LECTURE NO. 4LECTURE NO. 4LECTURE NO. 4LECTURE NO. 4

Dr. Felipe MedallaBSP-UP Centennial Professor

in Money and Banking

Financing the Aquino Administration’s Fiscal Program: Better Tax Administration and New Taxes?

4th Annual BSP-UP Professorial Chair Lecture

Financing the Aquino Administration’s Fiscal Program:Better Tax Administration and New Taxes?

BSP Professorial Chair Lecture

Felipe M. MedallaUP School of Economics

February 22, 2011

Basic Question in Public Economics:Why is it so hard to collect taxes?

• Free Rider Problem: Unlike private goods and services where the quality and quantity of goods and services that the consumer gets are directly proportional to how much he pays, the quality and quantity of public goods and services that a citizen/taxpayer gets is very weakly related to how much taxes he pays.

• Information Asymmetry: Each taxpayer is better-informed about his own sales, income and expenditures than anyone else. (“Modernization” of the economy might aid tax collectors since access to reports and information that economic agents share with each other will reduce information asymmetry. For example, holding sales and profits constant, it is “easier” to collect taxes from publicly listed corporations than from family-controlled corporations or businesses. “Tax handles” is the label Musgrave gives to this phenomenon.)

• Weak Justice System: Tax-evasion is high-reward and low-risk activity

What the Data Tell Us• GDP is not a very reliable basis for bench-marking BIR collections.

(Different bases for target setting for each important revenue source. GDP includes imputations for non-market activities.)

• Tariff reductions and international trade agreements significantly reduced BOC’s capacity to raise revenue.

• Taxation of Corporations and the Withholding Systems account for all the gains. (Adjusting for inflation and population growth, collection from individuals and businesses that are not covered by the withholding systems stagnated.)

• Inflation, decline in interest rates and the Asian Financial Crisis (AFC) have reduced the ratio of BIR collection to GDP

• The Aquino Administration’s medium-term fiscal program requires an increase in tax effort by 4 percentage points. That may not be achievable without new revenue measures.

Government must increase spending on investments in infrastructure and human capital. To some extent, it can finance its programs with higher tax collections and increases in its debt stock without threatening fiscal sustainability.

We have had seven consecutive years (and counting) current account surpluses. Before the seven straight years of surplus, there were only two years (1986 and 1998) when the current account was in surplus. In both cases, the surplus was the result of huge drops in imports brought about by a huge drop in the growth rate of GDP. The current account surpluses are effectively excess savings that government can tap if it has credible fiscal plan.

It should be noted, however, that off-budget expenditures account for as much as the NG deficit in the increase of the National Government’s Debt Stock. (PSALM alone is likely to add seven billion dollars to the NG’s debt.)

One of the reasons why the official budget is not the main source of fiscal non-sustainability is that , with a two or three year lag, expenditures get compressed when revenue targets are not met. (But expenditure compression is precisely what the Aquino administration wants to avoid.)

BIR and BOC tax-effort ratios are now both two to three percentage points lower than their previous peaks. But that does not imply that tax effort can be increased by four percentage points (relative to GDP) without new tax measures.

The growth rate of GDP after the Asian Financial Crisis was higher than the growth rate of the gross sales of the Top 1000 and Top 5000 corporations.

Comparison of Nominal GDP Growth with the Revenue Growth of Large Corporations(Compounded Annual Growth Rate)

CAGR: 1996 to 2008 CAGR: 1998 to 2008Revenue of Top 1000 9.2% 8.5%Revenue of Top 5000 9.2% 8.7%GDP 10.8% 10.8%GDP vs Top 1000 1.6% 2.2%GDP vs Top 5000 1.6% 2.1%

A Large part of GDP is imputed, not measured. Estimates are based on very old, possibly obsolete, census frames and parameters. See quote below from a study on the Philippine National income accounts done by Ross Harvey, an expert in national income accounting. (“Assessment Report on the Philippine System of National Accounts” 25 September, 2008).

• “The general approach to compiling estimates for the unorganized sector is to derive an estimate of employment not covered in the establishment collections and to assume that value added per employee in the unorganized sector is the same as that for small establishments operated by a sole proprietor.”

But even if one uses a less demanding measure of revenue performance (revenue adjusted for inflation and population growth), BOC collections are now just about the same as they were 25 years ago in spite of RVAT. Tariff reductions and free trade agreements have reduced revenue from import duties.

VAT, the corporate income tax, and withholding systems account for all the increase in BIR collections. (But this part of the tax system is also the most vulnerable to economic and financial crisis.) Per capita real excise tax collections declined significantly and per capita real collections from the rest of the system barely increased.

Real per capita collections of taxes on net income and profits are cyclical but rising. In spite of RVAT, real per capita collection of domestic taxes on goods and services on domestic goods and services are stagnant after cyclical effects are factored out.

Revenue from excise taxes have been eroded by inflation (and healthier life styles?) Shift from domestic production to imports explains a very small part of the decline in BIR excise tax collections.

Due to falling interest rates, FWT on T-Bills on interest on bank deposits and T-bills have declined (in spite of the rise in bank deposits and outstanding government debt.)

It took ten years for corporate income tax revenues to recover from the AFC, but the growth of real per capita revenue from coporate withholding at source was high and uninterrupted by the AFC.

Withholding on wages account for all the gains in revenues from taxes on individual income.

Like it or not, VAT is a very important pillar of our tax system.