Breaking Away From The Fiscal Bind

Reforming The Fiscal System

Breaking Away

From The Fmcal Brad

Reforming The Fmcal System

Rosario G Manasan

pOsPhilippine Institute for Development Studies

Copyright eD 1994 by the

Phfl,ppme institute for Development Studies

Printed in the Philippines All rights reserved The findings interpretationsand conclusions m this book are those of the author and not necessarllythose of the Institute

This is Part II of a bigger study entitled 'PIDS Remew and Outlook of the

Philippine Economy for 1993 1994 which was presented m a symposium

jomtly sponsored by the PIDS with the Nat,onal Economic and Development

Authority (NEDA) and the Congressional House Committee on Socloeco

nomm Affairs on November 25 1993 at the Westm Philippine Plaza

Please address all mqumes to

Philippine institute for Development Studies4th Floor NEDA sa Makatl Bldg

106 Amorsolo St Legaspl Village Makatl 1229

Metro Manila Philippines

Fax No (632) 816 1091

Tel No (632) 893 5705 892 4059

ISBN 971 564 013 3

RP 9 94 500

Contents

List of Tables v11

List of Figures v111

List of _xes vln

Foreword IX

1 INTRODUCTION 1

2 rMPROVING GOVERNMENT REVENUE PERFORMANCE 5

Reformlnl the Tax System 6

Trends and eomposzhon 7

Tax structure 12

Taxes on income and profits 12

Import dutles and taxes 14

Excme taxes 18

Sales tax and hcenses 21

Tax euaszon 23

Evamon of the mdlvldual income tax 23

Evamon ofthe VAT 24

Sources of evaslon 24

Reformzng tax admm_strahon 27

Too much centrahzatlon 27

Weak systems and procedures 28

Low level of computenzatlon 28

Low compensatlon oftax collection_s_nt_l 31

Proposed tax enhancement meat_U_i_ . 31

Reformin I Local Government Taxation 34

Exploring the Potential of User Charges 4S

User charges zn government hosplta_s 50

User charges zn LGUs 53

3 IMPROVING THE ALLOCATION OF PUBLIC SPENDING SS

Trends and Patterns SS

Aggregate natlonal government expendztures 55

Economlc categories of natlonal government

expendztures 56

Current expendltures 56

Capital outlays 71

Functlonal categones of natlonal government

expendztures 72

General pubhc admmistratlon 72Social service sectors 72

Economic sectors 75

Publ,c Sector Investments and Growth 77

Composztzon of pubhc sector znvestment 77

By level of government 77

By sector 79

Trade off between current and capztal expendztures 82

Granger causality between economic growth and

public expenditures 82Results from macroeconometnc simulation 85

Impact of pubhc sector investment on pnuate sectorinvestment 85

Subsidies and Tax Expendltures 88

BOI incentz ues 90

Natzonal Food Authority 107

Petroleum product pnclng 109

4 CONCLUSION 111

BIBLIOGRAPHY 1 13

THE AUTHOR 119

LIST OF TABLES

1 RaUo of Na_onal Government Tax Revenues to GNP 1975 1992 8

2 Tax and Revenue Effort m Selected Asmn Countries 9

3 RaUo to Tax Revenues 10

4 Buoyancy Coefficlent of Major Tax Groups 1975 1991 11

5 Indlvldual Tax Rate and Corporate Income Tax Rate

m Selected Aman Countries 1990 13

6 Value of Imports and Dutaes CoUected

and Average Effective Rates 1980 1990 16

7 Average EPR and Standard DewaUon by Major Groups

Exportables and Importables 17

8 Compara_ve Yield of Sales Tax and VAT 1987 1992 22

9 Potential Revenue from the Indlvldual Tax

and the Level of Tax Evamon 23

10 Potential Revenue from the VAT and the Level of Tax Evamon 25

11 Potential and Actual Number

of Indlwdual Income Taxpayers 1985 1990 2612 Distribution of Taxable Returns Fried m 1990

and Assessment Personnel by Revenue Reglon 29

13 General Government Expenditures 35

14 General Government Revenues 36

15 Revenue Structure of Local Governments 1980 1991 38

16 Assessors Market Valuation and Advertised Market Prices

for Selected Prlces of Property 1992 42

17 Buoyancy of Revenues of Local Governments 1980 1990 43

18 CoUection Rate for Baslc Real Property Tax 44

19 Region 3 Cost Recovery Levels Income and Expenditures 1987 1989 51

20 Sapang Palay D1st_nct Hospltal Level of Cost Recovery

from the Revolving Drugs Fund 1989 1990 52

21 Profitabfllty Comparison Between City Government Operated Pubhc

Enterprises and Comparable Private Sector Run Facdlties 1988 54

22 National Government Expenditures by Economlc Classification

on an ObhgatJon Basls as a Percentage of GNP 1975 1992 60

23 NaUonal Government Deficlts 1975 1992 62

24 National Government Expenditures by Sectoral Clasmficatlon

on an Obhgataon Basis as a Percentage of GNP 1975 1992 73

25 Pubhc Sector Investment by Level of Government

as a Percentage of GNP 79

26 Pubhc Investment by Sector as a Percentage of GNP 80

27 Relatlonahlp Between Economic Growth G

and Government Expenchtures E 82

28 Reallocatlon of Expendlture from Current to Capital Outlays 84

29 Revenue Foregone by Type of Incentives 90

30 Factor Bias of BOI IncentJves Capital Labor RaUo

of BOI Reglstered F_-rns 1986 1992 93

31 Scale Bias of BOI IncenUves Average Number of Workers

per Firm of BOI Registered Fn-ms 1986 1992 94

32 Economywlde Average Number of Workers per Ylrrn 1986 1989 95

33 Location Bias of BOI Industries Share of NCR and Reglons III and IV

m Total Number of Projects Employment and Project Cost 1986 1991 9634 Economyw_de D1st_nbution of Number of Estabhshments

Employment and Book Value of FLxed Assets of Large

Estabhshments Across Reglons 1986 1989 99

35 Market Bias of BOI Incentives Share of Export Actlwties

m Total Number of ProJects Project Cost

and Employment ofBOI Reglstered Firms 1986 1992 102

36 Internal Rate of Return of a Hypothetical Firm Under

Selected Incentlve Schemes m ASEAN Countries 1988 106

37 NFALosses 1986 to 1991 108

38 Cost of Dehvermg NFA Submdy 1991 109

LIST OF FIGURES

i National Government Tax and Non Tax revenues 1992 5

2 NaUonal Government Expenditures as a Percentage of GNP 1975 1992 57

3 Per Capita National Government Expenchtures

m Real Terms 1975 1992 58

4 Pubhc Sector Investment by Level of Government

as a Percentage of GNP 78

LIST OF BOXES

1 Increased Pubhc Investments Financed by Domestlc Borrowing 2

2 Use of HCV for Import Valuatlon 19

3 Pricing Access to Forest Lands 47

4 Mopping Up of Excess laqulchty 63

5 Dynamlcs of Domestlc Debt 67

Foreword

In November 1993 the Phfllppme Institute for DevelopmentStudms (PIDS) launched the PIDS Review_and Outlook of the

Philippine Economy (PROPE) as part of Its continuing analysm of

the mtua_on and outlook of the Phlhppme economy For its maugural presentahon the PIDS focused on the country s fiscal cnsls as

the special theme of the report ldenUfymg It to be the period s most

crmeal concern and the one posing the biggest challenge to thecountry s economic performance and prospects

Thin present volume deals with the specml topic of the inaugural

PROPE report on the Philippines fiscal poslhon SpecLfically itanalyzes the roots and effects of the current fiscal bmd provides

estimates on the magmtude of leakages from the revenue systemand offers opportumtles and measures that can help release the

fiscal brad that ties the hands of government fiscal planners anddecls_onmakers

By pnntmg this part or special theme of the PROPE report as astand alone pubhcatlon thereby expanding its circular_ton to m

clude sectors outside the formal pohcymakmg circle the PIDS hopesto impress to a larger audience the enormity and urgency of theproblem -- that if left unattended and understated it may stymie

all other efforts to improve and sustmn the economy Hopefully byexplaining the msue m more detanl more people wall come tounderstand and advocate measures that will help resolve the sltuatlon

It m with this hope that the PIDS is pleased to present thisvolume

PONCIANO S INTAL JRPresldent

September 1994

1

Introductlon

The past two years showed that the present fiscal posltlon of the

pubhc sector hmlted the optlons open to the government to support

economlc recovery sustain growth and allevmte poverty The strln

gent monetary and fiscal celhngs under the st-_bdmatlon program of

the International Monetary Fund (IMF) restricted government s

ability to pump prlme the economy and stimulate economic revlval

More _mportanfly excessive monetary and fiscal restraints pre

vented the government from financing power and infrastructure

projects needed for long term growth Thus de D1os (1992) proposed

that monetary and fiscal targets be relaxed as a first step toward

rewwng the economy

While It m possible to ]umpstart the ec nomy m the Immediate

term by slackening fiscal and monetary restraints the economy

cannot afford to contmually run large fis al deficlts A counterfac

tual mmulatlon where public sector lnveo rnents were increased by

P5 bllhon and financed through domestlc _orrowlng revealed that

whale the effect on output remmns poslt_ e m the first two years it

turns negatlve from the thlrd to the fifth vear (Box 1)

Clearly the government has to respc nd to the fiscal challenge

of _reconcflmg lower fiscal deficits with growth in the medlum term

Fiscal mlsmanagement undemably cot tnbuted to the series of

balance of_payment/economlc crises that the country has had to

deal wlth m the past Thus the Importance of a prudent fiscal pohey

which glves rise to sustmnable deficits m the long run cannot be

overemphamzed

:2 ROSARIOG MANASAN

BOX 1

Increased Publ,c Investments Financed by Domestm Borrowing

The effects of _ncreastng capital outlays by P5 bilhon in current

prices which is financed by increased domestic borrowing was

stmulated ustng an extension and update of the PIDS NEDA Macroeconometnc Model The shock or change in the baseline scenario is

apphed =n1986 (period 1) and the effects are monitored up to the

year 1990 (penod 5) A five year s_mulatlon period _srequtred m order

to account for dynamic adjustments and medium term _mphcations

of the pohcy change Specifically domestic borrowing entails interest

and amorttzat_on payments which affect the economy after the loan

proceeds are spent

From the results (Table A) tt is evident that private expenditures

are crowded out by domestm debt financing primarily through ther=se in the interest rate Comsumpt_on spending manages to post a

gain _nthe first penod but dechnes thereafter Output expands _nthefirst year Because of the short term nature of domesttc debt thebonds are assumed to be redeemable atthe end of the penod Thus

upward pressure =smaintained on the interest rate up to the second

period and this results in further cuts m prtvate investment The need

to meet _nterest obhgatlons causes a reduction in producbve spend

Lng(as mdmated by a drop In government comsumphon expenditureCG) and the double cr-,wdwng out effect leads to a drop m output

beginning _nthe th rd pertod wNch lasts untd the end of the simulation

pertod

BREAKING AWAY FROM THE FISCAL BIiND 3

Table A Scenario 3 Deflctt Financing by Domest=cBorrowmg

Variable Period

1 2 3 4 5

Percentagedewatsonfromthebaseline

GDP 0437 0 085 0 063 0 111 0 126GNP 0 449 0 081 0 066 0 113 0 126CPI 0 616 0 319 0 102 0 016 0 020TBILL 7 675 2459 0 864 0 475 0 175

CP 0 012 0 045 0 091 0 105 0 098CG 0 596 0409 0 063 0 023 0 023CONSPR 0966 1 132 1064 0 855 0 789IDER 0 912 0 615 0492 0 394 0 361

GOCF 3498 0520 0219 0354 0368XD 0 144 0 046 0067 0 100 0 103MD 0 483 0 051 0 196 0 191 0 162

DEFNG 31834 17239 2 045 1235 0 688

DevfatlonfrombaselineOnmllhonUS$)

TRABAL 17839 5 543 10645 9 006 8 759BOP 19331 5 813 11581 9 946 9 690

Variable definitions

GDP Gross Domeshc ProductGNP Gross National ProductCPI Consumer Price Index

TBILL Treasury Bdl RateCP Personal Consumphon ExpenditureCG Government Consumption ExpendttureCONSPR Total Private ConstruchonIDER Investment _n Durable EquipmentGDCF Gross Domestic Capital FormatLonXD Dollar Exports (million)MD Dollar Imports (million)DEFNG Nahonal Government DeficitTRABAL Trade Balance (mtlhon $)BOP Balance of Payments (mJlhon $)

Source Josef T Yap and Ceha M Reyes 1993 F_scal Pohcy Alternahves _nthe

Phd_ppmes

4 ROSARIO G MANASAN

Good fiscal management is not easy since the fiscal sector m

buffeted by competing clalms On the one hand increasing govern

ment spending on maintenance and capltal investments is a press

mg need These items had to absorb the brunt of the severe cuts m

government expendlture as part of the stablhzatlon program m

recent years Today inadequate maintenance of government capital

stock and a shortage of bamc infrastructure severely constrain the

country s growth potentlal Yet the government has to expand social

serwces and provlde adequate safety nets to protect the most

vulnerable groups from the burden that comes with stablhzatmn

and structural adjustment processes that w111inevltably take place

If growth Is to be sustained At the same tlme the sustained pursult

of the structural adjustment program m expected to reduce govern

ment revenues All these imply that the government may be trapped

m the mclous cycle of low growth and hlgh fiscal deficlts unless

steps are taken to _mprove government revenue performance fur

ther reduce some items m the government budget and allocate

government spending more efficiently

More revenues and less spending w111both be needed However

the potentml gains from the former will far exceed the latter because

the fiscal adjustments mstltuted in recent years were dominated by

expenditure cuts Thus opportumtles for incremental budget cuts

are extremely limited Nonetheless there are ways to further im

prove budgetary allocation

2

ImprovingGovernment Revenue Performance

Government revenues may come from tax and non tax sources

Taxes remain the government s pnnclpal source ofmcome account

mg for 86 percent of the natmnal government revenues or 15 2

percent of the gross national product (GNP) m 1992 In contrast

non tax revenues which conmst of grants user charges income

from public sector enterprises and proceeds from the pnvat_atmn

program account for 14 percent of total government revenues (2 5

percent of GNP) m the same year (Fig 1)

NonTax Revenues14/

Tax Revenues86 /

Figure 1 Nat=onalGovernment Tax and Non Tax Revenues 1992

6 ROSARIO G MANASAN

Whde capltal rece:pts from the sales of government corporations

accounted for a slgnlficant portion of non tax revenues since 1987

the potentml income from thls source Is expected to dwindle as the

pnvatlzatlon program unwinds m the next few years In the short

run however add:tlonal revenues could be generated If the pnvatlzatlon program were accelerated Moreover the contrlbuhon of

foreign grants essenhally fall outslde the government s control and

will hkely follow a downtrend in the 1990s wlth the general dechne

m officlal development asslstance (ODA) worldwlde and the removal

of the US base facdltles from the country m 1992

In examining the scope for increasing and restructunng pubhc

revenues th_s chapter therefore focuses on taxes and user chargesalone The first two sectlons address Issues related to central and

local government taxes whde the thlrd section assesses the potential

of user charges as a source of government revenues

Reformsng The Tax System

In 1986 the government restructured the tax system extenslvely

Whde prewous efforts to change tax pohcy were p_ecemeal m nature

and generally concerned with revenue generation the 1986 tax

measures represented the first attempt at a comprehenslve reform

of the country s tax system In hne with art:culated pohcy the

measures that comprlse the Tax Reform Package were not solely

dlctated by the need for government revenues Equity and efficiency

objectlves also recelved conslderable weight

The following major components make up the Tax Reform

Package 1) a shlft from the schedular to a more global approach m

taxing redly:dual income from compensation business trade and

exercise of professlon 2) increase m personal exemptions 3) sepa

rate income taxation of spouses 4} an increase m the final with

holding tax rate on interest income (17 5 percent) and royalties (15

percent) to a umform rate of 20 percent 5) the phase ou_ of the final

withholding tax prevlously lewed on dlvldends 6) the unlficatlon of

the earlier dual tax rate (of 25 and 35 percent) on corporate income

to 35 percent 7) the mtroductlon of the value added tax (VAT} m

place of the sales/turnover tax and a host of other taxes 8) the

BREAKINGAWAYFROMTHE FISCALBIND 7

convermon ofumt rates formerly used for exclse taxes to ad valorem

rates 9) the abolition of export taxes except those on logs i0) the

general rewslon in the valuation of real property for tax purposes

and 11) further reduction in tariff rates 1

In the last six years government had to introduce more tax

changes primarily to respond to the need to raise more revenues in

vlew of a series of fiscal adjustment programs But not all were

conslstent with the spirit of the 1986 reform package Some like

the Import levy Imposed m 1991 were put in place because they

were admimstratxvely and pohtically convement But they were

generally seen as hlghly dlstortIonary and having a perverse effect

on long term growth

The foUowmg subsectlons show that while tax moblhzatlon

achleved sigmficant gains In the last six years still more remain to

be done They also hlghhght the fact that the biggest opportunity

for increasing tax revenues at present lies in tax administration

even as certain structural changes have been identified Many of the

proposed changes in tax structure were shown to bear negative

revenue Impact Thzs makes st doubly important to increase revenue

on the basts of adminlstratlve mnouat_ons

Trends and composstson

The 1986 Tax Reform Package together wlth the other tax measures

put in place in the ensuing years resulted m a slgnificant improvement in the tax effort 2 Thus the ratlo of total tax revenues to GNP

chmbed from an average of 11 3 percent in 1975 1985 to 15 2

percent in 1992 (Table 1) This development allowed the Phihppmes

to somewhat catch up with the tax effort of other Aslan countries

Despite thls improvement however the country contmues to lag

behind the performance of Indonesla Malaysia South Korea and

Thailand (Table 2) a

1 This last item xsnot usually wewed as part of the Tax Reform Package but as themare element m the Tariff Reform Program2 Tax effort xsdefined as the ratao of tax revenues to GNP

3 Singapore s tax to GNPratao is low because a conslderable portaon of thelr revenuescomes from government capltal investments i e non tax revenue

Table 1 =Ratio of Nabonal Government Tax Revenues to GNP 1975 1992

(In percent)

t97585 197582 198385 198692 1988 1987 1988 1989 1990 1991 1992

Taxrevenues 1126 1187 1059 1356 t098 1276 tl 36 1340 1410 1445 1523

1 Bureauof InternalRevenue 6 94 720 6 65 9 05 7 85 8 71 801 897 9 66 921 9 77

a Incomeandprofits 2 85 2 90 2 79 4 29 3 21 3 24 345 4 11 4 61 484 5 12

Corporatetncometax 1 10 0 76 1 48 1 85 144 182 163 167 177 198 2 24

Indlvtdualincometax 0 83 0 70 0 97 1 38 1 O0 108 1O0 120 151 164 167

Others 0 17 0 02 0 35 1 06 0 78 033 0 82 124 134 122 121

b Excisetax 2 02 194 2 12 247 2 75 336 2 46 2 72 268 201 2 02

c Sa_estaxandhcenses 148 161 1 34 183 155 180 155 172 194 192 203

d Otherdomesttctaxes 0 59 0 75 040 046 034 030 0 55 042 043 044 061

2 BureauofCustoms 3 82 4 07 353 434 293 386 3 15 4 20 427 5 10 532

a Importdutiesandtaxes 3 6I 3 86 332 4 33 2 83 386 3 15 420 4 27 5 10 532

b Exporttaxes 0 21 0 21 021 001 0 ll 0002 0 0004 _"

3 OtheroEces 0 51 0 60 0 41 0 '_7 0 20 0 20 020 023 0 16 0 13 0 14o

Sourceofbasicdata BureauofTreasuryandOepartrnentofFinance >_

BREAKINGAWAYFROMTHE FISCALBIND 9

Table 2Tax and Revenue Effort m Selected Asian Countries

(In percent of GNP)

Country Tax Effort RevenueEffort

Indonesia(1990) 1981 20 93

Malaysia(1989) 1745 2645

Phdlpplnes(1992) 1523 1772

Singapore(1989) 1379 23 18

Thailand(1990) 1900 2028

SouthKorea(1990) 1654 1827

Source AsianDevelopmentBank

Hand in hand with the improved revenue performance of the tax

system a notable change in the composition of national government

taxes took place in recent years The marked rise m the share of

direct taxes to total taxes constitutes a positive development The

proportion contributed by taxes on income and profits (which

comprise close to 95 percent of aggregate dlrect taxes) expanded

dramatically from an average of 24 4 percent in 1975 1982 to 33 6

percent in 1992 Conversely excise taxes accounted for a dechnmgfraction of total taxes between 1987 and 1992 Meanwhile sales tax

and licenses as well as import duties and taxes maintained their

share through the years (Table 3) Despite the increasing share of

direct taxes In 1986 1992 the bulk of natlonal government taxes

continues to come from indirect taxes

More significant than changes in the relative importance of the

different tax groups are changes in their levels when measured

relative to GNP Taxes on income and profits when measured as a

proportlon of GNP rose by almost two percentage points in 1986

1992 after hovering in the three percent level in 1976 1985 Importduties and Indlrect internal revenue taxes also recovered In 1986

1991 the losses they suffered in 1981 1985 The resurgence of

revenues from import duties became striking as it increased by two

percentage points to reach 5 3 percent of GNP m 1992 even

Table 3Rat,o to Tax Revenues

(In percent)

197_85 1975-82 t98385 198692 1986 1987 1988 1989 1990 199t 1992

Taxrevenues 10000 10000 10000 10000 10000 10000 10000 10000 10000 10000 10000

1 Bureauof IntematRevenue 6160 6064 6281 6674 7t 47 6820 7053 6696 6855 6378 64 16

a Incomeandprofits 2527 2440 2635 3t 62 2924 2537 30 34 3070 3270 3349 3360

Corporate_ncometax 977 641 1394 1363 t3 10 1427 1437 1243 1253 1368 14 69Indlvldualincometax 7 33 587 9 15 1014 907 8 49 8 80 8 98 1068 1138 1095

Others 155 0 16 3 26 7 84 7 07 2 61 7 17 928 949 843 797

b Excisetax I795 1632 1999 1824 2502 2635 21 69 2030 1903 1394 1324

c Salestax andlicenses 13 18 1361 1266 1348 '_412 1412 1368 1281 1373 1328 1332

d Otherdomestictaxes 5 20 6 32 3 81 3 41 3 10 2 36 4 82 3 16 308 3 07 4O0

2 Bureauof Customs 3389 3432 3337 3199 2672 3025 2769 3134 3029 3533 3492 I_

m_

a Importdut=esandtaxes 3202 3253 3138 3191 2574 3023 2768 3134 3029 35 33 3492

b Exporttaxes 1 87 1 79 198 0 07 0 97 0 02 0 0033

3 Otheroffices 450 505 3 83 127 182 t 55 1 79 170 1 18 0 89 093

SouroeofbasK:datB Bureau(YTreasuryandDepadmentofF_nance i

BREAKINGAWAYFROMTHEFISCALBIND 11

surpassing its peak of 4 5 percent m 1983 (Table 1) One observes

that the increased dependence on direct taxes m 1976 1992 did notresult from the replacement of redirect taxes by direct taxes Ratherit followed the marked rme m the overall direct tax effort without an

accompanying reductlon m the overall mdzrect tax effort In short

the yield of redirect taxes measured agmnst GNP did not dnmmsh

while that of direct taxes increased slgmficantly

Concomitant with thin progress the buoyancy of the tax systemwith respect to GNP rose from 088 m 1976 1985 to 134 m

1986 1991 {Table 4) 4 The improved tax buoyancy has been suchthat _ts 1986 1991 level did not only rise above the 1981 1985 level

(0 92) but also surpassed the 1976 1980 level (1 09)

Table4BuoyancyCoefficientof MajorTaxGroups 19751991

19761985 19801985 19861991

Alltaxes 088 0 92 1 34

Income/profit 094 1 12 1 62IndlwdualIncometax 0 44 1 08

Corporateincometax 1 18 1 20Passive 5 05 3 20

Sales/l_censetax 095 0 69 1 26

SalesNAT+otherpercentagetax 0 83 149Exc_setax 102 138 0 58

Otherdomestictax 0 77 187 141

Importdutiesandtaxes 076 0 49 1 66

Source Author'sestJmates

4 Buoyancy refers to the ratao of the percentage change m tax revenue to the

percentage change m aggregate income GNP w_th the revenue changes mclus_ve ofthe increments m revenues brought about by thscre_onary tax measures It measures

the responsiveness of tax y_elds to changes m economm ac_wty

12 ROSARIOG MANASAN

Tax structure

Taxes on income andprofits The revenue performance of the aggre

gate tax on income and profits dramatically improved due to the

almost equal increases {0 6 percentage points on the average) m the

tax yield to GNP ratio of the mdwldual Income tax the corporate

income tax and the tax on passive income in the last SL_years (Table

1) Revenues from taxes on income and profits registered above

average growth rate dunng the period Compared with other direct

taxes revenues from taxes on passive Income exhibited the fastest

rate of growth (9.3 4 percent annually) in 1986 1992 Revenues from

the mdlwdual income tax (21 3 percent yearly) followed In contrast

revenues from the corporate income tax grew at a slower pace (19 3

percent yearly)

The tax rate hikes on interest income and royalties m 1986 as

well as the high Interest rate regime m the last six years completely

cancelled the negative revenue effect of ehminatmg the tax on

dlmdends The pomtive revenue impact of the switch from the

schedular to a global system and the reforms m tax administration

particularly the expanded coverage of the withholding system also

blunted the antmlpated revenue loss from the following 1) lowered

mdlmdual income tax rate on business and professional income

2) Increased personal exemptions and 3) the newly introduced

separate computation of spouses tax habihty However the mtro

ductlon of the tax holiday as an investment incentive in the Omm

bus Investment Code of 1987 and the existence of certmn loopholes

m the tax structure (such as those where firms enter into back to

back loan transactions to reduce their tax habflity) sermusly eroded

the corporate income tax take 5

On the whole the prowsmns of the 1986 Tax Reform Package

also promoted efficleney and equity Manasan (1990) showed that

the promslon allowing spouses to compute their tax liabilities

separately equalized effectively the marginal tax rates on the pn

5 Firms have an mcentave to engage m tax arbitrage by takang out loans and mvestangthe proceeds m high 3neldmgq_reasury bills In thas arrangement interest income istaxed at a rate of 20 percent while corporate income net of the interest expense istaxed at 35 percent

BREAKINGAWAY FROM THE FISCAL BIND 13

mary and the secondary earner She also demonstrated that ab

stracting from evasion the switch to the global system resulted m

a more neutral treatment of wage and non wage earners and m a

more progressive tax structure Moreover she argued that umfymg

the corporate income tax rate removes the blas against large and/or

profitable enterprises inherent in the dual rate structure that was

prevlously in place Finally Table S shows that the Phlhpplne

income tax structure is roughly comparable with those of other

countries In the region

Table 5

Indw,dual Income Tax Rate and Corporate Income Tax RateIn Selected Asian Countries 1990

(In percent)

MaximumMarginalRate CorporateIncomeCountnes Ind,wdualIncomeTax Tax Rate

Indonesia 35 35

Malaysia 40 40

Ph=hppmes 35 35

Singapore 33 33SouthKorea 50 30

Thailand 55 35

Source Manasan(1990)forcorporateincometaxrates

In 1992 Republic Act 7497 was passed permitting mamed

mdlvlduals to claim personal exemptions equal to P18 000 each

prowded both spouses were working While this amount is not large

If compared wlth the cost of hying mdlcators it is out of hne wlth

the P9 000 personal exemptlon allowed for single indwlduals Thus

this provlsmn led to a substantml loss m revenue (equal to about

P2 bilhon) wlthout any clear efficiency gains

The S1mphfied Net Income Taxation (SNITS) was also enacted m

1992 It reverted the ]ndlvidual income tax to the schedular system

14 ROSARIOG MANASAN

It reduced the tax rate on business trade and professlonal income

to 3 30 percent in contrast to the 0 35 percent rate for compensatlon income However SNITS restricted allowable deductions

against gross income to seven types of direct cost salaries of

employees raw materials and supphes business rental teleeom

mumcatlon and utilities expenditures depreclatlon interest pay

ments and contributions to government accredlted relief

orgamzatlons Expendltures on transportatmn representatmn and

advertmements are no longer tax deductlble as prevlously prac

tlced However _t replaced the provmion for a 10 percent optmnal

deductmn w_th one that allows 40 percent optlonal deductmn

SNITS clearly sought to plug the leakages m the system arising

from overstatmg tax deductmns particularly those related to trans

portatmn representatlon and advertmmg expenditures The tmpor

tance of Imposing celhngs on deductlons cannot be overemphamzed

But at this point the dlrectlon of net revenue gain from the SNITS

remains unclear Some anecdotal ewdences mdlcate that the SNITS

may result in a lower tax take than antlclpated Some also pointed out

that the 40 percent optmnal deductmn may be too liberal for certmn

groups of taxpayers Income sphttlng for mlxed income earners and

the reduced tax rate also work to lower the effective tax rate Moreover

the return to the schedular system once again Implies the recurrence

of efficlency problems assocmted with that system as noted earher

Import duties and taxes Of all indirect taxes duties and taxes

on _mports are the most Important in terms of revenue yield

Although their proportion to total taxes dechned from an average of

32 5 percent in 1975 1982 to 31 4 percent m 1983 1985 the share

of import revenues again chmbed upwards m the succeeding years

to about 35 percent m 1991/1992 (Table 3) In those years importdutles and taxes combined proved to be the blggest revenue earner

of all the major tax types

Measured relatlve to GNP national government revenues from

imports regained m 1986 1992 the two percentage points lost m

1980 1985 Thus Import duties and taxes stood at 5 3 percent of

GNP m 1992 from a low 2 8 percent m 1985/1986 (Table 1) Thin m

even greater than its peak level of 4 6 percent of GNP m 1980

BREAKINGAWAYFROMTHE FISCALBIND 15

Moreover tariffs and taxes on imports combined surpassed all

other types of taxes m terms of growth rate m 1985 1991 wlth an

average annual rate of increase of 26 4 percent during the period

Imtlally thls development was surprising given the overall reductionm tariff rates under the Tariff Reform Program started m 1981 A

number of factors moderated the expected negative impact of the

program on tariff revenues First an import surcharge/levy took

effect m 1983/1985 and then again m 1991/1992 m response to a

balance of payments {BOP) cnms in those years Second the wlth

drawal of the privilege of government corporations to capltal Impor

tatlon free of tax and duty in 1984/1985 blunted the likely drop m

revenues from thls source Table 6 shows a dechne in the proportion

of non dutlable imports to total imports m 1986 1988 In 1988

however the share of non dutlable imports began to inch up again

Third the mtroductlon of the Comprehensive Import Superwmon

Scheme (CISS) m 1987 somewhat improved customs collection

efficlency On the whole the changes m the tariff rates and m the

coverage of exemptions appear to have largely cancelled each other

out as suggested by the fairly even estimates of effectlve tariff rates

on total imports m 1980 1987 Although the effectlve tariff rate on

total imports tapered off in 1987 1990 a trend reversal occurred

when the import levy took effect in 1991 Finally the rapld growth

m tariff revenues m the last SLXyears resulted to a large extent

from the robust growth m Imports during the period

EO 470 which hopes to further cut down tariff rates and

restructure the tariff system over a five year pemod took effect in

1991 While the revenue effect of EO 470 is expected to be negatlve

its posltlve effects on overall competltlveness through further reductlon In the level and variation in effectlve protectlon rates are

well documented {Table 7)

An outstanding Issue on the tariff system still emsts Thls relates

to the use of the home consumption value (HCV) as the basls for

computang tariff To date the Phfllpplnes m the only country in the

world which does not use either the Brussels Definitlon of Value

(BDV] whlch is essentaally based on the export price plus insurance

and freight or the GATT system whlch m based on transactions

value Some sectors argued that since the HCV is generally higher

Table 6Value of Imports and Duties Collected and Average Effectwe Rates 1980 1990

(In b,ll,on pesos)

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Total_mports 48.080 54030 64120 82.220 99710 92060 98697 124108 137206 225240 290082

Dutiableprnporls 37850 42780 54280 44270 61760 54370 70701 101153 103114 148013 187202

Non-dubabte_mports 10230 11250 9 840 379,50 37950 37690 27998 22955 34092 77227 102880

/otototal 2128 2082 1535 4616 3806 4094 2837 1850 2485 3420 3547

Totalimportdubesandtaxescollected 11453 10603 12141 15839 17329 16590 16965 25627 24866 38231 46514

TotaldutJescollected 7867 7 38t 8 551 12088 14199 13497 13013 1801t 17614 28197 33692EffecWetariffrates

Totaltrnportdubesandtaxescodlectec_

totaldurable_rnports 3026 2478 2237 3578 2806 3051 24CO 2533 2412 2583 2485Effectrvetariffrates

To_aldutP_,scollected/

totaldurable=reports 2078 1725 1575 2731 2299 2482 1841 1781 1708 1905 1800

EffecbvetanffratesTotaltmportdubesandtaxes _>

collected/total=mports 2382 1962 1893 1926 1738 1802 1719 2065 1812 1697 1603 ,._

Effectivetanffrates

TotaldutJescollected/_altmports 1636 1366 1334 1470 1424 1466 1318 1451 1284 1252 1161 I_

Sourceofba_cdata BureauofCustoms

==Table 7

Average EPR and Standard Deviation by Major Groups Exportables and Importables(Using pnce comparison)

1979 1985 SD 1986 SD 1988 SD 1990 SD 1995 SDSector

Group

0396 AIlsectors 06470 04904 11655 03937 07564 03649 07084 02539 0384 02002 02642 ,..:j

Exportables 00690 0069t 00594 00411 00325 00414 00327 >_

lmportables 11756 10226 14507 08072 09053 07514 08806 04810 04904 03806 02620 :ZE_

03 22 Agnculture fishery and

foresb'y 01229 00900 03737 00503 02616 00521 02632 00353 02365 00265 02094

Exportables NA 0 0849 00967 0 0570 00967 -00570 00967

Importables NA 07962 02088 04833 02702 04928 02627 03527 01152 03109 00414

28-96 Manufactunng 09330 07335 15895 06017 10604 05549 10080 03582 04925 02804 03446

Exportabtes 00445 00455 01113 00119 00989 00128 00994

Importables 02710 10727 18010 08693 11724 08024 11194 05055 04787 03927 03221

Source MedallaErl_ndaMAnAssessmentofTradeandlndustnalPolcy1986-1958PIDSWo_ngPaperNo90-07andMedallaErlindaM "TanffReformAssessmentpresentedatt_ePhitlpp_neEconomicSooetyAnnualMee_ngonDecember131991

18 ROSARIO G MANASAN

than the BDV or transactions value its continued use effectively

raises the tariff on Phihpplne tmports and reduces the international

competmveness of local products Medalla et al (1993) shows that

while the wedge between the HCV and the mvome value is not very

high on the average inter industry variation is quite substantial

As such the dlstortlonary impact of the use of the HCV may be more

slgmfieant than what the average HCV to lnvome value ratio lnd_

cates Moreover the revenue impact IS not as large as earher

estimates suggest (Box 2)

Excise taxes Of all the major mdlrect taxes lemed on domestic

goods and servmes excise taxes on alcohohc products tobacco

products petroleum products fireworks clnematographm films

automobiles and certain product goods classified as non essentml

goods provide the most slgmficant revenue yield Measured m terms

of their share in total tax revenues of the national government and

their raze relative to the GNP excise taxes are also larger than any

of the tax components on income and profits The traditional role of

excise taxes has been maintained m recent years despite its sluggish

growth (10 8 percent) m 1986 1991 compared with the growth of

other tax categories (average growth rate of all tax revenues m the

same period settled at 19 1 percent) and its own growth m earher

periods (18 0 percent m 1976 1982 and 32 9 percent m 1983 1985)The share of exc_se taxes in the total tax revenues of the national

government rose from an average of 16 3 percent m 1976 1982 to

20 percent in 1983 1985 After peaking at 26 4 percent m 1987 its

contribution continuously dropped to 13 2 percent m 1992 (Table

3) It exhibited a mmllar trend when measured relative to GNP

Excise taxes remained steady at about an average of two percent of

GNP between 1976 1985 Rising from 1985 onwards it peaked at

3 3 percent of GNP in 1987 From then on it took a downtrend and

stood at two percent of GNP in 1992 (Table 1)

The poor performance of excise taxes in recent years resulted

from a number of factors F_rst the excise tax on petroleum products

diminished when the excise tax on fuel oll was abohshed m August1987 and the effective tax rates on other items were reduced m 1990

Second some cigarette manufacturers avoided or evaded paying the

BREAKING AWAY FROM THE FISCAL BIND 19

BOX 2

Use of HCV for Import Valuat=on

Since the Jnactment of the Ph_hpp_neTanff Act of 1990 the dutiable

value of imported articles depends on the price at which the good ts freely

offered for sale in the usual wholesale quantities _nthe domestic market of

the exporting country at the time of exportation Th_s price is also referred to

as the Home Consumption Value (HCV) The actual determination of the

HCV was rather spotty over the years because of the hmlted resources that

the Bureau of Customs (BOC) was able to allocate to verify the HCV) Since

the Society Generale de Surveillance (SGS) was engaged to inspect and

value imports the use of the HCV for import valuation has been raised

Importers have complained that the use of HCV for tariff assessment tend

to overvalue imports and effectively _ncrease the cost of doing business _n

the country w_th d_re _mphcatlons on the international competitiveness of

Phdlppme exports and the country s ability to attract foreign investorsThe results of Medalla et al (1993) demonstrate that the HCV valuation

system indeed raises the dutiable of imports and thus further d_storts the

protection structure Table B shows that the weighted average ratio of HCV

to invoice value (IV) is equal to 1 11 after the globahzatlon of the CISS The

study also noted that inter industry vanatlon Jn the HCV IV ratJo Is qu_tesubstantial w_ththe ratio varying from 0 95 for mrscellaneous manufacturers

to 1 18 for machinery and transport equipment The antra industry dtspersion

in the HCV IV ratio as measured by the standard deviation Jsalso uneven

The study concludes that the wedge between the HCV and the IV translates

into an additional tanff on imports The unevenness _n the HCV IV ratio

across and within industries imphes that the use of the HCV produces a

highly arbitrary impact on the protection structure Consequently the use of

the HCV introduces additional distortions that are not fully predictable fromthe nominal tariff rates

Note that Medalla s numbers tend to underestimate the true Increment

_nthe cost of _mported goods because _tdoes not take transactions cost _nto

account SGS officials md=cated that the number of appeals submitted to the

BOC SGS Import Valuation and Class=ficatlon Committee increased _n

recent months The appeals process _s not costless to firms and consider

able amount of resources has been expended on th_s

The use of the HCV also deters the flow of foreign _nvestments It does

so not only because _traises the cost of doing bus_ness _nthe Ph_hppmes

but also because _tmakes doing business In the country more cumbersome

4

20 ROSAPIO G MANASAN

Note that the Phthppmes_sthe only country _nthe world that has not adoptedthe Brussels D_fit itlon of Value (BDV) or the General Agreement on Tariff

and Trade system which is based on transactions value Thus foreigninvestors who are more familiar w_ththese systems find that they need to

acquaint themselves to a new system when they enter the Phfl=ppmemarketAt the very least they vLewedthis as an _rksomeand burdensome process

From the policy perspective tt _sthus tmperabvefor the Philippinestoshift awayfrom the use of the HCV VVhdethe countrys economic managersagree on the disadvantages of the continued use of the HCV they are veryconcerned about the negative impact on government revenues that such amove wdlentail In this regard it is important to point out that the reductionintariff revenues estimated by Medalla ranges from 3 9 percent (P2 8 billionbased on 1992 revenues) to 6 5percent (P4 7 bdhon)depending onwhetherthe elastlctty of demand for imports _sNgh orzero These numbers are lowerthan official estimates

Table B

Average HCVIIV by Commod=tyGroupMarch 16 December 31 1992

Stmple WeightedAve Std Ave Std

SITC Description HCVIIV Dev HCVIIV* Dev

0 Food 1095 0328 0947 0042

1 Beveragesand tobacco 1208 0394 1 054 0 0442 Crudematprlals=ned=ble 1 292 0685 1 130 0 0133 Mineralfuels 1 186 0426 1 120 0 008

4 Anlmalandveg oils and fats 1341 0841 1118 00125 Chemicalsandproducts 1381 0 755 1063 00626 Mftdgoodsby matenal 1609 0 925 1044 0 1227 Machineryand transport 1 191 0 440 1 183 0 031

equtpment8 Misc manufactures 1 361 0 873 1076 0 004

9 CommodltlesNEC 1 355 0661 1126 0033M_xed 1348 0712 1166 0006

Allcommod=tlesexceptSITC9 1291 0713 1 110 0033

ValueofimportsisusedasweghtSource Medallaetal 1993Notes BOCBureauofCustoms

NECnotelsewhereclasaredSITCSlandardIntemaIionalTradeClassification

BREAKINGAWAYFROMTHE FISCALBIND 21

correct taxes through transfer pricing and mlsclasslficatlon of

brands Some analysts estimated the revenue loss at about P3

bllhon per year {Monsod 1993) Th:rd the tax base generally lagged

behind GNP m terms of growth Thxs last point rinses the msue of

whether the present excise tax rates are too high such that they

exert a negahve impact on demand and consequently on taxrevenues

In June 1993 Congress enacted a law revaslng the exeme tax on

clgarettes following acnmomous debate and intense lobbying from

various interest groups Unfortunately much of the debate centered

on the relative merits of specific and ad valorem taxation when the

real problem hes m the system s loopholes whlch permltted relative

ease m reducing tax hablhty through transfer pricing between the

cigarette manufacturer and wholesalers/traders and the mmclassl

ficat:on of brands While the mlsclasslficatlon issue appears to have

been adequately resolved the use of marketing frms to avold paying

the correct taxes is only i_artlally addressed by the mtroductlon ofthe floor tax 6 Moreover the new law continues to wolate GATT rules

by maintaining the higher rates on imported clgarettes relative to

their domest:cally produced counterpart

Sales tax and hcenses Sales tax and hcenses became the thlrd

fastest growing tax category m 1985 1991 wlth an average annual

growth rate of 20 3 percent compared wlth a 19 1 percent rate of

increase for aggregate tax revenues Thls marked a big shift from its

past performance Of the major tax groupings sales tax and hcenses

proved to be one of the most sluggnsh m 1982 1985 expanding by

only 15 8 percent on a yearly average

Consequently the share of sales tax and hcenses to total tax

revenues expanded from 12 5 percent m 1985 to 13 3 percent m

1992 (Table 3) Similarly revenues from sales tax and hcenses rose

from 1 4 percent ofGNP m 1985 to two percent m 1992 its highest

level m the last 18 years (Table 1)

6 Abstracting from the floortax and the classdicatton msue the provasxonthat apphesa 20 percent mark up to the reglstered manufacturer s price to arnve at the constructive pnce effectively raxses the revenue by 20 percent However _t tends to penahzefirms that used to pay the correct taxes relative to those that avoided doing so

22 ROSARIOG MANASAN

The VAT s mtroductlon m 1988 largely accounts for the credltable

performance of sales tax and hcenses The first two years of _ts

Implementatmn were problematm The ratm of revenues from sales

tax/VAT and other percentage taxes to GNP dropped from 1 4 percent

m 1987 to 1 2 percent m 1988 and 1 37 percent m 1989 But it has

recovered since then reaching 1 6 percent m 1992 It Is slowly

emerging to be a better revenue earner than the sales tax (Table 8)

Table 8

Comparatwe Yield of Sales Tax and VAT 1987 1992(In mdhon pesos)

1987 1988 1989 1990 1991 1992

VAT 59312 71467 101345 130793 150957 181129

OPT 34734 21449 24136 28143 35077 37171

Total 94046 9 2916 125481 158936 186034 218300

% toGNP 140 1 17 137 148 147 159

OtherpercentagetaxesareincludedinthisanalysisbecausetheVATreplacedsomeofthesetaxes

Manasan (1990) showed that the introduction of the VAT greatly

Improved efficmncy by reducing the average effectwe tax rates or

ETR (t e the sum of direct and indirect taxes on output resulting

from the successive layers of taxes on output taxes on inputs mto

outputs taxes on inputs into inputs etc ) from 14 4 percent to 6 5

percent as well as the variation m the ETRs from a range of 1 3 34 6

percent to a range of 0 4 13 3 percent The difference between the

ETRs and the nominal rates (whmh measures the extent inputs are

taxed mdmatmg the dmtorttons arising therefrom) was halved from

an average of 7 2 percent to an average of 3 3 percent Manasan also

estabhshed that the VAT m shghtly more progresswe than the

sales/turnover tax it replaced However she noted that taxes on

inputs under the present VAT stall accounts for more than 50

percent of the ETRs mdmatmg that some gains m efficmncy could

be achieved if the number of goods exempted from VAT is reduced

Thus thin supports current proposals to further refine the VAT

BREAKINGAWAYFROMTHE FISCALBIND 23

Meanwhile the gross recelpts tax on banks was found to con

tribute to the hlgher cost of financlal mtermedlatlon m the country

today (Lamberte 1990) Because of thls it is recommended that the

gross recelpts tax be abohshed

Tax evasion

The previous section indicates that changes in both the structure

of the tax system and its admlmstratmn m the last half of the 1980s

greatly improved revenue performance However estzmates of tax

evaslon zn recent years zndzcate that vast opportunzt_es exzst for

collecting more revenues w_thout the need to razse tax rates or to

tmpose new taxes It should also be emphasized that tax evaszon

weakens the progressltnty of even the best designed tax systems

Evaszon of the mdwldual zncome tax Table 9 presents revised

and updated estimates of the potentml revenue from the mdw1dual

income tax The numbers suggest that some improvement albelt

somewhat spotty occurred m its collectlon rate from 26 9 percent

m 1985 to 34 percent m 1991

Table 9Potent,al Revenue from the Indw,dual Tax and the Level of Tax Evasion

Collect,on Potent,al Actual Evas,on

Rate Revenue Revenue Difference Rate

(%) Year (PM) (PM) (PM) (%)

269 1985 2194960 5 9120 160376 73 1

383 1988 1550474 59400 95647 617

28 5 1988 2788730 79470 199403 715

35 1 1990 46 20030 162060 299943 649

340 1991 61 11210 207446 403675 660

Source Potent,alrevenueauthor'sest,matesActualrevenueBureauofInternalRevenue

24 ROSARIOG MANASAN

Despite the progress achieved to date m reducing the evamon

rate of the mdlmdual income tax Table 9 also shows the big potentlal

to increase the government tax take by improving further the

collection machinery Uncollected revenue from the mdlwdual m

come tax amounted to some P40 4 bflhon (or 22 2 percent ofnatlonal

government tax revenues) in 1991

Evaszon o/the VAT Potential revenue estlmates from the sales

tax/VAT mdlcate that while the collectmn rate deteriorated from

31 7 percent in 1985 to 27 8 percent in 1989 it has recovered since

1990 to reach 38 4 percent in 1992 (Table 10) Undeniably the early

years of VAT implementatlon were problematlc However emdence

seems to show that It has Improved considerably in the last three

years

Again the gains to be had from an admmlstratlve reform of the

VAT system continue to be large VAT s potential revenue m 1992

is P47 2 bflhon or 3 5 percent of GDP while actual collectlon reached

only P18 1 bflhon or 1 3 percent of GDP Thls Implies that the

amount of evasion and other leakages in that year amounted to

P29 1 billion (or 13 9 percent of national government tax revenues)m 1992

Admlttedly tax evamon estlmates are not preclse Because what

ts being measured Is something whmh is hldden and not directly

observable measurement errors cannot be assumed away Thus

the estimated evamon levels are at best approximate However the

magnitude of tax evasmn levels are so huge that even If one allows

a margin of error as large as 50 percent the estlmated leakage m

the tax system remains substantial

Sources of" evasmn 7 Manasan (1988) noted that tax evasion

usually takes the followmg forms non flhng of tax returns overstated

deductions and non reporting and/or understated income/sales

Comparing the actual and the potentlal number of Individual

income tax fliers reveals that outright non fihng of tax returns is amajor source of mdlmdual mcome tax evasion Table 1 1 shows that

7 This section draws heavily from Manasan (1988)

Table 10Potential Revenue from the VAT and the Level of Tax Evasion

Potenbal Potential Actual Evasion Collecbon _:Revenue Revenue Revenue Difference Rate Rate

Year {Inre,ilionP) %of GDP (InmilSonP) (InmillionP) (%) (%)F

1985 94280 165 29960 64320 68 2 318

1989 364140 394 101345 262795 722 278

1990 393950 368 13079 3 263157 66 8 332

1991 454430 365 15095 7 303473 66 8 332

1992 47 1910 352 181129 29078 1 81 6 384

Source Authorse_mates

26 ROSARIOG MANASAN

only 22 5 percent of potentlal taxpayers filed their income tax retums

m 1990 The Economlc Intelhgence and Invest_gatlon Bureau or EIIB

{1992) noted a slmdar problem emsted wlth regards to the corporate

income tax The problem also exasts m other types of taxes

Table 11

Potential and Actual Number of Individual Income Taxpayers 1985 1990

PotentialNumber ActualNumberof Actual/

of Indwldual Individual Potential

Year Taxpayers Taxpayers (%)

1985 10074039 2336337 23 19

1986 9247644 2093335 22 64

1988 10544 154 2434520 23 09

1990 11651988 2 619271 2248

Source Potentialnumberofindividualtaxpayersauthor'sestimateActualnumberofwndMdualtaxpayersBureauofInternalRevenue

Whale many tax hable mdwlduals and corporatlons opt to file

thetr tax returns (because such is needed to expedlte certain

transactions e g wlth banks or those related to travel abroad)

many of these tax fliers underdeclare thelr income or recelpts Many

taxpayers appear to adhere to the following precept What the tax

collectlon agency does not know wdl not hurt the taxpayer

Another n-nportant source of evaslon _s overstating expenses and

allowable deducttons in the case of self employed mdlwdual income

taxpayers and corporate taxpayers The Natlonal Tax Research Center

or NTRC (1986) reported a wlde dlsperslon m the ratio of deducttons

claimed to gross income Moreover Manasan (1988) estabhshed a

slgmflcant posltwe relatlonsh_p between the ratio of deducttons to

gross income and the gross mcome levels of mdlvldual income taxpay

ers At the same t_me she also found a posltwe correlation between

the ratlo of the deficiency tax (due to audit) to actual tax and the ratio

of deductions to gross income for corporatlons All these lndlcate the

prevalence of overstating deductions for tax purposes

BREAKINGAWAY FROM THE FISCAL BIND 27

Theoretlcal hterature suggest that a hlgh penalty rate and a high

probablhty of detectlon can effectlvely deter tax evasion The preva

fence and magnitude of tax evaslon m the country thus mdlcate

that exlstmg penaltles and/or the Iukehhood of being caught and

pumshed are not hlgh enough to actually discourage evamon The

creation of special tax courts and the passage of new law prowdmg

stiffer penaltles on tax evasion are steps m the right dlrectlon

However resoluteness on the part of the BIR and BOC to enforce

the legal sanctlons continues to be a crltlcal concern It _s notewor

thy that m recent months such commltment seems to be more

forthcoming than ever before

The study also identified other weak points m the tax admml

stratlon system that encourage evamon low computemzatlon level m

the major collecting agencies and mabfllty of the BIR/BOC to access

avadable data on the true income/receipts of hard to tax mdlwduals

These will be discussed m greater detail m the following section

Reforming tax administration

Various studies identified the following Issues concerning tax ad

mlnlstratlon

Too much centrahzatzon The NTRC (1986 1991) noted that the

BIR has a hlghly centrahzed orgamzatlonal structure Both the

central office and the regional offices heawly engage m the actual

collection audit and mvestlgatlon of taxpayers This arrangement

has led to a number of mefficlenc_es m assessment and collection

enforcement

The centralized procedure m issuing the Letter of Authority to

audit has led to substantml delay m the assessment process For

instance Manasan (1993a) found that It took from three to six

months on the average between the receipt of an apphcat_on for VAT

credit and the issuance of the Letter of Authority to audit Also under

present rules collecting accounts receivable exceeding 20 000 falls

under the jurlsdlctlon of the national office This sltuatlon has not

helped unclog the plpehne collection of uncollected dehnquentaccounts as the number of accounts receivable has remmned high

28 ROSARIOG MANASAN

over time Thus greater delegatton of authority should be pursued

within the BIR to enable the central office to concentrate on pohcy

formulation program planning and evaluatlon of the management

effectiveness of the lower level offices regmnal offices should focus

on momtonng and evaluating the revenue dmtncts operataons

Under such a set up personnel across revenue dlstncts should be

reallocated since the dmtnbutlon of revenue personnel m hlghlyuneven and does not match the actual work load m some revenue

dmtncts (Table 12) Recent pronouncements mdlcate that BIR offi

clals are fully aware of these posslblhtles and have attached highpmonty to decentrahzatlon

Weak systems and procedures The absence of an updated

master hst of taxpayers mgmficantly contributes to the poor morn

tormg of tax comphance Manasan (1991) uncovered for instance

that revenue dmtrtct offices found it dlfficult to Identtfy stop fliersand follow up dehnquent accounts because of the absence of a

master file of VAT taxpayers The introduction ofa umfied taxpayer

identlflcatlon system with the msuance of a unique Taxpayer Iden

tlflcatmn Number {TIN) to all taxpayers regardless of the type of tax

they pay will go a long way m improving the system Increased

computerization will also make it easier to maintain the TIN system

Meanwhile the NTRC (1986 199 I) identified the need for a clear

cut and defimtlve pohcy on selecting audlt cases Thin should reduce

the assessment workload at the BIR to manageable levels While It

Is tempting to concentrate on the audlt of large taxpayers for reasons

of revenue producUvlty such a pohcy may lead to the unwanted

result of increasing concentratmn of collectmns from few taxpayers

(de Jantscher et al 1991) Thus a schelI_ whereto a specificpercentage of returns per income bracket m selected for audit shouldalso be consldered

The NTRC (1986 1991) als0 recommended the need to adopt amore vlgorous program of collectmn enforcement The non enforce

ment of warrants of distraint and levy on property that have already

been msued remains a major problem The study attributes thin

partly to the lack of revenue selzure agents and partly to the more

baslc problem of phymcally locating defaulting taxpayers

Table 12

D,stnbut,on of Taxable Returns Filed ,n 1990 and Assessment Personnel by Revenue Regton

AverageNo

ofTaxableRevenueRegion Numberof ReturnPerAssessmentAssessment

.11

Total Individual Corporation Pertnersh_p Personnel PersonnelE

(1) (2) {3) (4) (5) (6)- (1}/(5)Total 1694067 1672,052 20605 1410 2,215 765

56451 55993 446 I2 126 448 _.1 BaguloCity2andCAR TuguegaraoCegayanandCorddleraAdmln_sb'abonRegion 76900 76520 370 10 69 t 114 m

,.3A SanFemandoParnpanga 77077 76400 611 66 1t8 6533B ValenzuelaBulacan 173752 172276 1369 107 165 10534A Manda 178043 173681 3874 488 315 565

481and4B2 QuezonCdyandMa_tl 505248 495931 8964 353 591 8554C SanPabbC_ty 91562 90941 594 27 90 10175 LegaspCdy 55866 55602 264 -- 62 901

6A IlodoQty 57295 56820 433 42 60 9556B Baco_ndC_ty 54731 53825 848 58 t08 5077 CebuC_ty 95855 94701 1046 108 140 685

8 TaclobanCdy 39485 39298 182 5 59 6699 ZamboangaQty 40940 40662 243 35 57 718

10A CagayandeOroCity 57601 57253 330 18 65 88610B BuPJanQty 31260 31133 116 11 45 69511A CotabatoCdy 33693 33425 249 19 59 571

11B DavaoQty 68308 6759"= 668 51 86 794

Source BIRAnnualReportasc_tedknNarwhalTaxResearchCenter(1991)

30 ROSARIOG MANASAN

Low level ofcomputenzatmn Although the BIR has a long hmtory

(starting m the mld 1960s) of computer use its present state of

computerlzatmn remains pnm_tlve Thin was attributed to the grow

mg obsolescence of the mainframe computer system their made

quate maintenance the acute backlog m data procesmng and the

lack of an integrated database m the BIR (Crown Agents 1993)

Instltutlonahzmg a major computenzatlon program wouldgreatly enhance the agency s collectlon enforcement and assess

ment functlons It should be emphamzed however that while

computemzatlon will greatly improve collectlon and collectlon en

forcement It will not cure all the 111s that currently plague the tax

admmmtratlon system Better systems and procedures w111lead to

better collectlon performance even wlthout the benefit of increased

automatlon (see preceding sub sectlon 1

Manasan (1988) noted that increased computemzatlon would

make It earner for the BIR to access mformatlon lodged m other

d_vlslons within the BIR and m other government agencles hke the

Bureau of Customs Socml Secunty System Department of Trade

and Industry and Secuntles and Exchange Commmmon In thls

way the BIR would be able to seek out more aggresmvely tax hable

mdw_duals and corporatlons who do not file thelr returns

The greater ability to access these external sources of mforma

tmn through greater computemzatmn could also help the BIR combat underdeclaratmn of income First It w111 be earner to

operatmnahze presumptlve income taxatmn (whereby tax m as

sessed not on the basra of declared income per se but on mdlcators

of income) Following the experience m other countries {World Bank

1982) specified amounts of income may be presumed to be assocl

ated wlth for instance ownership of remdent_al property automo

bales boats mrplanes and race horses forelgn travel and

employment of servants Related to thin the Bank Secrecy Act

prohlbltmg the dmclosure of mformatmn on bank deposlts greatlyimpedes the BIR s access to reliable mformatmn on the net worth

(and accretmn thereto) of mdlwduals An amendment of thin lawtherefore m m order

Second computer asmsted audit selectmn cnterla will greatly

increase the cost effectlveness of BIR audlts S1mllarly the enlarged

BREAKINGAWAY FROM THE FISCAL BIND 31

mformatlon system that would also result from a major upgrade of

the computemzatlon level should make It earner for the BIR toestabhsh "norms and standard ratlos that its examiners can use

m evaluating taxpayers deductlon clalms The D1scmmlnant Func

tlon System or DIF (whlch measures the probablhty of tax error m

taxpayers returns glven mdlcators hke economlc act_vlty sales

reported annual mark up and dlscrepancles resulting from cross

checking mformat_on from other agenclesl has been used m other

countries to maxlmlze the effectiveness of audlts (de Jantscher et

al 1991)

Thlrd computerization should mmlmme m the medmm term

contact between the revenue agents and the taxpayers whlch

presents opportumtles for corruptlon For instance computenmng

BOC operations should lead to mechamzed processing of tax docu

ments clasmficatlonoflmports assessment and paymentofdut_es

and taxes Under thls system only taxpayers tagged as hlgh risk

ones will be subject to audlt (Alano and Medalla 1993)

Thus the ongoing computenzatlon program at the BIR and

BOC whlch is expected to be completed m 1997 w111greatly improve

tax admmlstratlon m the medmm term

Low compensa_on of tax collectlon personnel Alano and MedaUa

(1993) pointed out that the low wages of revenue agents compared

w_th the large amounts that tax evaders can offer provldes the

blggest problem m curbing tax evaslon They suggest that a per

formance based compensatlon scheme be mstltuted to effectlvely

mmlmlze the dlspamty between legal and illegal raceme of revenue

agents They argue that such a system coupled w_th greater flexa

bdlty m hlnng and firing tax collection personnel will be a powerful

dlsmcent_ve to corrup_on at the BIR and BOC They noted that the

success of private agenmes hke the SGS can be traced to then" abfllty

to employ and mmntmn a hlghly quahfied effiment and honest

workforce by using the right combmatlon of reward (compensation)

and pumshment (hlmng and finng)

32 ROSARIOG MANASAN

Proposed tax enhancement measures

Since 1986 numerous tax measures have been proposed and

enacted year after year because of the need to bridge the gap between

projected revenue and programmed government expendltures Most

of these measures have the overriding objectlve of generating addl

tlonal revenues However the analysis above shows that thelr

impact on overall efficlency and equlty has not always been favorable At the same tlme the ceaseless stream of new tax measures

leglslated each year places undue burden on the tax admlmstratlon

system whlch further exacerbates the poor state of tax collectlon

and enforcement m the country

In pmnc_ple new tax measures should focus on plugging |oop

holes m the tax system should lead to efficiency gains and should

not make the tax system more regresmve than before Because not

all tax proposals meet all of these objectlves pohcymakers should

take into account the trade off between these sometimes confllctmg

goals as they often mdlcate the impact of vamous tax measures on

sustainable growth Also the cost effectiveness of each tax measure

0 e potentlal revenue relatwe to the cost of collecting the tax)should recelve due conslderatlon

Given the above perspective it _s appropnate to broaden the VAT

base and ratlonal_ze the motor vehlcle reglstrat_on fees As noted

elsewhere m thls paper including more goods and serwces m the VAT

system will lead to efficlency gains as _t reduces tax cascading Given

the earher expemence w_th the VAT It _s hkely that such a move will

not make the tax system more regresslve than before On the other

hand transport studies show that the current revenues from road user

charges do not suffice to cover the cost of road wear and traffic

congestion {Nathan Associates Inc 1990 World Bank 1988b) These

studles also show that registration fees follow an overly complex and

dlstortlonary structure They noted that damage done on roads de

pends primarily on the axle load rather than on total weight Conse

quently rigid trucks 0 e two and three axle trucks) appear to be

under taxed relative to articulated trucks under the exlstmg system

In contrast the proposed increase in the documentary stamptax and m the stock transactions tax the shlft from the ad valorem

BREAKINGAWAYFROMTHEFISCALBIND 3:]

to the specific system m taxang dlstflled splnts and fermented hquor

and the land convermon tax do not seem deslrable Ralsmg the

documentary s_amp tax (DST) would further increase the already

hlgh cost of doing business m the country In partlcular theproposed increase m DST on financml instruments would increase

the cost of capltal It would also exacerbate the uneven treatment

of foreagn exchange transactaons an the banking sector compared

wath those m the informal sector and does not take into account the

hagher counterpart risk m the latter Contrary to the contentlon of

certain sectors the prevmhng DST m most cases as effectavely an ad

valorem tax it as not a Fixed tax Thus except for the DST on bank

drafts and checks warehouse receipts promes and powers of

attorney DST rates need not be adjusted penodacally for mflataon

Also the proposed increase m the DST (on stocks and bonds) and

m the stock transactaon tax _s mconsastent wath the government

thrust to develop the capatal market since at tends to hamper the

much needed investment growth Converting the present ad valorem

tax on dlstdled sprats and fermented hquor to specafic tax wall make

the system less buoyant and will necessltate frequent adjustment

m the tax rate through legaslatave actlon samply to mamtmn the real

value of tax revenues The pubhc debate on the c_garette tax shows

that thas case reqmres a tamper proof defimtlon of the tax base (one

that would make the tax less vulnerable to tax avoldance) coupledwlth stricter enforcement of the law

Meanwhile the proposed land convermon tax would tend to

deter the socaally optlmal shift m land use If the present landclasslficat_ton under the CARP law as v_ewed to be reflectave of the

best land use then the conversaon from agricultural to resldentmlcommercaal or industrial use should not be allowed at all But if

thls as not the case then the land converslon tax would tend to have

deleterious allocatlve effects

Finally while the proposed expansaon m the excase tax coverage

on non essential commodltaes and the amposatlon of a national tax

on real property are demrable to enhance the redlstnbutlve charac

ter of the tax system they requxre further study m terms of thear

_mpact on other economic goals Wdl the exc_se tax on affluent

consumption generate enough revenues to warrant the cost of

84 ROSARIOG MANAS/

collecting it? Will a natlonal tax on real property adversely affect tax

revenues of local governments?

Reforming Local Government Taxation

Pubhc sector finance 112recent hlstory Is largely concentrated at the

center wlth local government units (LGUs) accounting for seven

percent of general government s expendltures or 1 6 percent of GNPm 1980 1990 (Table 13) The degree of fiscal decentrallzatlon ap

pears lower when measured in terms of revenues Local govern

ments account for approxlmately five percent of total general

government revenues during the perlod (Table 14) Thls has resulted

from the fact that about 50 percent of total LGU income comes from

external sources mainly transfers from the natlonal government

Thus the revenue effort of all LGUs m the aggregate has remained

low with locally generated revenues not exceeding an average of one

percent of GNP m the 1980s

The real property tax (RPT) is the single major source of locally

generated LGU income in 1980 1990 contributing 41 percent of

total LGU income from local sources But its importance weakened

in the 1980s its share in total local source LGU income dechned

from 46 percent in 1980 to 40 percent m 1990 Real property tax

effort hkew_se deterlorated from 0 5 percent of GNP m 1980 to 0 3

percent m 1990 (Table 15)Meanwhile revenues from other local taxes also dechned

throughout the period relatlve to total local LGU revenues andrelatlve to GNP Revenues from other local taxes shrank from 29

percent of total locally sourced LGU income m 1980 to 25 percent

m 1990 S1mdarly it contracted from 0 3 percent to 0 2 percent of

GNP dulnng the period (Table 15) In contrast LGU income from

economic enterprlses kept pace wlth GNP and remained stable at

0 3 throughout the 1980s

Given the massive transfer of functions authol_tles and respon

slb111ties from natlonal government agencles to LGUs under the

8 General government Is composed of the natJonal or central government and thelocal government unlts

BREAKING AWAY FROM THE FISCAL BIND 35

Table13GeneralGovernmentExpenditures

(In millionpesos)

Year Total NG Local

1986 119122 110874 8 2481987 162487 153444 9 0421988 173328 162570 107581989 206613 193316 132971990 265411 247502 179091991 306435 282824 23611

Average198085 67502 61532 5 970198691 205566 191755 13811

%DIstnbubon

1986 10000 9308 6 921987 10000 9444 5 561988 10000 9379 6 211989 10000 9356 6 441990 10000 9325 6 751991 10000 9229 7 71

Average198085 10000 9116 8 84198691 10000 9328 6 72

RatiotoGNP(%)1986 1998 1859 1381987 2414 2280 1341988 2180 2044 1351989 2261 2115 1461990 2466 2300 1661991 2429 2242 187

Average198085 1788 1630 158198691 2320 2164 156

Sources AnnualF;nanc4alReportsDepartmentof InteriorandLocalGovemmentsandCommLss;ononAudit

Table 14

General Govemment RevenuesNominalLevels(tnmdhonpesos)

I Average19801985 Average19861991 t988 f

Total NG LG Total NG LG Total NG LG

Total 50101 46721 3 380 148813 141570 7 243 118360 112861 5 499Taxrevenues 43 540 41 163 2 378 121218 116368 4 851 94203 90352 3 85tNon taxrevenues 6 560 5 558 t 002 27 595 25203 2 392 24158 22509 1649

Raboto GNP(in percent)

I Average19801985 Average19861991 1988 I

Total NG LG Total NG LG Total NG LGTotal 1327 1238 090 1680 1598 082 1489 t4 19 069

Tax revenues 1153 1090 063 1368 1313 055 1185 1136 048Nontaxrevenues 174 147 027 3 11 284 027 3 04 283 0 21

PercentageDistnbut_on

I Average19601985 Average19861991 1988 IoO

Total NG LG Total NG LG Total NG LG

Total 1000O 9325 6 75 10000 95 13 4 87 10000 9535 4 65Taxrevenues 10000 9454 546 10000 9600 4 00 10000 95 91 4 09Non taxrevenues 10000 8472 1528 10000 9133 867 10000 93 18 682

Table 14 (conbnued)

NominalLevels(Inmillionpesos)

I 1989 1990 1991 I

Total NG LG Total NG LG Total NG LG

Total 161066 152411 8 655 190170 180902 9 268 231321 220788 10533 '<Tax revenues 128020 122463 5557 157710 151700 6010 189256 182276 6980

Nontaxrevenues 33046 29 948 3 098 32460 29202 3 258 42065 38512 3 553RabotoGNP(Inpercent) r_

[ 1989 1990 1991 I i

Total NG LG Total NG LG Total NG LG _.Total 1763 1668 095 1767 1681 086 1833 1750 083Taxrevenues 1401 1340 061 1465 1410 056 1500 1445 055Nontaxrevenues 362 328 0 34 302 2 71 030 333 305 028

PercentageDistnbubon

[ 1989 1990 1991 ]

Total NG LG Total NG LG Total NG LGTotal 10000 9463 537 10000 95 13 4 87 10000 9545 455

Taxrevenues 10000 95 66 4 34 10000 96 19 381 10000 96 31 369Nontaxrevenues 10000 9063 937 10000 8996 1004 10000 91 55 845

Notes LG- LocalgovemmentNG- Nabonalgovemment

t4OlD

Table t5

RevenueStructure of LocalGovernments 19801991

NominalLevels(inmillionpesos)

19801985 19861991 1986 1987 1988 1989 1990 1991Average Average

A Localsources 3 380 7243 4616 4 887 5499 8 655 9 268 10533

1Taxrevenues 2 378 4 851 3288 3 418 3851 5 557 6 010 6 980

1 Realpropertytax 1 460 2872 2080 2 123 2276 2 733 3 728 4 2932 Others 918 1978 1208 1295 1575 2 824 2 282 2 687

I_Operahngandm=screvenues 993 2 202 1323 1461 1634 2 444 3 039 3 310

Ill Capital 9 191 5 9 14 653 219 243B Externalsources 2 980 7 621 4 045 4036 7860 6 626 9 794 13366

1 Sharesfromnationaltaxes 2 335 5 234 3249 3359 4 202 4 097 6 995 9 504

2 Grantsandaids 496 2 253 734 633 3 604 2 457 2 693 3 396 o

3 Interlocalgovt trans 16 19 12 30 20 24 10 17

4 Borrowings 133 115 50 13 33 48 97 448

Totalincomeandextraordinary r.,,9

receiptsandborrowings(A+B) 6361 14864 8 661 8 923 13359 15281 19062 23899

BR

EA

KIN

GA

WA

YFR

OM

TH

EFISC

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D39

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00

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00

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_03

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Table15(continued) o_

PercentageDistr=bubon

19801985 1986-1991 1986 1987 1988 1989 1990 1991Average Average

A LocalSources 5314 4873 5329 5477 4117 5664 4862 4407

I Taxrevenues 3739 3263 3796 3830 2882 3637 3153 2921

1 Realpropertytax 2295 1932 2402 2379 1704 1789 1956 17962 Others 1443 1331 1395 1451 1179 t848 1197 1124

II Operabngandmlscrevenues 156t 1481 1527 1637 1223 1600 1594 1385

III Capital 0 15 128 0 06 0 10 0 11 4 28 115 t 02B Externalsources 4686 5127 4671 4523 5883 4336 5138 5593

1 Sharesfromnabonattaxes 3671 3521 3752 3765 3146 268t 3669 3977

2 Grantsandaids 780 1516 848 7 09 2698 _608 1412 1421 _o

3 InterIocaIgovt trans 025 0 13 0 14 0 34 0 15 0 16 0 05 007 _o4 Borrowings 2 10 0 77 0 57 0 15 0 25 031 0 51 188

Totalincomeandextraordinary >_receiptsandborrowings 10000 10000 10000 10000 10000 10000 10000 10000

BREAKINGAWAYFROM THE FISCALBIND 41

Local Government Code (LGC) of 1991 It Is imperatlve that LGUs

m'e able to generate an increasing portion of thelr income from local

sources Thls is partlcularly true for some 20 percent of total LGUs

whlch wdl suffer negatlve net transfer of resources and expendlture

respons:bdltles from national government to local government

(World Bank 1993) For the other LGUs improvements m local

revenue mob:11zatlon is equally important if local autonomy is to be

meaningful Financial independence of LGUs Is a key mgredlent tothe success of decentralization mlhatlves Thus a clear under

standing of the problems underlying the poor revenue performanceof LGUs is in order

A number of factors account for the poor revenue effort of LGUs

First the central government severely restricted the latitude of LGUs

m determining the rates at which they may levy local taxes Also

the prescrlptlon of umt rates rather than ad valorem rates for mostlocal taxes other than the RPT made these taxes hlghly melastJc

(Table 16) Similarly the centrally mandated postponement of the

general revlslon of the schedule of fair market value of real propertles

meant that untd 1987 the real property tax was lewed on grossly

outdated (1981/1982) property values 9 The results of Tan (1993)

confirm findings from key informant lnterv-lews (Manasan 1992a)that the ratlo of the _rue market value to the falr market value m

the assessor s schedule vanes from 3 to 5 (Table 17) 10

The Code also reduced the assessment levels on real property

for tax purposes and exempted remdentml buildings wlth fair marketvalue below P175 000 Thus the schedule of fair market values

must be adjusted upwards to levels that more closely apprommatethelr true market values to counteract the negative impact of these

changes on potentlal RPT revenues Where possible LGUs scheduleof fair market values should not fall lower than the zonal values

9 Pres_dentlal Decree 464 (Real Property Tax Code of 1974) mandated that theschedule of fau"market values should be rewsed every three years In 1980 such arew_aon was implemented However the revlslon scheduled for 1983 was contmuously delayed t.fll 1987 Under the Local Government Code of 1991 a new scheduleis supposed to be put m place not latcr than 199410 The Local Government Code of 1991 transferred the authority and respons_blhty

to update and unplement the schedule of fair market values to IX]Us

42 ROSARIOG MANASAN

Table 16

Assessors Market Valuation and Advertised Market Prices

for Selected Prices of Property 1992

Assessors_ Actual Assessors_Market Market Valuation

Value Value MarketPrice

(PIm2) (PIm2) (%)Diliman QuezonCityCommonwealthAvenue 1800/m2 8000/m2 225

(DonMananoMarcosAve)AyalaHeightsSubdivision 2 000/m2 6 000/m2 333LaVistaSubdivision 800/m2 2 900/m2 27 6XaviervllleSubdlwslon 800/m2 7 000/m2 114

Makati

ForbesPark(residentalproperties 3 500/m2 15000/m2 233

boundedby EDSA Aim

McKinley Pih Tamannd

Buend=aandGu_nguaPasayRoad(commercialproperties 8 500/m2 41000/m2 207

fromEDSAtoPasongTamo)PasongTamo(VJtoCruzto J P 2 800/m2 9 300/m2 30 1

RizalSt )MakabAvenue(commercial 4 000/m2 38000/m2 105

resident=alpropertiesfrom

Gen LunaSt to J P RizalSt)MakatiAvenue(commerc=al 10500/m2 64000/m2 164

propertiesfromPasayRoadto JupiterSt )

SanMiguelVtllage 3 000/m2 50000/m2 6 0

Assessors Actual Assessors

Market Market Valuation

Value Value MarketPrice

(PIm2) (PIm22) (%)AgriculturallandLaguna

Coconutland P18/m2 P50/m2 3 6Fishpond P120/m2 P421/m2 285

Source E A TanRealPropertyTaxationandItsPotentialAsaMajorSourceofLocalRevenue=nPovertyGrowthandtheF#scalCrtsssbyDeDiosetal 1993

BREAKING AWAY FROM THE FISCAL BIND

Table17Buoyancyof Revenuesof LocalGovernments19801990

(In percent)

RevenueSources Buoyancy*

TotalRevenues 0 87I Localsources 078

A Taxrevenues1 Realpropertytaxes 0672 Taxesongoodsandservices

Businesstaxes 072Occupationtax 0 24Franchisetax 1 15F=nesandpenalt=es 109MKscellaneous 0 83

3 OthertaxesResidencetax 0 51Amusements 070Sandandgravel 024Others 1 22

B Operatingandmiscellaneousrevenue1 Governmentservices 0992 Governmentbusinessoperattons

Rentals 107Pubhcutlhtles 062Market 0 71Slaughterhouse 100Tollsonroadsandbndges 0 59Cemetenes 091Otherbusinessoperations 127

3 Interest 2014 Others 044

Totaloperatingandserviceincome 0895 Incomefrompublicenterpriseorinvestments 0 916 Msscellaneous=ncome 107

ContnbutJons 0 10Others 140

C CapitalrevenueSalesofassets 241

II Externalsources 0951 Sharesfromnat=onaltaxes 0 912 Grantsandaids 1 333 Inteflocalgovernmenttransfers 0484 Borrowings 0 84

BuoyancyisdefinedastheratJoofthepercentagechangeintaxrevenueto thepercentagechange

fn aggregate=ncorneGNP

ROSARIO G MANASAN

estabhshed by the BIR for purposes of determining the capztal gainsand the estates taxes

Meanwhile the LGC perm:ts LGUs to :mpose taxes on some

actlvlt:es and sectors that were formerly outslde the amblt of local

taxatlon Moreover the Code razsed the mammum allowable rates

at whlch most local taxes can be zmposed Desp:te these modzflca

tlons the scope of LGUs authority to levy business and other typesof taxes remains severely clrcumscr:bed and hmlted

Second local officlals faded to maxlmlze the use of thelr hmlted

revenue ra:smg powers (NTRC 1981 1992) Many LGUs d:d not

_mpose the mammum allowable rates under the old Local and Real

Property Tax Codes and chose to maintain thelr taxes at the same

nominal umt rates over the years desplte the clear eromon of their

tax yields by mflat:on In th:s respect LGUs must acqulre the

techmcal and poht:cal expertlse m setting local tax rates at levels

that are hlgh enough to maxlm_ze local revenues and low enough so

as not to dlscourage businesses from locating m thelr junsdlctlon

Third the admmlstrat_on of local taxes has been mefficlent In

the aggregate LGUs collect less than 60 percent of potentml real

property tax revenues (Table 18) Whde no est:mates ernst of the

efficlency m collecting other types of local taxes they may be lower

than that of RPT whose collect_on Is better orgamzed

Poor LGU tax admmlstratlon can be traced to the inadequate

systems and procedures that currently govern assessment collec

Table 18

Collectmn Rate for BasmcReal Property Tax(In percent)

Year CollecbonRate

1983 58 61

1984 54 24

1985 46 85

1986 51 37

1987 5282

1988 5430

1989 6815

1990 5774

BREAKINGAWAYFROM THE FISCAL BIND 45

tlon and enforcement The Associates m Research Development

(ARD 1992) noted that the required improvements are rumple they

only need to be practiced conmstently These improvements include

I) estabhshmg a tax roll for each type that the LGU admmlsters

(conducting a tax census and developing an integrated revenue data

bank are key steps in thls regard) 2) using mdlcators of presumptave

income prudently to arrlveat the _true gross recelptsofbusiness

estabhshments (thisinvolvesthe use ofstandard ratiosthat relate

the amount ofincome with givenlevelsofeasilyvcrlfiableexpendi

ture varlableshke utlhttes{electnclty/water)consumption rental

number ofemployees and the hke) 3)sending tax billson a regular

basis 4) consclentlouslymonitoring tax payments and identifylng

and collectingtax dehnquencles and 51strictlyimplementlng sanc

tions and penaltles(hke auctlonlng dehnquent real propertles

closing business estabhshments imposing penaltles and sur

charges atratesthatare high enough to hurt}on erringtaxpayers

Computerization ofrevenue operationsand greateraccessto mfor

matlon maintained by other government agcncles (hke the BIR

Regmter ofDeeds) would alsohlghlyreinforcethe posmve effectsof

the abovementloncd improvements on LGU finances With regards

to the realproperty tax however the biggestopportunityfor Im

proving collectionhes m proper recordsmanagement

Exploring the Potentml of User Charges

User charges refer to fees that the government exacts from prlvate

sector beneficiaries of publicly provlded goods or servlces that are

associated with large private benefit Unhke taxes user charges

make households and firms pay for at least part of the cost of

producing those servlces they consume As such it has often been

argued by many economlsts that user charges increase efficlency

whde they raise revenues at the same tlme By collecting a charge

on the use of a pubhcly produced good or servlce the government

discourages wasteful consumption of such good/s_rvlce Moreover

funding the prowslon of these goods through user charges enables

the government to avoid the deadweight losses that are associated

wlth tax financing

415 ROSARIO G MANASAN

Some analysts have argued that since user charges are lewed

by the government on a quzd pro quo basis they effectively hmlt the

access of the poor to needed government sermces However others

have shown that thls crltlclsm is misplaced They point out that

2here are many subsldlzed (government} services in LDCs that

dlsproportlonately benefit the better off Tertlary education at the

University of the Phlhppmes prior to the implementation of the

socialized prlctng scheme is one such example They argue that

government can promote its equity and efflclency objectlves and find

some relief from Its fiscal constraints as well by charging all users

of the government service cost based fees and by surnultaneously

installing well targeted programs to deliver the needed subsldles to

the poor In the case of university education thls may take the form

of selective scholarshlps

The revenue potential of user charges has not been fully ex

plolted m the Phlhpplnes Thus the contribution of user charges to

total national government revenues continuously declined from

15 3 percent in 1976 to 5 8 percent m 1992 Measured relative to

GNP user charges were halved m the last 17 years from 2 2 percent

to one percent This resulted largely from the government s failure

to automatically adjust user charges to reflect changes in cost ofproducing the goods/servlces

Some specific examples of user charges m the Philippine context

are presented below The subsequent section describes the possl

bfllty of raising revenues from cost sharing or cost recovery through

user charges m government hospitals The discussion on the poten

tlal of user charges m LGU public enterprises follows

Many other possibilities exist for the more effective use of user

charges The road user tax is one possibility The use of forest

charges to capture the economlc rent from exploltmg natural resources is another (Box 3)

User charges in government hospltals

Over 60 percent of natlonal government s health outlays go to

hospital services which are under the Department of Health (DOH)

Because hospltals provide health care with large private beneflts

BREAKINGAWAYFROM THE FISCALBIND 47

BOX 3

Prtcmg Access to Forest Lands

Phthppmeforestlandsareclass=fiedaspartofthe publicdomain hencethey are notalienablenordisposablefor pnvateownership Accessto suchland and the resourcesthereto such as the t_mberand nonttmber resourcesminerals floraandfauna have beengrantedmthe formof licensesandpermttsforresourceextract=onThe privilegeto harvesttimberproductsfromnaturalforestshasbeengrantedthroughhcensesof25 year durationrenewableonlyonce withthe attendantItcenseapphcationfeesand forestchargesonlogsandthe usualtaxesonprocessedwood products

Variousstudtespomtedout however that stncethe Phlhppineforestcharge systemdidnotreflectsuchvalues tt led to the followmgeffects 1)wastefulprocessingandconsumptionofwood basedproducts(delosAngeles 1993) 2) htgheconom=crentand rent seekingactiwties(Paderanga eta/ 1983) 3) and a btas for capttal_ntensiveloggingtechniques(delosAngeleset a 1993)

Twomechan=smswere developedto =mprovepnc=ngofaccesstotimberresources The firstfocusedonthe longrecommendedstumpagevaluat=onsystem(e g Revtllaeta/ 1977 Cerna 1975) uponwhich to basea systemof btddmghmberharvesttngrights The Natural ResourcesDevelopmentCorporatton(NRDC) pdotedinthe late 1980swhichrecommendeda mm_mum bid price of 25 percentof the log price to _mplementm a T_mberProductionShanng Agreement(TPSA) However followthroughacttwttesto thiseffortwas minimaldueto problemsassoctatedwiththe NRDC whtchwas taskedwith the responsJbdltyof operationahzingthe TPSA The otherattempt focused on developingan _mprovedsystemuponwhichto baserevisionsof forestcharges Studsesconductedto explorethe =mphcat=onofthesystemofforestchargesandtaxesapphedontheforestbasedindustriesindicatethe needfor increasingforestcharges(delosAngeles 1980 Saastamomen1990 andBaut=sta1992) Alltheseindicatethe needsforadjustingforestchargesto enable governmentappropriat=onof economicrent

PartA of Table C illustratesthe pre adjustmentlevelsofeconomicrentfor both old growthand secondaryforest loggingfor extreme cases ofinefficientandefficientfirms For old growthioggmg the lowforestchargeof P30 percubtcmeterallowedeconomtcrentseven for inefficientfirms at18 percentof totalcosts Upwardadjustmentsof forest chargeswell thushkelyreduceinefficiency(causeshutdownfornon viableoperattons)aswellas lowerthe sizeof the loggingsector

The residualforest case mdtcatedin Part B lower loggingcosts onaccountof lower infrastructurecostspertainingonlyto road and buddmgmaintenance(versusroadconstructionforold growthoperations)Thehigh

48 ROSARIO G MANASAN

economic rent levels are indicative of the rewards that sustainable logging

practitioners could have expected from the second growth forest assuming

no total log ban is imposed

Part C of the table shows the current situation under full _mplementatlon

of RA 7161 which increase forest charges from P30 per cubic meter to 25

percent of the local log f o b price Under current log pnces Part C indicates

that Ioggings even with the old capital intens_ve techniques under hgher

forest charges is still wable Thus for as long as selective logging is allowed

under conservation onented practices h_gher forest charges are expected

to generate revenues for the government

The current sh_ft_nuser groups from large scale logging to small scale

communtty based logging in fact allows for h_gher econonlc rents from

logging Part D of the same table indicates lower production costs with the

use of less capital intensive logging log hauhng and transport technologies

which are more appropriate for smaller s_zed logs The potential economic

rents are h_gher as _nd_catedin Part C Assuming that these techniques are

also less soil erosive then the shift from lar£a scale capital intensive

logging toward community based labor intensive logging is favorable from

the perspectives of equity efficiency and conservationThe rewsion of the forest charge system through Republic Act 7161

passed in 1991 providing for a level that is 25 percent of the site specific

f o b log price (ex forest pnce) is not yet fully implemented Pending

ongoing studies on the system for determining local log prices an interimmechanism of basmg the forest charge on logging cost was developed A

study by Bautlsta shows that this results in lower government appropriationof economic rent from logging and wood processing actJwties compared to

DENR s administratively imposed Enwronmental Fee temporanly appSed in

the previous year Moreover the system currently disregards the off site

externaht_es of using upland areas Nevertheless the interim system results

_nhigher tax rates on the industries concerned compared to histoncal rates

and represents upward adjustments of user charges for scarce t_mberresources

With the current shift in forest cover from old growth to managed

secondary forests and of user groups from large scale to small scale an

_mproved .,ystem of charging the right price for exclusive access to a specific

forest ecosystem and the resources therein has yet to be developed Such

a system should have the following charactenstlcs (1) it must be based on

the expected flow of products both timber and non timber and serwces fromthe land management unit through a perpetual period of t_me instead of

being primarily timber resourse based and (2) it should allow for off site

externahtles penalize erosive pratlces and reward environmentally sound

practicessour e delosAngelesM S PricingEnv onmentalResourcesTheCaseof Foestry Water

andAhrResources 1993

Table CSimulated Profitabd,tyAcross Firm and Forestry Types 1987 1993

(In current pnces)

A B C D <_OldGrowthForest ResidualForest 1987 ResidualForest 1993 ResidualForest 1993

1987(capttalmtensive (capitalintensive (capitalintensive (laborintens_e

logging) logging) logging) Ioggmg)

Inefficient Efficient Ineffictent Efficient Inefficient Efficient Inefficient EfficientFirm Firm Firm Firm Ftrm Firm Firm Ftrm -%c_

>L-_

a Roundwoodprice 2932 2 932 2932 2932 4 000 4 00O 4 000 4 000 ._b Produc_oncost 1341 80l 939 523 1663 927 1331 741 uc Retumon_nvestment 1319 1 319 423 235 749 417 599 334

%pnce 45% 45°/ 45% 45 / 45 / 45 / 45% 45%d Forestcharges 30 30 30 30 1000 1000 1000 1000e Excessprofit 2416 7816 154045 2 14365 588 1657 1070 1925

(economicrent)percentof costs 18/o 98/o 164°/ 410% 35/o t79% 80°/ 260%

Notes a Ex forestpace actual

b 1987costfor averagefirm=sbasedonartaverageof variousestimates(delosAngeh_s1989) me retat_vecostsforeffic4entfirmswereestimatedusLngMoncayos

case stud,s 1993f_juresforK trttens_veIoggtngts basedon 10 percentgrowthrateperyearof 1987costof averagefirm labor_nlens=vetogg_ =sassumedto

be 20 percent_eaber tf_anK _ntenslvelogging

c ArLestimate assumedto be pricebased t

d As prowd,ed bylaw a fiatrateof P30percubtcrneterwas In effecttn 1987 RA 7161providesfora 25 percentofex forestprtceeffective1991

SO ROSARIOG MANASAN

and possess the administrative and control systems necessary for

implementing cost sharing mechanisms the charging of fees for the

services they promde represents a natural supplement if not an

alternative to the regular budgetary allocations financed by tax

revenues that now support their operations

A study (SGV Consulting 1991) showed that most DOH hospital

faclhtles in Region 3 exhibit low levels of cost recovery On the

average only five percent of the expenditures m these hospitals m

1987 1989 were covered by user fees (Table 19) The study attrib

uted thls poor performance to both external (1 e the overall level of

development m the catchment area of government hospitals and the

health seeking behavior of the market) and internal factors (1 e

pricing and costing practices for government hospital servmes the

income remittance pohcy and the culture/orientation of hospital

administrators and personnel)

The study pointed out that the mablhty of the current referral

system to steer patients to the appropriate health facdlty resulted

in the tendency of patients to seek all types of health care from the

DOH hospital network even if what they need could adequately be

promded by lower level faclhtles Thls tendency is exacerbated by

the underpriced services of DOH facilities In turn this has in

creased hospital operating costs making it more difficult to attam

full cost recovery At the same time lower level facflltles m the DOH

dehvery system are underutfllzed

Moreover the study noted that prices of hospital services are

usually based on outdated gmdehnes that do not truly reflect the

cost of providing the service Also DOH gmdehnes prescribe uniform

rates for all DOH hospitals and do not take into account the varying

paying ability of different catchment areas and different productmn

costs across hospitals The study further found that some DOH

hospital personnel are themselves resistant to the idea of charging

At the same time restrlctmns on the retention of income gener

ated by DOH hospitals severely hmlt the incentive to hospital

personnel to charge and collect user fees In contrast the cost

recovery level is qmte high m situations where hospitals are allowed

to retain the income collected from the user charge An example is

the Revolving Drugs Fund m the Sapang Palay Hospital (Table 20)

BREAKING AWAY FROM THE FISCAL BIND 51

Table19

Cost RecoveryLevels Incomeand Expenditures 19871989 Region3(Inthousandpesos)

TypeofHospltal t987 1988 1989

PrimaryNumber 8 7 7

Income 115050 29230 18990

Expenditures 2437330 6 10210 5 80170

Income/expenditures(%) 4 72 4 79 327

SecondaryNumber 29 28 24

Income 3 73980 4 68620 9 62330

Expenditures 9263830 14006020 12712250

income/expenditures(%) 4 04 3 35 7 57

TertCaryNumber 5 7 6

Income 4 92950 4 80740 4 87580

Expenditures 11051400 11069420 9410400

Income/expenditures(%) 4 46 4 34 5 18AllLevels

Number 42 42 37

Income 9 81980 9 78590 1468900

Expenditures 22752560 25685650 22702820

Incomelexpendltures(%) 4 32 381 6 47

Source AStudyonUserFeesandCost$hanng/Recove_/inDOHHospitals(FinalReport)

DepartmentofHealthOctober1991

52 ROSARIO G MANASAN

Table 20

Sapang Palay District Hospital Level of Cost Recoveryfrom the Revolving Drugs Fund 1989 1990

1989 1990

Totalcost ofdrugsandmedicinespurchased 792498 936961

Totalvalueofdrugsandmedtcmesreimbursedfromthe 8494 37027

mafntenanceandotheroperatingexpenses

(MOOEs)budget

Totalestimatedrevenuesgenerated 784004 899934

Costrecoverylevel(inpercent) 989 96 1

Source AStudyonUserFeesandCostShanng/RecoveryinDOHHospitals(F,nalReport)DepartmentofHealthOctober1991

Fortunately with the transfer of most DOH hospitals to LGUs

as part of the devolution program mandated by the LGC of 1991

restrictions on income retention no longer apply Thus the devolved

set up will substantially improve the incentives for cost recovery in

government hospitals For thin incentive to become operatwe how

ever LGU officials have to be sensitized to the advantages of setting

user charges at levels that are closely hrtked to the costs of service

dehvery Moreover LGUs should be prowded with technical assls

tance m cost based rate setting SGV Consulting s study suggests

that the following principles should guide rate setting for govern

ment hospitals 1) h_gher levels of cost recovery should be targeted

for services that generate higher prwate (versus social) benefits e g

drugs medicines and medical supphes 2) _ost recovery levels

should vary wxth demographic and Income characteristics of the

catchment area and 3) hospital admxnlstratlon should have the

flexlblhty to use their m_t_atwe to implement non cost or cost based

rates as well as cost containment efforts to attain an overall target

level of cost recovery

BREAKINGAWAYFROM THE FISCALBIND S3

User charges in LGUs

Like most LGUs cities operate a good number of pubhc enterprise

faclhtles hke markets slaughterhouses sohd waste and sanitary

services waterworks power facd,t,es telephone facilities and road

passenger transport fac_htles In principle these enterprises are

operated primarily for profit hke business enterprises Planning and

Development Collaborative International Inc (PADCO)/ Consult

ants and Planners Inc (PHILNOR) (1992) estabhshed that the

earnings of city pubhc enterprises as a group do not cover ade

quately the operation and malntenance costs of these fac111tles

In the aggregate pubhc enterprises run by clty governments

earned P0 33 for every peso spent on maintenance operating expen

dltures (MOE) in 1988 (Table 21) Pubhc utflltles operated by city

governments only earned P0 20 per peso spent in MOE While pubhc

markets and slaughterhouses appeared to be profitable undertak

lngs with an operating income to operating expense ratlo of 1 84

this figure was found to be misleading The cost figure dld not

include the outlays on securlty and engmeenng servlces provlded

to them by other city government offices Moreover the dllapldatedstate of a number of these facfl,tles mdlcate that actual MOE levels

are sub optimal

The study traced the roots of this problem to the high subsldy

level Imphclt m the pricing of city run pubhc enterprises While PD

231 (whlch has been repealed by the new Local Government Code)

restricted the rates LGUs can charge for the services of some of these

faclhtles the problem partly comes from the pohttcal orlentatlon of

local officlals that deters them from adopting cost based pricing

The Local Government Code of 1991 effectlvely removes the hmlt

on the levels of fees that LGUs may charge for pubhc enterprise

serrate The experience in other countries lnd_eates that firms and

households are more wdhng to pay user charges than taxes because

the corresponding benefits from the former are easily identifiable

Given this perspectlve one sees the great potential oflmproved LGU

pubhc enterprise performance on revenue generation if properlyharnessed

Table 21

Prof,tabm|=tyCompar,son Between Cm_ Government Operated PublmcEnterpr,sesand Comparable Pr,vate Sector Run Fac,htmes1988

(Values mnthousand pesos)

Pnvate

CI_Govt Sector

Operating Operating Profit Operating Operating Profrt

Income Expenses (3)= (1)/(2) Income Expenses (6)= (4)/(5)

ServJcerrype (1) (2) (3) (4) (5) (6)

PublicUtlbbes 157647 791221 0 20 t0 272099 7475623 137

Sobdwasteandsanl_ry se_l_S 182063 74312 2 45

Waterworkselectnclty/bght/power 51828 31584 164

Telephonefaclbtles 6 907182 4 935791 140

Roadpassengertransport 3131 026 2433936 129

Marketandslaugh_rhouse 146880 79 904 1 84 1262396 684018 185 I_Cemeteries 1 547 1 130 137 277460 177166 157

Otherbusinessoperations 13670 85 871 0 16 349218 233196 150

Total 319744 958 126 0 33 22433245 16045626 140 >_

Note Otherper_n_ge_,'(_aremduded=nth__alys__use t_ VATmp_cedsomeofth_ _y,_

3

Improving the

Allocation of Pubhc Spending

In recent years maintenance and other operatJng expenditures

(MOOE) and capltal outlays dramaUcally fell Whlle the government

undertook thin reductlon to achleve fiscal stabdlty m the short run

the economy cannot afford to continue such an unabated decline m

capltal spending iflt is to grow m a sustained fashlon Given its dlre

financial posltlon the government must also increasingly seek a

blgger value out of each peso it spends Thus It Is now nnperatlve

for the government to rewew its spending prlor1_es To do thin the

government has to reconmder _ts approprmte role and scope ws a ws

that of the private sector glven changing technologies and level of

economic development Also the government has to reassess how

Itshmlted resourcescan be spent most efficlentlyand effectivelyin

areas where government part_ctpatlonzsneeded

Trends and Patterns

Aggregate national government expendstures

National government expenditures on an obhgatlons barns 11 ex

panded mgmficanfly m the 1986 1992 period nsmg to 22 3 percent

11 Government obhgatlon expenchture data are based on accrual accounting assuch cxpenchtures are reckoned according to the tnne contractual obhgalnons aremade In contrast government cash expenchture data are based on cash accountingwhereto encpenchturesare reckoned relauve to the ttmc actual d_sbursemcnts forboth

56 ROSARIOG MANASAN

of GNP compared wlth an average of 16 9 percent m 1975 1985 (Fig

2) This came about as aggregate natlonal government outlays

exhlblted robust growth not only m nominal but also m real terms

While total national government expenditures grew by one percent

m real terms m 1975 1985 It surged by an annual average of 10 1

percent m 1986 1992 National government expenflltures increased

sharply m 1986 1987 1989 and 1990

These figures however are mlsleadmg indicators of the growth

and slze of the government dunng the period Thls is because of the

explosive growth of debt service m the government budget While

debt service accounted for 18 9 percent of the national government

budget m 1975 1985 this item ate up 40 8 percent of the budget

m 1986 1992 Thus debt service rose to 9 4 percent of GNP m

1986 1992 almost three times its 1975 1985 level of 3 2 percent

Consequently despite the substantial growth m the overall outlays

of the nataonal government total national government expenditures

net of debt servace has been depressed since 1983 Moreover per

capita government expenditures net of debt service m 1985 pnces

stood at P1 720 m 1992 well below its peak level of P2 031 m 1981

(Fig 3) Thls mdicates the extent to which the debt burden has

hampered the government s capacity to provide much needed serv

ices to the people

Economic categories of national government expenditures

The marked increase in total national government outlays m 1986

1992 largely came from the rapid growth in current expendltures

Current expenditures expanded from 11 6 percent of GNP in 1975

1985 to 18 percent in 1986 1992 while capital outlays contracted

from 5 3 percent to 4 2 percent of GNP (Table 22)

Current expendztures Further decomposition of the natlonal

government s current expenditures showed that the increased ex

pendltures in the last slx years followed the rapid growth in three

current and prior years obhgattons are made Under the Modified DisbursementSystem the Department of Budget and Management first releases the Advise ofAllotment (AA)which gives government agencies the authority to recur obhgataons orenter contracts Then it releases the corresponding Notice of Cash Allocatlon (NCA)which specifies the maximum amount of wlthdrawal an agency can make from agovernment servlcmg bank

26 F,gure 2 Nat,onal Government Expend,tures as a Percentage of GNP 1975 1992 I_

24 N

p _e 20 N

r _c

e 18 Nn

t 16

14

12

101975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

Av

Total Expend¢tures Total Net of Debt Servce

==

F,gure 3 Per Cap,ta Nabonal Government Expend,tures ,n 1985 Pnces 1975 1992

3000

2800

2600

I 2400

n 2200

_ooo - _/_o 1800s

1600

1400

1200 _)

1000 !1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

= ° iTotalExpendf(ures TotalNetof Debt$e_ce

BREAKINGAWAYFROMTHEFISCALBIND 59

items interest payments current transfers to government corpora

t.tons and expenditures on personal sermces Interest payments

soared to 6 3 percent of GNP in 1985 1992 compared wlth an

average of I 3 percent in 1975 1985 Personal sermees expenditure

rose from four percent to 5 6 percent of GNP Current transfers to

government corporations grew from 0 2 percent of GNP in 1975

1985 to 0 3 percent in 1986 1992 (Table 22)

Interest payments were so huge in the last seven years that they

even surpassed the national government deficit during the period

Thus if interest payments were netted out of the overall defimt of

the national government the country would have reglstered sur

pluses of 0 1 percent of GNP in 1983 1985 and 3 2 percent in

1985 1992 (Table 23) The phenomenal rise m the interest payments

may be traced to three factors 1) the national government assumed

the guaranteed Imblhties of government corporations and financial

mstltutions 2) domestic interest rates were rising and 3) the

government s access to the foreign sources of finance also dnnln

]shed On top of this the government s mopping up operation to

meet hqmdity targets under the IMF Program demanded much

larger volumes of domestic debt issue compared vnth what is

reqmred to finance the national government defimt At the same

time the government increasingly relied on domestic debt in the late

1980s partly tnggenng the higher interest rates during the period

The government had to offer higher rates to make the larger volume

of Its T bills more attractlve The government also followed a high

interest rate policy to keep the forelgn exchange rate down to avmd

upward adjustments m sermcing its forelgn habihties Thin led to an

explomve situation where the large stock of domeshc debt led to an

ever increasing domestic debt sermce burden further exacerbating

the fiscal defimt that had to be financed by more domestic borrowing

(Boxes 4 and 5)

The salary adjustments granted to government employees dur

ing the Aquino admmmtration partly explmned the dramatic in

crease In national government expenditures on personal sermces

These included the I0 percent across the board salary increase in

July 1985 the five percent salary increase for career executive

positions and the 30 percent salary increase for rank and file

Table 22

Nabonal Government Expend,tures by Econom,c Ciass,ficabon on an Obhgatlon Basis as a Percentage of GNP 1975 1992

1975- 1975- 1983 1986 1986 1987 1988 1989 1990 1991 19921985 1982 1985 1992

Tota_ 1690 1674 1709 2264 1920 23 I0 2105 2180 2377 2324 2395

I Currentoperatingexpend=tures t157 1087 1234 1844 1298 1896 1814 1864 2001 1885 1901

A Personalservices 408 435 377 5 56 478 469 548 569 5 97 5 49 602

B Ma=ntenanceandotheroperabngexpend_tu[es 749 652 8 57 1288 8 20 1427 1266 1295 4 04 1335 1300

a Interests 130 092 172 6 27 362 1043 5 77 603 6 61 594 587

b Transfers 1 20 1 42 097 137 10 0 88 10k 120 153 140 19Z

1 tok:_algovernment 067 087 067 0 65 061 0 28 058 041 0 5t 055 125

2 toall9ovemmentcorporations 019 024 013 033 022 029 039 029 063 026

tofinancralgovernment

corp0raUons 001 000 0 01

_ tononfinancialgovernment ,_c_rporatJons 0 t8 0 24 0 12

3 toothers 035 05t 0 17 040 043 0 39 0 19 040 0 73 022 041 ©

c Loanrepaymentands,nk,ngfundcontob 204 073 34_ 268 108 000 320 304 327 361 284 ,_

d OtherMOE 296 346 240 256 246 296 264 268 263 241 237 _>

_0

Table 22 (continued)

1975- 19"/5- 1983- 1986- 1986 t987 1_ 1989 t990 1991 t992

19_, 1982 1965 1992<>

II Cap_aloutlay 5 34 587 4 75 420 622 415 291 317 375 4 39 4g4

A Landland_mprovementsands_ctureoutlays 161 212 103 154 0 51 112 094 1 17 175 190 230

B Budd_sandskuctures 061 077 042 082 100 056 055 069 099 100 081

C Eqmpment 028 027 029 0 34 010 018 0 35 0 38 023 040 0 51

D 7nvestmentoutlay 227 237 215 064 209 070 030 061 052 040 051

a tolocalgovernment 018 000 0002 0002 023 024 025 031

b toallgovernmentcorporabons 218 232 202 043 206 069 027 030 027 014 0191 tofinancmlgovernment¢orporabons117 0 86 151

_0

2 tonon-financialgovtcoq_oratmns 101 146 051 028 206 069 027

c toothers 00g 005 013 002 003 001 003 008 001 001 001

E Loar_o_y 058 033 085 086 253 158 077 032 027 070 080

a tolocalgovernment 002 0003 003 003 00t 002 002 001

b toallgovernmentcoq)orabons 053 028 080 061 253 t14 062 017 020 064 011

1 tofinanaalgovernrnentcorpoxatmns064 001 007

2 tonon-Jinanc_algov'Lcorpoxabons0 48 0 27 0 72 034 Z53 114

c.toofhem 005 005 005 023 0003 042 012 013 005 004 069

Sourceofbasedata Deparl_entofBudgetandManagemenLotk,=

b_

Table 23National Government Deficits 1975 1992

(In mdhonpesos)

1975- 1975- 1983- 1986- 1986 1987 1988 t989 1990 1991 19921985 t982 1985 1992

Overallsurplus/(deficJt) 67687 39050 28637 170225 -31252 16693 23206 19567 -37194 26348 15965

Interestpayments 43584 13527 30057 384671 21612 36905 45865 54714 71 114 74922 79 539

Pnmarysulplus/(defiat) 24103 25523 1420 214446 9640 20212 22659 35 147 33920 48574 63 574

%to GNPI _rl

Overallsurplus/(def_t) 2 25 246 2 01 255 524 248 2 92 2 14 3 46 2 09 117 I

IInterestpayments 145 085 2 11 575 362 548 5 77 5 99 6 61 5 94 5 81

Primarysuq)lus/(deficd) 080 161 O10 321 162 300 285 385 3 15 365 464

Sourcesofbasedata Deparbne_ofBudgetandManagema¢andBureauofTreasury

BREAKING AWAY FROM THE FISCAL BIND 63

BOX 4

Mopping Up of Excess Liquld,ty

The national government s domestm debt started to pick up dunng the

Aqutno government By May 1993 domestic debt of the national government

stood at P541 5 billion or about P400 bdhon more than the outstanding publfc

debt at the end of 1986 the first year of the Aqutno government (Table D)

A factor behind this spiralling public debt _s the mopping up of excess

liquidity

Liquidity in the system increases if net foreign assets of the Central Bank

(CB) improves among other things If a ceiling on hquldlty is imposed then

the increase in net foreign assets has to be offset by reducing net domestic

asset This process Is commonly called the balance of payments (BOP)sterilization

Balance of payments (BOP) sterilization is easily explained using the

balance sheet of the CB In the balance sheet of the CB reserve money

(RM) falls under the hablhtles column The assets column has two major

items net foreign assets (NFA) and net domestic assets (NDA) In turn the

NFA comprises two items international reserves (positive) and foreign

habthttes (negative) The NDA includes a major item net domestic credit

(NDC) to national government (r e the CB s lending to the national govern

ment [NG] less NG s savings in CB) Expressed In an equation form we have

RM = NFA + NDA

Thus Jfa cethng on RM Is imposed then an increase JnNFA ts stenhzed

by decreasing NDA NDA can be reduced if the NG increases its savings _nthe CB

Except for 1990 BOP registered annual surpluses since 1986 These

surpluses Improved the NFA From a deficit of P133 bllhon Jn 1986 the NFA

deficit declined to P108 2 billion in 1989

The BOP stenhzatlon in the Aqumo government took the form of a

dechne of CB net credit to NG CB net credit to NG dropped from +P42 3

billion in 1986 to P29 5 bJlhon in 1989 TNs decline arose from the surge inNG deposit in the CB from just P16 4 Nlhon _n1986 to almost P70 bdhon m

1989 NG savings m the CB came from the increased issuances of Treasury

NIIs (T bills) for open market operations In 1986 total outstanding T billsreached P55 4 bdhon In 1989 tNs rose to P172 5 billion or an increase of

P117 btlhon in three years

This operation drastically reduced the growth of reserve money

64 ROSARIO G MANASAN

Tfe ry Bill O tst.= dl g(I b il p )

50O

450

4OO

350

300

250

2OO

150

100

5O

O1986 1987 1988 1989 1990 1991 1992 1993

RM grew at 31 7 percent m 1986 In 1987 the growth declined to 15 5

percent In 1988 RM growth settled at 16 5 percent In 1989 however RM

growth surged back to 38 percent The increase can be attributed to the

wage standardization of government employees among other things

In 1999 a foreign exchange crisis took place BOP registered a deficit

of US$185 million Thus NFA in 1990 swelled backto P140 5 btlhon As a

result BOP stenllzatton efforts stayed "tt rain=mum levels In fact NG deposit

in the CB dechned by P2 3 btllion

BOP sterilization operation resumed in 1991 and 1992 (or even _n the

first half of 1993) as shown in the data The BOP surpluses led to an upsurge

in NG deposits in the CB which amounted to P137 8 bdhon in 1992 In termsof NG cash balances in the CB the level stood a lot higher P150 billion m

1992 As a result the growth In RM was pulled back to 12 percent in 1992

The mopping up operation increased the stock of domestic debt of the

national government In 1991 domestic debt grew to P340 8 billion or anincrease of P87 billion relative to the outstanding debt for 1990 In 1992

T bdls outstanding stood at P441 1 bllhon or an increase of P169 6B relative

to the 1991 level As of May 1993 domestic debt outstanding stood at P541 5bllhon and T bills at P482 2 bdhon

The above analysis showed that the price that the economy had to pay

for trlmm=ng down the growth =nreserve money _sdomestic debt accumula

tion Generally thts is not sustamable because a nslng stock of debt makes

it harder to sustain macroeconomlc balances since debt servicing introduces

an additional burden This is especially true for countries with large debt

stock to begin with hke the Philippines Therefore, adjustment via additional

debt is usually not viable in the long run

source caesarCororaton PublicSectorDefiet andDomesticDebtHeavyBurdenofPhf ppneEconomicGrowth 1993

Table DDomesttc Debt of the Natmnal Government and Central Bank Balance Sheet

1986 1987 1988 1989 1990 1991 I992 1993

Domesbcpublicdebt(PB) 1444 1612 2072 2372 2538 340$ NA 5415

T btNsoutstandng(PB) 554 1059 1426 1725 1926 2135 4411 4822

Reservemoney(EOY PB) 500 577 673 92 9 1087 1294 1448 N A o

(growth/) 317 155 165 380 171 190 120 NACB netforeignassets(EOY PB) t33 3 1323 1216 1082 1405 685 38 2 N A

Balanceof payments($M) 1242 264 516 447 185 1065 498 NA

CB netdomest_cassets(EOY PB) 1843 1900 1889 20t 1 2493 1979 1067 N A

CB nelcred_tto NG(EOY P8) 423 32 173 295 275 432 1095 NA

NGdepostts_nCB (EOY PB) 164 42 6 582 696 673 753 1378 N A

May1993PB--tn bllJonpesosEOY-- end-ofyearItA -- notap_lcable

Table ECash Balances of the Nahonal Government by Locabon 1986 1992

(In mLIlionpesos)

1986 1987 1988a 1989 1990 1991 1992

Treasuryvautt 318 281 270 280 417 319 314

CentralBankof thePh_hpplnes 14403 39636 55512 68145 59587 73395 150270

PhlhppmeNationalBank 5496 5848 572I 5370 5377 8002 t6978

PhilippineVeteransBank 1502 1492 1492 1486 1486 1486 1486

LandBankof thePhd_ppmes 4712 2016 1773 1430 I523 2565 3954

DevelopmentBankof the Phtl_ppmes 2617 2361 1721 1530 416 414 4602

PhtltpptneAmanahBank 118 127 t43 105 91 91 79

Otherbanks 2545 3t07 6179 7647 403I 4803 396909

Total 31711 54868 72811 85993 72928 91075 181652 >O

Includesbalancesofbankdepomtaccountsofna'oonalagenoesunderthenewdisbursementscheme '_

So_rce BureauofTreasury

Co>2:

BREAKING AWAY FROM TIIE FISCAT BIND 67

BOX 5

Dynamics of Domestic Debt

Box 4 shows that as of May 1993 the domestic debt of the National

Government (NG) stood at P541 5 billion (B) NG s domestic debt increased

by more than P400 billion since the end of 1986 the first year of the Aquino

government It is shown below that at the rate the economy usmoving (i e

=eal interest rate asstill structurally way above real economic growth) the

present domestic debt accumulation behavior cannot be sustained If the

present pattern _snot reversed it would be hard to sustain macroeconomic

balances conducive to a sustainable economic growth because of heavydebt service burden

Let the debt income ratio be1

(1) b-- B/(P Y)

where B _sthe nominal stock of debt outstanding P the general price

level and Y level of real output of the economy

The debt income ratio changes through time by Ab This change can

be derived by differentiating (1)

(2) Ab = AB/(P Y) - b,(AP/P + AY/Y) = AB/PY - b*(_ + y)

where _ ,s the rate of ,nflat,on y ,s the real growth of the economy

The increase ,n debt ,s equal to ,nterest payments which ,s equal to the

debt outstand,ng t,mes the ,nterest rate , B less the nonlnterest budget

surplus x wh,ch is written as the pnmary budget share t,mes nom,nal outputThus

(3) AB=I*B-xPY

Subst,tute (3) ,nto (2) and rearrange to obtain the follow,ng result

(4) b--b(r y) x

where the real rate of ,nterest is (, e r =, =)

1 SeeDornbuschandFischer(1990)pages6278

68 ROSARIO G MANASAN

Box 5 (continued)

T ry B Iis Outstanding

(t bin p )

00

4O

400

35O

30O

250

2OO

150

100

5O

01986 1987 1988 1989 1990 1991 1992 1993

An unsustamable budget deficit pubhc debt problem occurs when (4) is

posEtJve ] e debt Is mcreasmg relative to income Thts can happen in twocases

Case 1 the debt service (the first term in the right hand side of the

equatton) Is btgger than the surpluses in the pnmary balance x

Case 2 the pnmary balance (budget deficit net of interest payments) isin the defictt

The first case properly describes the Ph[hppme budget deficit pubhc

debt ddemma There were surpluses _n the basic acttvttres of the nabonal

government but th_'se were not enough to service debt (see Table m this

box) The pnmary balance was negative only m 1986 In 1987 up to the

present primary balance always remained positive In 1992 pnmary bal

ance amounted to P63 3 Nlhon wNle Interest payment was P79 6 bdhon

The national government has been borrowing more than the amount

required to finance tts deficit For example NG s deficit m 1988 amounted

to P23 3 billion The net increase m public debt amounted to P46 bilhon oran excess of P22 7 btlhon in 1989 the excess was another P10 bdhon There

was no excess however m 1990 But in 1991 the excess soared to P60 7

Nlhon In 1992 the gap between the net increase m T bills outstanding andNG defic=t amounted to P153 3 bflhon

Domestic government borrowing _sstill excesstve even when compared

to the consohdated pubhc sector deficit (CPSD) especially rn the last two

years 1991 and 1992 In 1991 the gap between CPSD and the net tncrease

_ndomestic debt stood at P66 7 bdhon In 1992 the gap between CPSD and

the net increase in T bills outstanding reached P143 5 b_lhon

BREAKING AWAY FROM THE FISCAL BIND 69

Box 5 (continued)

Box 4 attnbuted th=s excessive government borrowJng to the mopping

up operation which in turn emanated from the tight monetary policy pursued

by the government all these years

The question anses Is th_s process susta_nableV This process Is h_ghly

unstable and explosive because real interest rate _sstructurally way above

real economic growth In terms of (4) r real interest rate _salways above y

real economic growth It was only _n 1988 when real economic growth

marginally exceeded real interest by 0 3 percent Since then the gap haswidened In 1992 the gap amounted to 7 1 percent Th(s high degree of

unsustamabfl_ty comes from the fact that the gap generates a snowball effect

on the debt problem High interest payments on exlsbng debt add on to the

existing debt level

In the first half of 1993 average interest rate on T bLIIsd_pped to about

11 percent With _nflatlon rate of about 7 percent real _nterest rate shd to 4

percent The recent drop in interest rate however is just temporary the

dechne came mainly from the slack tn the demand for loans because of the

ongoing recession If the demand picks up then an upward pressure oninterest rate would occur Th_s will therefore put a heavy burden on fiscal

finances because of the huge stock of domestic debt and w_ll make healthy

macroeconomic balances very d_fficult to sustain _nthe future(Conhnued nextpage)

Box5 (continued)

1986 1987 1988 1989 1990 1991 1992 1993

NatJona_government(inb_thonpesos)Revenue 793 1032 1128 1524 1803 2208 2424 NAExpendqture 1105 1199 1361 1720 2169 2471 2587 NA

Interestpayments 216 36 9 459 547 7t 0 75 1 796 N4Balance 31 2 167 233 196 366 263 163 NAPnmarybalance 9 6 20 2 226 351 344 488 633 NA

Consolidatedpublic

sectordeficit(Jnb_l]lonpesos) 29 7 155 29 8 3Q1 578 203 28 1 NA/ toGNP 50 23 37 43 54 16 19 NA

Domesticpublicdebl (inbdllonpesos) 1444 1612 2072 23/2 2538 3408 NA 5415

Increaseinpublicdebt (Lnbillionpesos) 168 46 0 300 166 870 NA 2007T billsoutstanding(inbillionpesos) 554 1059 142b 1725 1926 2135 44l 1 4822IncreaseinT billoutstanding(/_) 505 36 _ 299 201 209 2276 41 1

T bill rates(ave alLmaNntbes)(/) 143 131 157 195 249 226 169 NAlr_flabonrate(/) 08 38 88 122 141 187 89 NA

p_

GNPgrowth(/) 4 1 5 I 7L 58 4 3 0 3 0 9 NA(T billrate_ (inflationrate)(/) 135 _3 70 73 108 39 80 NA >(GNPgrowth) (reaI interestrate)(/o) 9 3 4 1 0 3 17 6 5 3 6 7 1 NA

rb

May1993 _<Source CaesarCororaton(1993)PubflcSectorDeficitandDomesticDebt.HeavyBurdenofPhlhpptneEconomicGrowth

BREAKINGAWAYFROM THE FISCALBIND 71

employees m selected government agencles m 1987 and the m

creases under the salary standardlzatlon scheme implemented m

July 1989 These adjustments were more than sufficlent to keep

pace with mflaUon Thus after adjusting for mflatlon personal

sermces expenditure rose by 10 9 percent m 1986 1992 compared

w_th 1 1 percent m 1975 1985 The expanmon of personal sermces

expenditure may have also emanated from the rise m the number

of government employees The Department of Budget and Manage

ment (DBM) data reveal that the government s personnel complement rose from one million m 1987 to 1 2 mflhon m 1990

Natlonal government subsldles to government owned and con

trolled corporatlons (GOCCs) meanwhile substantlally expanded

despite some improvement m the operating performance of govern

ment corporatlons (Manasan and Intal 1992) The bulk of the

subsldles to GOCCs dunng the period went to the Natlonal Food

Authority the National Irrigation Admmmtratlon and the Off Prod

ucts Stabfl_zatmn Fund

In contrast MOOE other than interest payments current trans

fers and loan repayments (1e the non contractual or dmcretmnary

portion of MOOE) contracted from 3 percent of GNP m 1975 1985

to 2 7 percent m 1986 1992 While thin expenditure item posted

pomt_ve nominal and real average growth m the last seven years it

has not yet fully recovered from the setback it suffered dunng the

1983 1985 crlsm To make matters worst the growth rate of otherMOOE m 1991 and 1992 dld not exceed the mflatmn rate Thin

development led to the premature detenoratmn of the government s

capital assets and the need for thelr earher rehabflltatmn

Capztal outlays The brunt of the fiscal adjustment carried since

1983 has been primarily absorbed by capital expendltures of the

national government Aggregate capltal outlays of the natmnal

government continued to shnnk dechnmg from 5 9 percent of GNP

m 1975 1982 to 4 8 percent m 1983 1985 and 4 2 percent m the

last sux years This contractmn occurred mostly m the investment

outlays of the national government partlcularly those to govern

ment corporatmns Meanwhile natmnal government investment on

its own account regmtered a turnaround m 1987 and started the

72 ROSARIO G MANASAN

slow upward climb reaching 3 6 percent of GNP In 1992 higher

than Its average level J'_ 1976 1982 (Table 22) However this m still

lower than its peak lev 1 of 5 1 percent In 1975

Functional categories of natlonal government expenditures

The last s_x years saw national government resources reallocated

from the economic service sectors and natlonal defense to general

public admlmstratIon debt service and the socml service sectors

Generalpubhc admmzstratmn Government expenditures on gen

eral pubhc admlntstratmn proved to be remhent to the stringent

cost cutting measures of the crisis years Dunng the Aqutno admlni

stratlon It figured among the fastest growing items in the govern

ment budget next only to expenditures on agrarian reform social

welfare and debt service Consequently it rose from 1 2 percent of

GNP in 1975 1985 to two percent In the last mx years In 1990 _t

reached 2 7 percent of GNP its highest level in the last 18 years

(Table 24)

Some reallocatton appeared within the government s general

pubhc admlnlstratmn budget The share of current expenditures to

total expenditures (net of transfers to government corporations)

declined from an average of 92 5 percent m 1975 1985 to an average

of 88 8 percent in 1986 1992 This arose from the increased outlays

for durable equipment build ngs and structures

Soclal service sectors National government expenditures on the

social servlce sectors grew substantially in both nominal and real

terms m 1986 1992 Outlays for the social serwce sectors rose from

3 2 percent of GNP In 1975 1985 to 4 1 percent in the last su¢ years

(Table 24) These expenditures on social service ranked only second

to debt sermee in terms of growth a reversal of the pattern in

1983 1985 While thelr share In the total national government

budget dechned marginally from 18 9 to 18 3 percent the share of

the social service sectors actually Increased from 23 3 to 30 3

percent when measured relative to total national government expenditures net of debt service

Table 24

Nabonal Government Expend,tures by Sectoral Classification on an Obl,gatlon Bas,s as a Percentage of GNP 1975 1992

1975 1975 1983 1986 1986 1987 1988 1989 1990 1991 t9921985 1982 1985 1992

Grandtotal 1690 1674 17 09 2264 1920 2310 2105 2180 23 77 2324 2395 _>

Totaleconom¢services 682 764 5 92 5 52 6 94 4 95 4 16 4 54 5 26 5 94 6 45

Agriculture 0 78 087 0 68 0 61 0 25 t 33 057 0 59 0 53 054 057Agrarianreform 0 08 0 11 0 06 0 37 0 06 0 18 020 0 54 0 50 021 063Naluralresources 0 68 0 31 1 08 0 29 0 19 022 024 0 34 0 36 033 029

lndust_ 0 27 0 36 0 16 0 12 005 041 0 10 009 009 0 10 009Trade 004 005 004 001 0002 0006 001 001 001 001 001Tourism 0 03 0 04 0 02 0 02 0 002 002 003 0 03 0 02 002 003

Powerandenergy 0 86 121 0 47 0 24 002 020 002 0 08 0 59 045 0 14Waterresourcesdevelopment 0 16 021 0 12 005 000 008 0 06 005 0 04 006 0 07Transportationandcommunlcabons 2 88 3 90 174 2 99 172 2 24 2 21 2 62 2 80 3 61 4 19Othereconomicservices 103 0 56 155 0 80 4 64 0 27 0 71 0 19 0 33 0 59 0 43

Totalsocialservices 319 350 2 86 4 14 4 22 3 58 376 4 29 4 52 3 91 4 43

Educabon 187 204 168 2 78 2 34 2 51 277 2 98 3 09 260 290Health 057 062 052 0 67 0 55 0 60 069 0 69 0 71 070 069

SoQalserv=ceslaborandemployment021 025 016 030 017 011 011 014 017 027 078Hous=ngandcommun=tydevelopment0 51 055 047 0 32 1 14 034 0 16 0 35 0 41 027 001Othersoc=alserv=ces 0 03 003 0 03 0 07 0 03 002 0 03 0 13 0 14 006 005

_z

Table 24 (continued)

1975 1975 1983 1986 1986 1987 1988 1989 1990 1991 19921985 1982 1985 1992

Nabonaldefense 1 78 2 22 128 1 31 1 29 129 156 141 1 30 1 22 121

Totalpubbcservices 1 92 199 184 2 59 2 05 285 260 236 2 80 2 63 264Pubbcadm=nlstrabon 1 18 1 27 107 1 97 1 12 223 182 190 272 1 84 190Peaceandorder 0 54 053 054 0 59 0 67 061 078 047 008 0 79 074Others 0 21 0 19 023 0 02 0 26

Debtservice 3 19 140 5 18 895 4 71 1043 8 97 902 9 88 955 875

Unallocated 0 12 0 19 0 002 047

Net lending 0 53 028 0 80 0 58 2 53 114 0 62 0 17 0 20 045 0 11

Grandtotal debtserv_ce 1371 1534 1190 1369 1450 1267 1208 1279 1388 1369 1521

Grandtotal debtservtcenetlendlng 1319 1506 1110 13tl 1197 1153 1147 1261 1368 1324 1510

Nabonaldefense peaceandorder 2 31 2 75 182 1 90 1 96 190 2 34 187 1 38 201 196

Sourceof baspcdata Deparlrnentof BudgetandMar_agemenL

BREAKING AWAY FROM THE FISCAL BIND 7S

National govemment expendlture on social welfare m nominal

real and real per caplta terms exhlblted a well defined upward trend

during the penod under study In 1986 1992 Its nominal growth rate

accelerated to five tlmes that m the 10 year period ending m 1985

whlle its share m GNP almost doubled from 0 16 to 0 3 percent

However thls increase does not mdlcate a major pohcy change It

largely reflects a reactlon to the series of calamltles (volcamc eruptlons

typhoons and earthquakes} that hlt the country at that lame

Natlonal government expendltures on educatlon and health also

reglstered an upward tendency during the perlod although both

tapered off m 1991 1992 Natlonal government outlays for educa

tlon rose from 1 9 percent of GNP m 1975 1985 to 2 8 percent m

1986 1992 whlle those for health grew from 0 6 to 0 7 percent Real

per caplta expendltures on education reached its peak (P329) m the

last 18 years m 1992 In contrast real per caplta expendltures on

health has not yet recovered the reductions It suffered dunng the

cnms years such that its 1992 level (P78) is even smaller than the

1982 level (P85)

In the soclal serwce sectors the share of current expendltures

to total national government outlays {net of transfers to government

corporatlons) decreased m the period under study In education it

went down from 92 6 percent m the decade ending m 1985 to 89 2

percent m the Aqumo years In health the share of current expen

dltures to total government expendltures dechned from 93 to 90 4

percent In the other social service sectors reduction was sharpest

from 69 to 49 7 percent

Economic sectors The growth of national government outlays for

the economlc sermce sectors lagged behind most of the other

expenditure categories For 1986 1992 expendltures on the eco

nomlc sectors grew by 5 4 percent in real terTns compared wlth a

10 1 percent growth m total national government expendltures As

a result government expenditures on these sectors dropped from

7 6 percent of GNP m 1975 1982 to 5 9 percent m 1983 1985 and

to 5 5 percent m 1986 1992 (Table 24) Moreover the share of the

economlc servlce sectors in the aggregate budget sank from 40 4

percent m 1975 1985 to 24 4 percent m the last slx years

76 ROSARIOG MANASAN

Desplte thin contractlon m the allocatlon for the economlc

service sectors the agrarian reform sector emerged to be a blg

winner m 1986 1992 The budget for agrarlan reform expanded by

60 8 percent on a yearly average m 1986 1992 compared wlth 3 7percent m 1975 1985 Relatlve to GNP outlays for agrarian reform

rose fourfold from 0 1 to 0 4 percent (Table 24) Thin m consmtent

w_th the government s commltment to the land reform program

In contrast power and energy water resources developmentand the trade and industry sectors figured as big losers Natlonal

government expendltures on power and energy dlved from 1 2

percent of GNP m 1975 1982 to 0 5 percent m 1983 1985 and to

0 2 percent m 1986 1992 Those on water resources development

plummeted from 0 2 percent m the decade ending m 1985 to 0 05

percent m the last sLxyears National government outlays on trade

and industry fell from 0 07 to 0 03 percent (Table 24)Government expenditure on transportation and commumca

tmn which was hit hard during the cnsm years regained some

ground m 1986 1992 The expenditure level m 1986 1992 averaged

three percent of GNP Thin m higher than the 1983 1985 level (1 7percent) but lower than the 1975 1982 level (3 9 percent)

In the economic service sectors no clear pattern emerged m thebudget allocation between current and capital expenditures in the

last 18 years In all the economic service sectors the share of current

expenditures to total expenditures (net of transfers to government

corporations) consmtently increased from 52 8 percent m 1975

1982 to 58 9 percent m 1983 1985 and to 63 1 percent m 1986

1992 A mmflar trend occurred m the power and energy sub sectorIn the transportatmn and commumcatmn sub sector the trend m

the share of current expenditures took the reverted U form For

instance the share of current expenditures stood at 43 3 percentm 1975 1982 then increased to 68 1 percent m 1983 1985 anddechned to 53 8 percent m 1986 1992

From the above the government seems to have shifted its

resources from capital to current expenditures m sectors usually

assocmted w_th pubhc sector investments (1e economic sectors)and from current to capital expendltures m sectors usually assocl

ated with making current expenditures Largely however these

BREAKINGAWAY FROM THE FISCAL BIND 77

movements slmply evolved from the reductaons in capital expendl

tures during peraods of fiscal restraint (1983 1992)

Pubhc Sector Investments and Growth

Because of severe fiscal constraints m the last half of the 1980s

public sector investments plummeted in real terms from 1985

through 1989 While some real growth took shape in 1989/1990this was eroded m 1991 1992 Pubhc sector investments followed a

similar trend when measured relatave to GNP (Fig 4) Moreover

actual levels of public sector investments (equal to 5 1 percent of

GNP in 1986 1992) fell way below the target levels set under the

1987 1992 Medium Term Public Investment Program (MTPIP)

The depressed level of pubhc sector investment m the last six

years does not augur well for the country s growth prospects The

posltlve relataonshlp between economlc growth and public invest

ment xs generally taken to be part and parcel of conventlonal wasdom

or received knowledge However firm estimates of this relataonshlp s

parameters partacularly for developing countraes are scanty and

hard to come by Attempts to derive estamates of the emplncal

relataonshlp between economic growth on the one hand and public

expenditures/ investments on the other show that 1) while afeedback relataonshlp exists between current pubhc sector expen

d_tures and growth public sector infrastructure expenditure

Granger cause economic growth 2) public sector capital expendl

tures have a stronger output effect than pubhc sector current

operating expendltures and 3) pubhc sector infrastructure invest

ment crowds In pravate sector investment while pubhc sector non

infrastructure investment crowds out private sector investment

Composition of public sector/nvestment

By level of government National government investments on its own

account climbed from 1 7 percent of GNP m 1983 1985 to 2 5

percent m 1986 1992 Capital outlays of local governments also

grew from 0 27 percent to 0 32 percent In contrast those of GOCCs

contracted further from 5 8 percent to 1 9 percent of GNP (Table 25)

=F,gure 4 Public Sector Investment by Level of Government as a Percentage of GNP

10

9

8

P 7

r 6c

e 5n

t4

3

2

01978 t979 1980 1981 t982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

A • zTotal Pubhc Sector Nat onat Government LGUs GOCCs

3o_>z

BREAKINOAWAYFROM THE FISCALBIND 79

Thus public investments m sectors that are traditionally dominated

by GOCCs hke agriculture power and energy and water resource

development suffered severe cuts

Table 25

Publ,¢ Sector Investment by Level of Government, as a Percentage of GNP

TotalPublic National

Year Sector Government LGUs GOCCs

1978 1982 7 34 2 58 O34 4421983 1985 7 81 173 0 27 5 811986 1992 5 14 248 0 32 2 34

1986 428 154 0 13 2611987 3 97 173 0 19 2 051988 3 72 193 0 22 1 581989 4 99 2 51 0 26 2 22

1990 7 26 3 30 0 32 3641991 5 15 268 046 2011992 533 2 73 044 2 16

Sourceofbasedata Na_nal8tat_bcsandCensusBoard1992(prekm=nar/)

By sector The share of the economic sectors in pubhc sector

investments dechned by roughly 12 percentage points between1981 1985 and 1986 1992 But the contnbubon of the social

sermce sectors and that of pubhc administration expanded stgnffi

canfly by 8 1 and 5 S percentage points respectively

Relative to GNP pubhc sector investments in the economic

sectors dechned from 6 6 percent in 1981 1985 to 3 9 percent m

1986 1992 Public sector investments in transportation and corn

munlcatton dropped slightly from 2 1 to two percent but those on

power and energy were halved from 2 3 to 1 2 percent of GNP Pubhc

sector investments in water resource development dropped by a

factor of three from 0 50 percent to 0 15 percent of GNP (Table 26)

In contrast pubhc sector investments in general pubhc admml

strat_on (from 0 08 to 0 34 percent of GNP) and the socml service

sectors (from 0 65 to 0 86 percent) expanded significantly

Table26

PublicInvestmentbySector as a Percentageof GNP

198t 1983 1986 1986 1987 1988 1989 1990 1991 19921982 1985 1992

Gran(ltotal 8 14 7 81 4 08 4 28 397 3 72 499 726 5 15 533

Generalpubhcserv=ce 0 09 0 22 0 28 0 03 033 047 040 047 0 27 040

Publ=cadmlnlstrabon 0 07 0 08 0 27 003 032 046 033 047 0 25 039

Peaceandorder 0 01 0 02 0 01 001 001 007 000 0 02 001

Unallocable 0 12

Defense 0 12 0 17 0 05 003 0 06 008 0 10 0 11 0 04 006

Educabonhealthsocialhousingand 0 68 0 69 0 68 171 0 81 062 0 89 1 15 0 68 0 69

others !

Educationcultureandsports/ 0 24 0 27 0 30 028 0 42 037 0 39 0 51 0 39 0 30manpowerdevelopment

Healthnutritionandpopulaboncontrol 0 06 0 04 005 005 0 07 009 0 09 0 13 005 0 03 r;_

Soaal_ laborandwelfare/employment 0 00 000 0 01 000 t_>=Housingandcommunitydevelopment 0 37 0 37 0 32 138 0 31 0 15 0 40 0 51 023 0 36OthersocJatservices 0 01 0 01 001

Table26(continued) ._.

1981 1983 1986 1986 1987 1988 1989 1990 1991 19921982 1985 1992 <>

Agnculturenaturalresourcesindustry 7 25 6 73 3 06 251 277 255 3 60 553 4 16 4 17tradetounsmpower

'zd

Agrananreform 0 02 0 02 0 03 001 0 02 005 0 17 008 0 01 i

Agnculture 0 68 0 90 0 17 041 0 51 042 036 0 14 004 0 06 _'_2Naturalresources 0 02 1 57 0 08 0 01 0 01 004 0 15 0 23 0 12 0 10 z

Indust_ 0 05 0 01 0 01 0 04 001 0 01Trade

Tourism

Powerandenergy 283 206 092 1 10 069 058 121 197 097 131Waterresourcesdevt.andfloodconlrol 0 41 0 57 0 12 0 15 0 12 0 10 0 15 0 21 0 19 0 12

Transportationandcommunlcabon 3 23 1 59 1 59 0 80 142 131 156 263 2 61 2 25Othereconomicservices 0 13 0 03 001 027 0 22 0 33

less 1ban01 percent.

I.L

82 ROSARIO G MANASAN

Table 27

Relabonsh,pBetweenFconomlcGrowthG andGovernmentExpend,turesE

OptionalLags

G=f(G E) E=f(E G) Relat,onshlpsI Nabonalgovernmentonly

Totalexpend,turesa (31) (12) feedback

Currentexpend,turesa (31) (14) feedback

Capitalexpend,turesa (34) (11) EcausesG

Maintenanceexpendituresb (13) (32) feedback

Infrastructureexpend,turesb (13) (11) EcausesGII Totalpubhcsector

Totalexpend,turesc (16) (11) EcausesG

Currentexpend,turesc (31) (14) feedback

Cap,talexpend,turesc (12) (26) feedback

Infrastructureexpend,turesb (13) (11) EcausesG

E_rnabonpenodfrom1960 1990

bEstlmatJonperiod_m 1975 1990

CEsbrnabonpedodfrom1970 1990

Source Manasan(1993b)unpublished

Trade off between current expenditures and capital expenditures

In the sub sectmns that follow two dlfferent approaches analyzed

the relatlonshxp between economzc growth and the compomt_on ofgovernment expendltures At the crudest level the test for Granger

causahty was apphed between government expenditures and itscomponents and economic growth As another optlon a macro

model was used to estabhsh the impact of Increased government

expendztures on output m a general equlhbrmm context

Granger causahty between economic growth and pubhc expendz

tures 12This sub section examines the question of whether 1) govern

12 A variable ts stud to Granger cause another variable _f the former and Its pastvalues are good prechctors of the latter in a statistical sense regardless of theunderlying theoretlcal relattonshlp

BREAKINGAWAYFROMTHEFISCALBIND 83

ment expendltures Granger cause econormc growth defined here

as the rate of GNP growth 2) economlc growth Granger causes

government expendltures or 3) bl directional causality exists be

tween the two variables Most studies to date (the PIDS NEDA

Macroeconometnc Model included) assume that government expen

d_ture IS an exogenous vanable Thus government expenditure 18

imphclfly assumed as causing economlc growth However other

analysts have argued that economlc growth promotes government

expendltures and that a feedback relatlonshlp emsts between thesevariables

Table 27 summarizes the results of applying the Hsmo (1981)

procedure to estabhsh Granger causahty between economlc growth

g and real levels of government expenditures •

Uslng nabonal government expendltures alone (based on obh

gations data from the DBM) a bl directional relation was found to

exist between economlc growth on the one hand and real levels of

current expenditures and maintenance expendltures on the other

In contrast real levels of national government capltal expendltures

and natlonal government infrastructure expenditures are shown to

Granger cause economic growth

Using data on real totalpubhc sector expendltures the analysls

reveals a feedback relationship between total pubhc sector current

expenditures and economic growth A SUnllar relationship is found

between total pubhc sector capital expenditure and economic

growth However real levels of pubhc sector infrastructure expen

dltures are found to Granger cause economic growth Moreover the

F statistic of the g = f(g,e) suggests the joint slgmficance of the

coefficients of lagged economic growth and of lagged pubhc sector

infrastructure expenditure lZ

13 Towlt

g = 007+031 st +0000017 el 0000018 2 0000014 3(364) (165) (310) (234) (153)

R2 = 0 89 F= 1453

where the numbers m parenthems are t statistics

84 ROSARIO G MANASAN

Table28Reallocationof ExpenditurefromCurrentto CapitalOutlays

Period

Variable 1 2 3 4 5

Percentagedeviationfromthebaseline

GDP 0 390 0 132 0 073 0 053 0 039

GNP 0 392 0 1331 00734 0 0529 0 0385

CPI 0 257 0 035 0 025 0 019 0 008

TBILL 1822 0 611 0024 0 026 0022

CP 0 088 0 068 0042 0 029 0021

CG 6 047 2 306 0808 0 270 0 079

CONSPR 0 597 0 475 0423 0 305 0 241

IDER 0 554 0 446 0307 0 172 0 107

GDCF 4462 1395 0578 0 249 0 133

XD 0 262 0 130 0 076 0 046 0027

MD 0 332 0 173 0086 0 045 0025

DEFNG 0 309 0 581 0905 0 407 0 195

Deviationsfrombasehne

(InmillionUS$)

TRABAL 4 5344 3 7485 1 5996 0 4768 04385

BOP 5455 -4270 1893 0 625 0 536

VanableDefinitions

GDP GrossDomesticProduct IDER InvestmentinDurableEquipmentGNP GrossNationalProduct GDCF GrossDomesticCapitalFormat=on

CPI ConsumerPnceindex XD DollarExports(million)

TBILL TreasuryRillRate MD DollarImports(million)CP PersonalConsumptionExpenditure DEFNG NabonaLGovernmentDet]clt

CG GovernmentConsumptionExpend=tureTRABAL TradeBalance(million$)

CONSPR TotalPrivateConstruction BOP Balanceof Payments(million$)

Source Table10A ofYapandReyes(1993)

BREAKINGAWAY FROM THE FISCAL BIND 8S

In summary the results of the Granger causality tests described

above indicate that real levels of government infrastructure expen

dltures Granger cause economic growth However the relatlonshlp

between current government expendltures and economic growth IS

bl dlrectlonal in nature Thus we conclude that pubhc sector znfra

structure expendzture ts a good predtctor of economic growth wh_le

current pubhc sector expendzture ts not

Results from macroeconometnc szmulatzon Using the PIDSmacroeconometnc model Yap and Reyes (1993) studled the ecor_

omy wlde effects of reallocatmg government expenditures from cur

rent to capltal outlays They dld a counterfactual slmulatlon whereto

they reduced the level of pubhc sector current operating expenditure

in 1986 by P5 b11hon and increased the level of pubhc sector capital

expendlture by P5 bllhon relatlve to thelr baseline levels They

tracked the impact of these changes on key endogenous varlables

over a five year period Table 28 summarizes the results of thlssimulation In essence the results show that

The outcome of thls exerclse demonstrates the stronger out

put effect of capital expenditures as compared to current operating

expenditures This can be attrlbuted to two factors (1) Government

investment actlwty dlrectly adds to the capital stock and thus

permeates more sectors of the economy (2) The imphclt deflator

of CONSGO (government constructlon expenditure) IS less senm

tlve to changes In the general price level thus maintaining the

impact of nominal investment m real terms relative to consumption

spending (Yap and Reyes 1993)

The statement further hlghhghts the gains that could be derived

by generating savings via the streamhnlng of bureaucracy and usingthose resources to finance additional public sector investments

Impact of public sector investment on private sector investment

In the hterature there is some debate on whether pubhc investment

crowds out or crowds m prlvate investment A number of countries

offer some evldence that pubhc infrastructure investment crowds tn

86 ROSARIOG MANASAN

or complements private investment while pubhc non infrastructure

investment crowds out or substitutes for prlvate investment (Blejer

and Khan 1984 Chlbber and Van W_jnbergen 1988) In a country

wlth severe budgetary constraints hke the Phfllppmes _t is impera

tlve that _ts pubhc investment program be consclously formulated

to adequately explolt whatever complementantles ernst between

pubhc and private investments

Given thls perspectlve private investment was regressed against

the following explanatory variables capaclty utlhzatlon (cu) real

effective cost of borrowing (rl) ratlo of net domestic credlt to prlvate

sector to GNP (ndcrp) lagged share of pubhc sector infrastructure

investment to total pubhc sector investment (sgn) and real GNP

(y) 14 In an alternatlve speclficatlon the lagged levels of real pubhc

sector infrastructure and non infrastructure investment (g11 and

gnn respectlvely) were included instead of sgu In both cases all

variables were entered m logar_thms except rl which was entered

as (1+rl) The real level of private investment pl set"red as the

independent variable

Apnon ifcapacltyut_hzatlonlslow pnvatemvestmentlsexpected

to be letharglc other things being equal The ndcrp and the rl varmbles

are included to account for the posslble crowding out of prlvate

investments elther through the decreased avaflablhty of credlt to the

private sector or through the mcreased cost of money The hlgher the

expected rate of economlc growth (proxled here by lag GNP) the more

prlvate investment is expected to be stlmulated FmaUy pubhc invest

ment could e_ther spur or deter private investment depending on

whether the former Is seen by the private sector as supporting or

competing wlth private investment It _s expected that the impact of

pubhc investments wdl be felt after some lag because the capaclty of

installed infrastructure rather than the investments m the current year

will have _mpact on private mvestment at any given tlme

14 Followmg Chlbber and van Wijnbergen (1988) the estlmatlon equation wasderived from an accelerator model ofprivate investment where actual stock of capitalIs assumed to adjust to the desn-ed stock following a partlal adjustment mechanxsmThe coefficlent of the adjustment _s then assumed to vary w_th government pohclesand other econormc factors i e the variables used as explanatory varmbles m theesumat_on equation

BREAKINGAWAYFROM TI-IEFISCALBIND 87

The estlmatlon results for the first speclficatlon show that the

coefficlent for the raUo of pubhc sector infrastructure investment to

total pubhc sector investment lagged three years (sg11 31 is posltlve

and statlsUcally mgmficant at the five percent level 15 Thls mdlcates

that pubhc infrastructure expenditure crowds m prlvate invest

ment The results also show a rapld adJustment as mdlcated by the

low t statlstlc for the pl I varmble The coefficlent of real cost of

borrowing is not slgmficant and has the wrong mgn However the

net domesUc credlt to the private sector varmble _s mgmficant at the

five percent level Thls tmphes that the domestic financing of pubhc

investment crowds out prlvate investment not so much through the

increased cost of borrowing but through the effectlve ratlonmg of

credlt to the prlvate sector Thls mlght be explained by the fact that

the financlal market was not yet hberahzed for many years m the

estlmatlon perlod (1973 1990}

When the levels of pubhc infrastructure and pubhc non mfra

structure investment were both included m the equaUon the esU

mated coefficlents suggest that the latter crowds out prlvate

investment whlle the former has no slgmficant effect on privateinvestment 16

15 The estlmatlon of the first speclficaUon ylelded the following result

Inpl- 24 97+0421np11 +3481ncu+0 13 In(l+rl)(2 51) (I 19) {237) (0 38)

+067nderp+ 141sg113 +0561nyl(2 20) (172) (157)

R2=089 F_ 19 81

16 The estm_at_on of the second specdicatlon (after dropping all variables wh,ch hadmslgmficant coefficlents) ylelded _armlar results

Inpl= 834+086Innderp 0621ngnu3 + 172Inyi(7)(1 55) (7 96) ( 3 00) (3 27)

R_=091 F_ 19 30

88 ROSARIOG MANASAN

Subsidles and Tax Expenditures

In prlnclple government may grant subsidies to the private sector

for two pnnclpal reasons First it may devise subsldy programs to

encourage a more efficient allocation of resources An example are

speclahzed lendlng programs designed to glve farmers and fisher

men access to production credit Another Illustration are subsidies

given to private businesses to encourage them to invest in actlvltles

deemed to be winners Second the government may provide subsl

dies for purely egahtartan reasons Current transfers from the

natlonal government to the Natlonal Food Authority (NFA) to bolster

farmers incomes and support government prescribed price ceihngs

fall under this category Subsldlzed housing programs and fertfllzer

subsidms serve as other examples

Government subsldms may or may not revolve actual cash

allocatlon from the government s coffers On a cash barns over two

percent of the natlonal government dmbursements in 1986 1992

went to submdles of various types including a subsidy for oll prace

support m 1990 The average share of submdles in the national

government budget m 1975 1985 stood at 1 6 percent Subsidies

that are reflected in the government s expenditure program are

subjected to the usual budgetary review process m both the execu

tlve and the legmlatlve branches Other government subsidies may

be Imphclt Thus preferentlal tax treatment of certain private sector

acttwtms over others through tax exemptlons tax credits and

addltlonal tax deductlons are largely extra budgetary They fall

outside budget process because they represent revenues that are

not collected and therefore not programmed As such revenues

foregone from tax exemptions are sometlmes referred to as tax

expendltures Nevertheless tax expenditures should be considered

as outlays just llke outlays for wages and salarms of government

personnel

Given the government s hmlted capacity to generate resources

It lS essential that the relative benefits and costs ansmg from the

various subsidy programs be evaluated The two case studms

provided below tame doubts on the cost effectiveness of the subs1

dins given to firms registered with the Board of Investments (BOI)

BREAKINGAWAY FROM THE FISCAL BIND 89

and to the NFA This paper specifically suggests that the resources

now being allocated to these programs exphcltly or lmphcltly be

put to better use elsewhere This paper also argues that the present

rules and regulat10ns govermng the setting of 011 and petroleum

product prices unnecessaraly expose the government to pressures

to subsldLze the consumption of these products during per10ds of

severe upward adjustments m the exchange rate and the mterna

t10nal price of crude 011

BOI lncentsves 17

Since the post war perlod various tax lncentlve laws were enacted

as part of the country s mdustrlalLzatlon strategy The first such law

was Repubhc Act (RA) 35 of 1946 which granted a number of tax

exemptlons to new and necessary industries It was repealed m 1953

and its replacement was superseded many tlmes over since thenThe latest revlslon of the investment lncentlves law came in 1987

wlth the issuance of Executive Order (EO) 226 otherwise known asthe Omnibus Investments Code is

Since 1967 the BOI admmlsters the fiscal incentives made

available to preferred industries As part of thls function the BOI

prepares the Investments Prlorltles Plan (IPP) annually processes

the regnstratlon apphcatlons of enterprises/products processes

reglstered firms apphcatlons for avallment of incentives and monl

tors comphance of BOI registered enterprises with the terms and

conditions of their reglstratlon

Table 29 presents estimates of the revenue foregone due to the

incentives provided by the BOI The cost of fiscal incentives to

industry rose almost fivefold in nominal terms m the last sux yearsfrom P2 2 bllhon in 1986 to P10 8 bllhon in 1991

Relatlve to GDP the total revenue foregone from fiscal lncentlves

is not neghglble Moreover It grew quite steadlly from 0 4 percent

of GDP in 1986 to 0 9 percent in 1991 But revenues foregone from

17 Thls sectaon draws heavily from Manasan (1993c)18 Manasan (1993c) compares the incentlves granted under EO 226 and thosegranted under Batas Pambansa 391 the leglslatlon in effect prior to the former

TabEe29

RevenueForegoneby Typeof Incentives(inpesos) °_

Average1986 1987 1988 1989 t990 1991 19861991

Taxdeduchons 110783834 185279437 199664901 64670820 101659533 175584411 837642937

Taxexempbons 1028905786 4052 338930 3 730303809 4803 185898 6 044317587 7829241 961 27488293971

Taxcredits 1074482138 1664364987 3047531459 2064105465 2075448610 2824615398 12750548058

Total 2214171 758 5 901983355 6 977500170 6931962183 8 221425730 1082944177041076484967

Reallevel 2148429806 5332956858 5724423800 5243145135 5517920555 6210343519 30177219673

% toGDP 036 0 86 0 87 0 75 077 0 87 0 77

%to na_ona_governmentrevenue 279 5 72 8 18 4 55 4 55 4 90 4 84

%toconsolidatedpublic >

sector 7 19 4540 2349 1805 1442 51 57 2163 I_

Source Manasan(1993c)unpubhshed

BREAKINGAWAYFROM THE FISCALBIND 91

BOI incentives appear to be more s_gmficant when measured relative

to total revenues of the national government They represent 2 8

percent of natlonal government revenues m 1986 and 4 9 percent

m 1991 Revenues foregone from tax incentives amounted to 14 28

percent of the consohdated pubhc sector deficit m 1987 1991

Since the government has been scrounging for new tax measures

every year to cover its growing fiscal deficit a quest:on arises

whether the benefits arising from the fiscal mcentlve system exceed

its cost Using fiscal mcent:ves as a tool for mdustrlal pohcy was

justified on two grounds First fiscal mcentlves may be used to

d_rectly counteract genuine market fadures --e g _mperfect capital

markets and :mperfect informatlon mstltutlonal d_stortlons -- e g

wage duahsm and pohcy originating dlstortlons -- e g tariff and

non tariff protection (Power 1989) In thls regard various studles

note that the emstmg protectlon structure I) penalizes exports

relatave to :mport substitutes 2) encumbers non manufacturing

relatave to manufacturing sectors 3) dlscourages a more even

dlspersal of industries across reglons (because protected fimshed

goods tend to cater to the needs of urban populations and because

of these mdustrles heavy dependence on Imported inputs that can

only be accessed through the ports whlch are concentrated m urban

centers) and 4) impedes the development of small/medmm Indus

try thls Is because large enterprises have the inherent advantage

m successfully securing favorable tarlff rates (Bautlsta Power and

Assoclates 1979 Pernla and Paderanga 1983 Tecson et al 1990)

More recent studies {Medalla 1986 Medalla 1990 and Pante and

Medalla 1990) confirmed that whde both the average effectlve

protectlon rate (EPR) and the dlspermon of EPRs across sectors

d:mmlshed as a combined result of the tariff reform program and

the import hberaltzatlon program m 1980 1990 the changes dld not

Slgmficantly alter the inherent bmses of the protection structure

A question Is then ralsed Is the BOI mcentlve system effectlve

m offsetting these d_stortlons w_thout introducing new ones9 The

answer is no It was pointed out that the specific features of the

Phd_ppme investment system m the past reinforced rather than

neutrallzed the blases outhned above Thus BOI mcentlves were

perceNed to favor I) mdustrles locating m the natlonal cap:tal reglon

92 ROSARIOG MANASAN

(NCR) relative to other regions {because of inadequate decentrahza

tlon In the BOI reglstratlon process) 2) large relative to small

mdustrles {because smaller firms are less able to afford the fixed

cost associated with both reglstratlon and avatlment of incentlves

from the BOI and because the capltal blased incentives whmh BOI

use tend to favor larger firms whmh are generally more capital

tntenslve than smaller ones) and 3) sectors wlth hlgh tariff rates

through the choice of industries included in the IPP (Tecson et al

1990 Power 1989) Manasan (1986 1990) also showed that BOI

lncentlves tend to unduly cheapen capital relatlve to labor because

they rely on non factor neutral incentives Finally Manasan

(1993c) based on more recent data demonstrated that these blases

of the fiscal mcentlves system still remain Her findings include the

following 1) the capltal mtenslty of BOI pro3ects increased as

indicated by the 15 fold rise In the capital labor ratlo between

1986 1992 {Table 30) 2) although the scale bias of BOI incentives

decreased m the last seven years the average size of BOI firms Is

about twice as large as the economy wlde average firm size dunng

the period (Tables 31 and 32) 3) while the location blas of BOI

incentives tapered off dunng the period BOI firms remain more

concentrated m the NCR and Regions Ill and IV than firms m the

National Statistics Office (NSO) census/surveys {Tables 33 and 34)

and 4) the export market blas of BOI incentives declined in recent

years {Table 35)

The second lustlficatlon for the use of fiscal incentives is their

alleged importance in attracting foreign direct investments (FDI)

The changes introduced under the 1987 Omnibus Investments Code

were ostensibly put in place to make the Philippines more competl

tive with its neighbors Manasan (1993) showed that the country

offers roughly equal inducements m terms of the incentives impact

on the profitability of promoted firms (Table 36) However the

results of a number of studies (Allen 1979 Lindsey 1981 MITI 1988

Rana 1988 and Lamberte 1991) that examined the importance of

fiscal Incentives m stimulating FDI inflow m more systematm fash

ion tended to show that the location declsmn of foreign investors

were more influenced by market fundamentals (size of market GNP

growth macroeconomm stability and pohtmal stability} than the

Table 30

Factor Bias of BOI |ncenbves Capztal Labor Rabo of BOI Registered FInTls 1986 1992 I_(In real terms)

Code Indus'w 1986 1987 1958 1989 1990 1991 1992":>

31 Processedfcods 11972 9554 20316 12525 51684 20386 6303732 Tex'Ceweanngapparelandlealhermdustees 6364 11678 7548 29889 227.21 9063 482933 Woodandwoodproducts 4023 3122 12996 5818 8184 8088 3020

34 Paperandpaperproduc__nbngandpubl_shtng -- 34875 34306 63639 38139 164122 9966135 Chemicalsandchemcalproductsp_eum coalrubberfptasbc 28099 15591 72208 70329 73930 377128 122.23 L'q

products i36 Non-metalhcmineralproductse_ceptproductsofpe_oleumandcoal 134887 11753 44995 91357 252018 179334 57652837 Basemetalproducts -- 66617 74g0 46308 154620 92043 95151638 Fabncatedmetalprodudgma_me_'equ=pment 6I 29 8008 t5859 22594 37639 t4048 3857339 Mmcellaneousmanufacturedproducts 4218 2184 5997 5124 2412 2533 5t 08

Manufactunng 6795 9769 17979 26779 34133 51450 115438

Agnculture 19827 17782 12370 28270 18820 16764 30129Electnc_ygasandwater 49753 7639 334180 18969 1227409 1569460 922916Mlnlrlgandquarrying 23179 26476 69477 66375 41217 19621PublicutJT_es 134862 32054 45411 25364 t 43018

Tounsm-onentedpro_erv_ exporters 33330 107987 103240 76099 293.22Expodnders 3881Infras_ct_re/lndus_alservces 247317 858,9106 523746

Researchanddevelopmentprojects 159939 75043Totaf 8091 10517 18960 30848 59406 66633 t 178t5

Sourceofbascdata SelectedStabsbcsonPmjectsApprovedunderEO226bysoc_" 1986-1992Boardoflnvesbnents

Realtermscomputedbyd=_hngprojectcostbycapdalIo_abonPiNforIheyear(base1985) i,,oSectoraldc._s_cabonunder"manufactunngisbasedonNabonalStatJsbCSOt_ces dass_¢abonwhchfollowsPl_hpp_neStandardIndustrialC_ss_..,atlon(PSIC) I_

1992_sfromJanuarytoOctoberonly

Source Manasan(1993c)unpubhshed

Table 31Scale Bias of BOI Incentives Average Number of Workers per Firm of BOI Registered F,rms 1986 1992

Code Industry 1986 1997 1988 1989 1990 1991 1992"

31 Processedfoods 8046 12763 9668 14526 6800 15926 4015

32 Texblewearingapparelandleathermdosbqes 23394 23828 20784 214I0 16459 16662 156

33 Woodandwoodproducts 8890 22452 9523 12614 8465 12463 334 '_34 Paperandpaperproducts_nbngandpubhshm9 23275 10555 6305 8148 5890 321735 Cherncarsandchemtca_productspe,Voleumcoalrubber/plas_cs 460O 8533 12789 9575 6307 8427 11496

36 No_metalhcmzneralproductsexceptproductsofpetroleum/coal 26O0 6567 42662 t 17O0 10353 12666 1192937 Basemet_producls 'l,6800 29,00 7800 120,00 16250 15080038 Fabricatedmetalproducts/.mach=neryequ=pment 79706 27921 47866 19036 16665 14790 1033839 Mccellaneousmanufacturedproducts 6955 20197 23226 15708 18290 10308 9835

Manu'_n9 26259 20929 22497 16875 14220 13177 13083

Agnculture 12788 13434 20040 8563 8,160 12995 179I3Eledczotygasandwater 4367 38225 5811 1697") 25740 9088 9211Mlr_ andquany_n9 135OO 15855 24696 5t8 95 19353 12t78Pubicubhl_es 8767 5522 7961 8295 2042

Tounsm-onentedpro;_:lstservceexporters 1679 8450 t9084 17569 3600

Exportkade_s OO0 2333 I_Infrasbucture/in_s_=alsewces 16508 0 71 18O0

FResearchanddevelopmentprojects 3767 1967Total 23605 20073 20755 15231 14734 12871 12580

Sourceofbascdata Se4'ectedStabstcsonProjectsApprovedunderEO226bySector1986-1992Boardoflnvestmef_SectoraldizsslficabonundermanufactunngIsbasedonNa'bon_StabstcsOffices classlEcakonwhet=followsPhthppmeStandardIndustnarClasslrcabon(PSIC)

1992=sfromJanuazytoOctoberonly,Source. Manasan(19931:}unpublished

BREAKING AWAY FROM l HE FISCAL BIND 95

Table32

EconomywideAverageNumberof WorkerperFirm 19861989

Code Sector 1986 1987 1988 1989

31 Processedfoods 11774 13627 6419 808632 Textileweanngapparelandleather=ndustnes 19361 21846 9250 1299233 Woodandwoodproducts 12734 14816 7184 782434 Paperandpaperproductspnnt=ngand 5812 6061 4402 5255

pubhshlng35 Chemcalsandchemicalproductspetroleum11306 12689 9600 10334

coalrubbedplast¢36 Nonmetall¢mineralproductsexcept 10238 11171 6025 7633

productsofpetroleumandcoal37 Bas=c_talproducts 13249 14013 8102 1176638 I abncatedmetalproducts/machineryand 9064 10105 7435 9376

equipment39 M=scellaneousmanufacturedproducts 10335 9222 7650 6280

Manufactunng 12018 13504 7460 9363Construction 9115 10076 88Z,4 8868Electnotygasandwater 16486 16444 16647 12577Miningandquarrying 31710 34595 27913 19737_holesaleandretailtrade 3102 3306 2366 3102Commun_socialandpersonalsen/ices 5027 5307 3421FJnanc=ng=nsurancerealestateand 4670 5241 4359 4996

businessservices

Transportat=oncommuncahonandstorage 14742 14564 9914 11059Pubhceclucatu_nalmedicaldentalandother 14196 15201 14420 14331

servicesAgnculture -- -- 19871 20081

GrandTotal 7573 8255 5609 5958

Source 198619871989AnnualSurveyofEstabl_hrnents(ASE)1988CensusofEstabl_hments(CE)

NationalStabstcsOffice(N$O) Exceptforagriculturein 1986198719881989

andforconst_'uc_m=nlngandquarry=ng=n1989figuresrefertolargeestabkshments

Source Manasan(1993c)unpublished

96R

OSA

RIO

GM

AN

ASA

N

mZm__

_m

_g

N

"_

__

1=

SRE

AK

ING

AW

AY

FR

OM

TH

EF

ISCA

LB

IND

97

N

Q

N

_-

o-_

oe,_

ZZ

CO

•_O

.

98R

OSA

RIO

GM

AN

_

_._|_

___=_.___

__

_

100R

OS_O

G_A

_

m_

_N

_NN

NN

N_N

NN

NN

N

g_

_N

_NN

_N_N

N_N

NN

NN

N

_-

f_g

-_

Table34(continued)

3 BookValueofFJxedAssets(inthousandpesos) __

( 1986 1987 1988 1989 1 P.Regions Total of whch Total ofwhich Total ofwhich Total ofwhch

MFG MFG MFG MFG

PhdcpJnes 285461564 75390697296549978 82533547255904245 98746866229390146 80580053

'=1

% D=slnbubonr 0 76 140 0 68 _:Jr 0 60 124 067 126 0 49 0 40 0 21ill 2 84 5 23 319 5 38 3 71 5 45 3 51 616NCR 5129 24 96 4930 26 10 47 01 29 03 5935 49 28IV 13 12 1728 1418 1983 1041 1867 9 78 20 98

V 2 60 0 60 2 79 0 55 134 0 43 151 0 20VI 3 24 3 90 3 08 3 30 5 34 2 42 3 12 143VII 5 12 4 50 5 15 3 65 4 97 4 05 4 33 312VIII 7 20 2460 7 54 24 24 8 66 2077 2 63 5 53IX 0 61 0 85 076 0 73 0 94 0 97 0 81 0 73X 658 631 579 454 712 512 680 383Xl 2 57 4 29 2 34 3 37 4 09 4 01 3 74 3 30XII 2 50 4 81 341 5 54 3 21 6 76 2 04 4 25

Share f NCR Reg=onIIIandIV

toTotal(inpercent) 6725 47 46 66 68 5132 61 12 5316 7265 7642

ShareofNCRtoTotal(in percent) 5129 2496 49 30 26 10 4701 2903 5935 4928

Sourcesofbascdata AnnualSurveyofEstal_tshments(ASE)19861987and1989NabonalSta'osl_ocsOffice(NSO)CensusofEstab_shments(CE]1988Nat_onatSlaL._csOtlice(NSO)Inallestabhshmerdsinagnculturein19861987and1988 _"Inallestabhshments(nagxlcultureconst,'u_andnunmgandquar_ngin1989

Source Man,san(1993)unput_tshed

Table 35

Market B=asof BOI [ncent=vesShare of Export Acbv,ties m Total Number of Projects Project Cost,and Employment of BOI Reg=steredF=rms 1986 1992

A NurnberofProjects 1986 1987 1988 1989 1990 1991 1992

Totaldornesbcandexportproduct 95 727 619 925 625 432 289

AgricuLtureandfishery 1 362 109 126 45 38 31

Mining 3 11 24 20 15 9

Manufactunng 91 6 457 766 560 379 249

Energyrelatedprojects 3 349 9 7Olhers 4 29 1

PercenttoTotal

1986 1987 1988 1989 1990 1991 1992

Oomesttcproducers 2 11 3 85 1244 1276 1616 1806 15 22

Agncuttureandfishery 387 t8 35 2460 31 t 1 4474 4194 _Mmmg oManufacturing 2 20 6667 3 94 940 1286 1346 884 o

Energyrelatedprolects 2 01 7778 42 86 Ifk_

Others 25O0 93 10 >z

Table35(conbnued)I.,./

1986 1987 1988 t989 1990 1991 t992

Exportproducers 9789 9615 8756 8724 8384 8194 8478Agricultureandfishery 10000 9613 8165 7540 6889 5526 5806 _:

Mrnlng 3333 5455 5000 2500 3333Manufactunng 9780 3333 9606 9060 8714 8854 9116

Energy-relatedprojects 10000 9799 2222 5714 ._

Others 7500 1034 10000 z

B ProjectCost(inthousandpesos) 1988 1987 t988 1989 1990 t99t 1992

Totaldomesbcandexportproduct 1753555 16616161 28793233 55354957 52721228 48927993 20539236

Agricultureandfishery 19885 8 244199 3 201510 4 005886 1 154091 1461300 3 136014

M=nlng -- 30926 547066 5408434 10213579 2112049 403081

Manufactunng 1666767 207261 21901227 45617646 4 1353558 45354644 17000141

Energyrelatedprojects 66903 7 877074 2 070751 295983Olhers -- 128938 993275 13504

Table35 {continued)&

PercentzoTotal

1986 1987 1988 1989 1990 1991 1992

Domesticproducers 1050 7 71 4288 3028 5081 7775 6782

Agncu,ureandfishery 0 00 777 5144 5371 6655 3675 2137

Mining

Manufactunng 1104 9500 3827 2333 4453 7863 7563

Energy-relatedprojects 0 00 5 38 5757 3933Olhers 091 9328

Exportproducers 8950 9229 5712 6972 4919 2225 3218

Agricultureandfishery 10000 9223 4856 4629 3345 6325 7863

Mmln9 -- 4018 6351 2881 2553 1276 0 00Manufactunng 8896 5 00 6173 7667 5547 2137 2437

Energyrelatedprojects 10000 9462 4243 6067 I_Others 9909 736 10000

C EmploymentGeneration t986 1987 t988 t989 1990 1991 1992

Tota|dornesbcandexportproducts 24072 150231 128183 147353 96176 57782 38386 I_

Agncuilureandfishery 45 72490 21844 10789 4 190 4 938 5553I_-

Table 35 (conbnued)

1988 t987 1988 1989 1990 1991 1992Mlnzng 1 111 1 744 5 927 10379 2 903 1096

Manufactunng 23896 810 103012 129425 81607 4g941 29737

Energyrelatedprolects 131 73045 523 1 188Olhers 1 529 884 12

PercenttoTotal

t986 t987 1988 t989 t990 1991 t992 F_

Domesl]cproducers 098 267 1720 1337 1244 1797 9 16

Agricultureandfishery 72 13 49 76 2093 3493 1217Uznzn9

Manufactunng 099 5790 447 6 77 7 73 1288 525

Energyrelatedprojects 298 7706 96 38

Olhers 1851 9027

Exportproducers 9902 9733 8280 8663 87 56 8203 go84

Agncult_reandfishery 100O0 100O0 2787 5024 79 07 6507 8783

Mznm9 3 24 7208 25 17 54 01 2329

Manufactunng 99 01 42 10 9553 9323 92 27 87 12 94 75

Energy-relatedprojects 100O0 97 02 22g4 362

Others 8149 1482 100O0

Sourceofbasicdata SelectedStabsbcsinBO1-ApprovedProjectsbySector1986tolg_2BoardofInvesb_=ntsSource_Manasan(1993c)unpubtmhed

Table 36

Internal Rate of Return of a Hypothetical FirmUnderSelected Incentwe Schemes m ASEAN Countries 1988

Indonesta Malaysia PhBbppmes Singapore Thailandn=lO n=20 n=lO n=20 n=lO n=20 n=lO n=20 n=lO n=20

1 ReguJartaxes(noincentives) 90 120 103 111 103 115 t50 165 113 133

2 Taxholiday(m,n no ofyearsallowed) NA 165 150 125 135 170 173 120 135

3 Taxhol_lay(max no ofyearsallowed) NA 165 170 141 150 200 190 140 150

4 Dutyexempbononcapital 135 153 123 123 138 140 NA NA 150 165

5 (2+4) 135 153 194 174 175 170 170 173 165 170

6 (3+4) 135 153 200 193 193 184 200 190 190 185

7 Exportal]owanceonlya NA NA 165 160 NA NA NA NA 115 135

8 (2+4+7) 135 153 200 195 175 170 170 1725 170 175

9 (3+4+7) 135 153 200 200 195 t84 200 190 195 190

;o

MemoItem iIm 025b 012 02 0 02

u 015/025f035 040 + 005 035 033 035 _.

No_e Theassumed_rcomesi_eamusedmthesecalcufabonsisthatwhichymldsbeforetaxIRRof20Assumesfirmas100%exo(_

bTheanaly=susesu= 35forIndonesia

BREAKINGAWAYFROMTHEFISCALBIND lOT

presence of fiscal mcentlves Moreover the experience of countries

(hke Indones, a) that wlthdrew ,ncentlves mdlcate that they were not

hurt by such a move

In conclus, on the performance of the BOI mcentJves m coun

teractmg the dlstortlons in the overall policy envlronment for indus

trial promotlon and m attracting FDI does not seem to warrant the

fiscal cost of the present investment incentives system Thus _t _s

suggested that the BOI incentive package be ehmmated However

incentives for exports partlcularly those that prowde export producers

access to ,nputs at world prices (through duty/tax exemptlon and

drawback) should be malntamed Also the provtmon of net loss

carry over and accelerated deprecmuon to all fn'ms ,s recommended

to ,mprove the overall investment chmate Doing th, s could save the

government some P4 bdhon based on the 1991 mcentlves avadment

Nattonal Food Authority

The government conslstently played a major role m marketing nee

and corn The Nat,onal Food Authority (NFA) formerly the Natlonal

Grmns Authority (NGA) has been the lead agency m th,s area The

NFA has the foUowmg tasks 1) stablhzmg palsy and nee prices

2) setting a floor price for palsy to protect farmers income and

3) setting a ce,hng price for nee to protect the welfare of consumers

The floor and the ceiling prices are defended by NFA s procurement

and d, sbursement of nee stocks at the officlally determined prices

and through its monopoly on nee import/export

Because the NFA has to engage ,n an actlwty that ,nherenfly

entmls some losses the national government prowdes d,rect sub

sldy to the NFA Natlonal government submdy to the NFA reached

a yearly average of P1 2 b11hon m 1988 1991 (Table 37) Is thls

expense commensurate to the success of the NFA m carrying oLlt ,ts

mandate? The results of a number of studles (Lantlcan and Un

nevehr 1987 Umah 1989 Clarets et al 1992) suggest that the NFA

has not been very effectlve m stabfllzmg the price of palsy and nee

Clarete et al (T992) estimated that less than 10 percent of the

est, mated three m11hon farmers ,n the country could have actually

benefited from the imphclt NFA subsldy on palay and that only

IO8 ROSARIOG MANASAN

about two percent of the est:mated 10 mflhon households m the

country could have benefited from the :mphclt NFA rice submdy

Table 37NFA Losses t986 to 1991

(In bllhonpesos)

Year BeforeGovernment Government AfterGovernment

Subsidy Subsidy Subsidy

1988 1779 1100 0 679

1989 1785 1720 0 065

1990 1026 0 900 0 126

1991 2 761 0 996 1769

Total 11417 4 716 6734

Source ClareteRamonLet al SecuringFoodSecurityPerformanceAssessmentandFutureDirectionsfortheNFADecember1992

Finally C1arete et al showed that the total cost of the NFA

subsldy program was substant:ally hlgher than the actual submdy

receaved by nee producers and consumers The dlfference comes

from the h:gh cost recurred m the admmastratlon of the subsldy

They pointed out the possabdlty of a bloated overhead They estab

hshed that m 1991 the NFA spent PI 52 to dehver every P1 of

subsady to farmers and consumers ahke {Table 38) In recent years

NFA s losses continually exceeded naUonal government subsady

Thas mdzcates that the NFA had to effectavely draw on ats equity to

support its current operataons thus pmntmg to the unsustamabd:ty

of the current s:tuat:on If these wathdrawals from NFA s equity are

added to nat:onal government subsldy then the sum of exphcat and

imphclt subsldy to the NFA amounts to a yearly average of P1 8

b11hon m 1988 1991 {Table 37) Thas figure as more than 60 tames

the level of research expendltures dunng the per:od and Is about 36

percent hlgher than expendltures on irrlgatmn

BREAKINGAWAY FROM THE FISCAL BIND 109

Given thin perspective one can argue that the momes currently

spent on nce/palay price support through the NFA is better spent

on research and lmgaUon areas that are shown to have high

returns m relative terms (David et al 1992)

Table 38

Cost of Delivering NFA Subsidy 1991(In b,ll,on pesos)

Tradingloss 2532LESS Subsmdlestofarmers 0595

LESS Subsidiestoconsumers 0408

Costofdehvenngsubsidy 1 529

Source ClareteRamonLet8/ SecuringFoodSecurityPerfo_TnanceAssessmentandFutureDiredJonsfortheNFADecember1992

Petroleum product pricsng

In the last two years the price of o11 m the world market and the

exchange rate were fmrly stable These developments masked the

need to adopt a slmpler more transparent and more flemble off and

petroleum products prlcmg mechanism One does not have to look

far back into the past however to find out that the present set up

is not sustainable especlally m a sltuatlon where the landed peso

cost of oii is increasing

In the months leading to the 1990 Gulf cnms the government

failed to adjust petroleum product prlces m a timely manner in step

w_th rlsmg world price of crude off because of the strong popuhst

protest As a result the natlonal treasury became P4 5 bflhon poorer

since it had to effectively submdlze domestlc consumpbon of petro

leum products dunng that perlod

Under the present system the government fixes wholesale and retail

prices of dflTerent petroleum products based on pet_bons of off compames

and after pubhc hearings As such upward adjustments m petroleum

product prices become hlghly pohtlclzed Given tins perspectlve deregu

latmg off and petroleum product pricing is n-np_ratlve

110 ROSARIOG MANASAN

De Lucla and Associates (1990} succinctly outlines the character

of the pricing change that _s necessary thls paper particularly

hlghhghts nos 4 and 5 0) tying ex refinery prices (before taxes)

more closely with internatlonal pnces (u) brmglng the structure of

retml prices (including taxes) more m llne with International relative

prices and the reailhes of local demand (111)using retail prices and

complementary regulatory actions to stimulate competition (w}

msunng that pnce changes can be made _n a more tzmely manner {v}

making the regulatory pnce change process and rules absolutely

transparent -for both suppher and consumer pnces (emphasls

supphed) (Vl) msul_ng that financial prices at a minimum cover

full economlc costs {wl) msunng some degree of stability of othertax revenues

Several analysts proposed various ways of moving away from

the extremely regulated pricing reglme prevmhng at present Intal

(1987) suggested the use of a variable tax m tandem with a bamc

tax on crude ell and refined petroleum products The baslc tax is

set based on the followlng conslderatlons revenue needs of the

government the mcontlves to conserve energy and the impact onthe overall cost structure of various industries The variable tariff Is

essentlally a price stablhzatlon tax The tax rises when the world

crude off pnce is low or is decreasing It goes down when world crude

Oli price is hlgh or is increasing The changes m the flexible rate are

determined according to the dexnatlons of the current world price of

crude off from some mowng long run price reference

One of the options De Lucia (1990} proposed is reformulating

the O11 Price Stablhzat_on Fund (OPSF) into a real stablhzatlon fund

that operates only subject to i'uced and transparent procedures in

contrast to the current system One way of doing this is to set up a

trigger price mechanism whereby retail price changes automatlcally

to bring them in hne w_th mternatlonal prices once the OPSF hits

the lower or upper range of a fixed band

The other optlon rinsed was absolute price deregulatlon However

De Lucla pointed out that this may not be rentable m the Phthppmes

where the Oli market is small by mtematlonal standards the supply

structure is ohgopohst with slgmficant banners to entry and many

small consumers are ill reformed and/or have hlgh mformatlon costs

4

Conclusion

While it is possible to jumpstart the economy in the immediate term

by slackening fiscal and monetary restraints the economy cannot

afford to continually run large fiscal deficits Thus the government

has to respond to the fiscal challenge of "reconciling lower fiscal

deficits wlth growth in the medium term This is not an easy task

as the fiscal sector is buffeted by competing claims The government

will likely be trapped in the WClOUS cycle of low growth and high

fiscal deficits unless it take steps to improve its revenue perform

ance to reduce further selected government expenditure items and

to reallocate government spending more efficiently It should be

emphamzed that as a rule more revenues and less spending will

both be needed However the potential gmns from the former are

greater than from the latter because the fiscal adjustment that took

place in recent years was dominated by expendlture cuts Thus the

opportunities for incremental budget cuts are extremely hmited

Nonetheless _t should be stressed that budgetary allocation can still

be improved

While significant gmns have been achieved m tax mobihzation

in the last SLXyears more remmns to be done The analysis in the

preceding secnons pointed out that the biggest opportunity for

increasing tax revenues at present hes m tax administration The

paper also identJfied certain structural changes that are also reve

hUe enhancing However some of the proposed changes m tax

structure have negative revenue impact This makes it doubly

important to increase revenue from administralnve innovations

112 ROSARIOG MANASAN

The revenue potential of user charges is not yet fully exploited

m the Phthppmes Many analysts argued that user charges increase

efficlency and raise revenues at the same time Also the concern

that user charges will hm_t the access of the poor to critical pubhc

services is misplaced Thus the paper argues for more aggressive

cost sharing or cost recovery programs partlcularly m LGUs and

state owned enterprises

Recent years were marked by dramatlc reductlons m mature

nance and other operating expenditures (MOOE) and capltal out

lays While this was done to achieve fiscal stablhty in the short run

the economy if it is to grow m a sustained fashion cannot afford

such unabated dechne m capital spending particularly that on

infrastructure Moreover scnmplng on malntenance spending Is

myopic as it leads to the premature deterioration of capltal stock

which in the end necesmtates more money to be spent on capltal

Given Its dlre flnanclal posttlon the government must increasingly

seek to secure a blgger value out of each peso It spends It must

then rewew its spending prlorit_es In thls regard the government

has to reconsider its appropriate role and scope vzs--ws the private

sector given changing technologles and level of economic develop

ment Also the government has to reassess how its hmtted re

sources can be spent most efficiently and effectlvely in areas where

government part_clpatlon IS called for In this regard thls study

raises doubts on the cost effectiveness of the submdles glven to firms

reglstered with the BOI and to the NFA for rlce/palay price support

Th_s study also argues that the deregulation of the o11and petroleumproduct pricing Is imperatlve if future subsldles are to be avoided

It is essentlal that the regulatory price change process and rules be

made absolutely transparent and automatic for both suppher and

consumer prlces and that changes in dornestlc prices fully reflect

changes m the exchange rate and international prlce of crude odm

a timely manner

B1bhography

o Blenvemdo P Jr and Erhnda M Medalla "Streamhnmg

_ustoms and Tax Admlmstratlon Paper prepared for the PIDS

)IBM Government Streamhnmg Project 1993

Thomas "Direct Investment of Japanese Enterprmes m

_outheast Asia A Study of Motlvatlons Charactenst_cs and

kttltudes ECOCEN Study No 1 Bangkok Economlc Coopera

1on Center for Aman and Pamfic Region 1973a

"D_rect Investment of United States Enterprises m

_outheast Asm A Study of Motlvataons Charactermtacs and

_ttltudes ECOCEN Study No 2 Bangkok Economlc Coopera

ion Center for Aslan and Pacific Region 1973b

_Dlrect Investment of European Enterprlses m South

;ast Asia A Study of Motivations Charactelnstacs and AtU

.udes ECOCEN Study No 3 Bangkok Economlc Cooperatlon

_enter for Aslan and Pacific Region 1973c

"The ASEAN Report Vol I and II Asian Wall StreetIournal 1979

_cmtes m Rural Development Inc (ARD) Essential Actwns for

_GU Revenue Mobd_zatzon Local Development Asmstance Pro

gram (LDAP) USAID/Phlhppmes 1992

n Development Bank Key Indzcators of Developing Asmn and

Dac_fic Countnes Manila Aslan Development Bank 1992tlsta Romeo M John H Power and Associates Industnal

Promotwn Pohc_es m the Phdlppmes Makatl Phfllppme Institute

."or Development Studies 1979

114 ROSARIO G MANASAN

Ble]er Mario and Mohsm S Khan Government Pohcy and Private

Investment m Developing Countries Internatmnal MonetaryFund Staff Papers Vol 31 No 2 1984

Bureau of Customs (BOC} BOC Annual Report Manila Bureau of

Customs various years

Bureau of Internal Revenue (BIR} BIR Annual Report ManilaBureau of Internal Revenue vamous years

Chhlbber Ajay and Sweder van Wljnbergen "Pubhc Pohcy andPrivate Investment m Turkey PPR Working Papers Pubhe

Economics WPS 120 Washington D C World Bank 1988

Clarete Ramon L et al _Secumng Food Security Performance

Assessment and Future Dwectmns for the NFA Report submit

ted to the Department of Agriculture and the Government

Corporatmns Momtormg and Coordinating Council December1992

Commmslon on Audit Annual F_nanczal Report of Local Govern

ments Quezon C_ty Commmmon on Audit various years

Cororaton Caesar "Pubhc Sector Defic,t and Domestic Debt HeavyBurden of Phlhppme Economic Growth Unpubhshed 1993

Crown Agents 'Bureau of Internal Revenue Informatmn SystemsStrategic Plan Report submitted to the Bureau of InternalRevenue 1992

Dav,d Crmtma Ehseo Ponce and Poncmno Intal Jr _Organ,zmg

for Results The Phlhppme Agricultural Sector Working Paper

Series No 92 08 Makatl Phihppme Institute for DevelopmentStudles 1992

de Dins Emmanuel and Assocmtes Poverty Growth and the F_scal

Cnszs Makatl Phfllppme Instltute for Development Studles andInternatmnal Development Research Center 1993

de Jantscher Mflka Casanegra Carlos Silvan1 and Graham I-Iolland "The Audlt of VAT In Value Added Tax Admm_stratme

and Pohcy Issues edlted by Alan Trot Washington D C Inter

natmnal Monetary Fund 1991delos Angeles Marian "Pricing Enwronmental Resources The Case

of Forestry Water and Air Resources Unpubhshed 1993

BREAKINGAWAYFROMTHEFISCALBIND 115

de Lucia and Assomates "Proposed Off Price and Industry Deregu

lation in the Phlhpplnes Issues Options and Prehrnmary Rec

ommendattons Report submitted to USAID/Phlhpplnes 1990

Dornbusch Rudlger and Stanley Fischer Macroeconormcs NewYork McGraw HIll 1990

Economlc Intelhgence and Invest_gatlon Bureau (EIIB) "Tax Evasion

m the Phfllpplnes 1985 1989 Unpublished 1992

Hslao Cheng Autoregresmve Modelling and Money Income Cau

sahty Detectlon Journal of Monetary Economzcs 7 (1981) 85106

Intal Ponmano Jr "Towards Redefining Government Off Prlce Inter

ventlon Mamla Chromele September 30 1987

Lamberte Ms_no `Frlvate Financial Savings and Dkrect Foreign

Investment Unpubhshed 1991

and Juhus Relampagos An Assessment of Pohcles

Affecting the Financial Sector, 1986 1988 Working Paper Se

nes No 90 0S Makatl Phihppme InsUtute for DevelopmentStudies 1990

Lantlcan Fiordehza and Launan Unnevehr _Pdce Prlclng and Mar

ketmg Policy In UPLB Agricultural Pohcy Working Group

Pohcy Issues on the Phdzppme l_ce Economy and Agricultural

Trade Laguna Center for Pohcy and Development Studies

University of the Philippines 1987

Lmdsey Charles "The Development Contribution of Multmatlonal

Firms m the Philippines D1seussion Paper No 81 06 Quezon

City University of the Phlhpplnes 1981

and Ernesto Valencia "Foreign Direct Investment m the

Phfilpplnes A Revlew of the Literature In Survey of Pluhppme

Development Research II Makati Phlhppine Instltute for Devel

opment Studies 1982

Manasan Rosario G "Impact of BOI Incentives on the Rate of

Return Factor Prices and Relative Factor Use A Comparative

Analyms of Incentives under the Omnibus Investments Code of

1981 (PD 1789) and Investment Incentive Policy Act (BP 391)

Staff Paper Series No 86 01 Makatt Phihppme Instltute for

Development Studles 1986

116 ROSARIO G MANASAN

"Tax Evasion m the Phxhppmes 1981 1985 Journal ofPhdzppme DevetopmentVol XV No 2 Makatl Philippine Instltute for Development Studies 1988

An Assessment of Fiscal Pohcy m the Philippines

1986 1988 Working Paper Series No 90 06 Makatl PhilippineInstitute for Development Studies 1990

"Issues on GOP Comphance with VATPaying RegistrantsIndicator Report submitted to USAID/Phlhppmes 1991

"Fiscal Imphcatlons of the Local Government Code of1991 JournalofPhdzppmeDeveloprnentVol XIX No 1 MakatlPhflxppme Institute of Development Studies 1992a

"Intergovernmental Fiscal Relations Fiscal Federahsm

and Economic Development m the Phflxppmes Working PaperSeries No 92 04 Makatl Philippine Instxtute for DevelopmentStudies 1992b

Assessment of the Streamhmng of Duty Drawback andVAT Credit Systems Unpubhshed 1993a

_Rewew of Pubhc Expenditure in the Philippines Unpubhshed 1993b

_nvestment Incentlves The Investment Priorities Plan

and the Board of Investment Revlslted Paper prepared as

background materml for the World Bank Phfllppme PrivateSector Study 1993e

and Poncmno S Intal Jr "Prlvate Sector Led Develop

ment Strategy and the Role of Government m the PhihppmesPaper prepared for the Senior Pohcy Forum on the PrivateSector Led Development Strategy and the Role of Government

m Developing Countries Korea Development Instltute SouthKorea October 15 17 1992

Medalla Erlmda Assessment of the Tariff Reform Program and

Trade L1beraILzatlon Tariff Commlsmon/PIDS Joint Research

Project StaffPaper Series No 86 02 Makatl Philippine Instltutefor Development Studies 1986

An Assessment of Trade and Industrial Pohcy 19851988 Working Paper Series No 90 07 Makatl Phflxppme

Instltute for Development Studles 1990

BREAKINGAWAYFROMTHEFISCALBIND 117

_I'anff Reform Assessment Paper presented at the PES

Annual Meeting on December 13 1991Loreh de Dlos and Rafaehta Aldaba _rhe Effects of HCV

Valuation Manila PHILEXPORT 1993

Ministry of Trade and Industry Wlute Paper on Internahonal Trade

Tokyo Mmlstry of Trade and Industry 1988

Monsod Sohta _Calhng a Spade Donl Let Smoke Get m Our

Eyes Pluhppme Star March 16 1993

Nathan Associates Inc "Plnllppme Transport Sector Revlew High

way Subsector Report submitted to USAID/Phlhppmes 1990

National Tax Research Center (NTRC) Pluhppme TaxAdrmmstratlon

and Complmnce Manila Natlonal Economlc and Development

Authority (Tramlng and Development Issues Project) 1986

Tax Reform m Countries zn Asm and the Pacific (,4 SGATAR

Project) Manila NTRC 1990

"Phihppme Tax and Tariff System Unpubhshed 1991

A Survey on the Revenue Rinsing Powers of Local

Governments Unpublished 1981

A Survey on the Revenue Rinsing Powers of Local

Governments Unpublished 1992

PADCO/PHILNOR A Self Sustaining System of Financing for C1t

ies Report submitted to USAID/Ph_hppmes under the Decen

trahzed Shelter and Urban Development (DSUD) Project 1992

Pante Fflologo Jr and Erhnda M Medalla _rhe Philippine Indus

trial Sector Pohmes Programs and Performance Worlang Pa

per No 90 18 Makatl Phdippme Instltute for DevelopmentStudles 1990

Pernm Emesto M Cayetano W Paderanga Jr V1ctorm P Her

moso and Assoclates The Spatlal and Urban Dvnenswns of

Development m the Phdzppmes Makati Phihppme Institute for

Development Studms 1983

Power John "Investment Incentives m a Protectionist Regime The

Phihppmes _ Report submitted to USAID/Phfllppines 1989

Rana Pradumna "Recent Trends and Issues on Foreign Direct

Investment m Asian and Pamfic Developing Countries Eco

nomlc Staff Paper No 41 Manila Asmn Development Bank1988

118 ROSARIOG MANASAN

Repubhc of the Phlhppmes Real Property Tax Code (Presldent_al

Decree No 464) 1974

Ommbus Investment Code of198 7 (Executive Order 226}1987

Local Government Code of 1991 (Repubhc Act 7160}1991

S_mpl_ed Net Income Tax System (SNITS) 1992

SGV Consulting and Management Sclences for Health (MSH) A

Study on User Fees and Cost Shanng/Recovery m DOH Hospl

tals Paper submitted to the Department of Health October1991

Tan Edlta "Real Property Taxatmn and Its Potential as a Major

Source of Local Revenues In Poverty Growth and the Fiscal

Cnsls edlted by Emmanuel de D1os and Assoclates Makat,

Phlhpplne Institute for Development Studies and Internatlonal

Development Research Center 1993

Tecson Gwendolyn Llna Valcarcel and Carol Nunez _rhe Role of

Small and Medium Scale Industries in the Industrial Develop

ment of the Phlhpplnes In The Role of Small and Medium Scale

Manufactunng Industries m Industnal Development the Expert

ence of Selected Asian Countnes Mamla As,an DevelopmentBank 1990

Umall Dins "Rice Marketing and Pmces under Phfllpplne Govern

ment Price Stabllmatlon In Pohcy Cons_deratlonsfor Structural

Changes and Development in Philippine Agriculture by UPLB

Agricultural Pohcy Research Program Laguna UPLB Center for

Pohcy and Development Stud,es 1989

Yap Josef T and Ceha M Reyes "Fmcal Pohcy Alternatlves m the

Phfllppmes Report submltted to the As,an Development Bank1993

World Bank World Development Report 1988 New York Oxford

Umverslty Press 1988a

Phdzppme Transport Sector Retnew 1988b

"Phfllppines - Devolutmn and Health Serv,ces Managing

Rinks and Opportunities Report No 12343 PH 1993

THE AUTHOR

ROSARIO G MANASAN m a Research Fellow at the Ph111ppme

Institute for Development Studies (PIDS) She undetakes and coordlnates the Institute s research program in pubhc finance and fiscal

pohcy specifically taxation government expenditure and pubhc

enterprise policy Holder of a doctoral degree in Economlcs from the

Umverslty of the Ph111pplnes School of Economics Dr Manasan

later took her post doctoral studies in economics at the Massachu

setts Institute of Technology

Among her important works are _I'he Role of Fmcal Pohcy m

Economic Deregulation in the Phlhpplnes m the E1ghtles m Deregu

latwn and Economic Development _n the Phdzppmes edlted by Joseph

Llm and Katsuml Nozawa (Tokyo Instltute of Developing Econom

]cs 1991) Flscal Imphcatlons of the Local Government Code m the

Journal of Phzhpp_ne Development Vol XIX No 1 1992 A Revlew

of Investment Incentlves m ASEAN Countries m the Phdzppme

Economzc Journal Vol XXIX Nos 1 and 2 1990 Financing PUbhc

Sector Development Expendzture tn Selected Countnes Phzhppmes

(Mamla Aslan Development Bank 1988) and _rhe Public Enter

prise Sector in the Ph111ppmes - Economic ContmbuUon and Per

formance 1975 1984 in Pubhc Enterpnse Vol VIII No 4

(Ljubl3una December 1988)Dr Manasan has served as adviser and consultant to numerous

government International and private Institutions on pubhc finance

and fiscal issues over the years

She is a member of the Phlhppme Economlc Soclety and the

Phlhpplne Statlstlcal Assocmtlon She has also attended and pre

sented papers m varlous local and international fora