)

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Selling the Reforms

• CCT may in fact be a necessary condition for tax
  reform if the strategy is to substitute good
  indirect taxes for direct taxes
• Wage and salaried workers may accept new indirect
  taxes if they are accompanied by cuts in the
  individual income tax
• Giving the taxpayer value for money is a
  necessary condition for society to accept a
  higher ratio of taxes to GNP

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If the budget can be increased by 200 billion,
where should the money go?

• CCT
• Investments in human capital and physical
  infrastructure that will contribute to economic
  growth
• Completing missing parts of the transportation
  network
• The tourism development plan should be a key
  input in the prioritization of infrastructure
  investments
• Expanded and better mass transit in Metro Manila
  that relies as much as possible on revenue from
  fares, taxes that fall mostly on Metro Manilans,
  and is done through a transparent and competitive
  private-public sector partnerships