Taxing (y)our sins: a few lessons from post-Marcos

tax reform episodesProfessor Amado M. Mendoza, Jr.

Department of Political ScienceUniversity of the Philippines Diliman

Typical ‘taxable’ sins

Taxable sins II

Touch but do not tax!

May be tax free; not kotong-free

Fiscal policy, on both its tax and expenditure sides, should be among the most controversial of policy issues. The fis cal process…occupies the middle ground between anarchy and absolute rule. It provides the forum on which interest groups and ideologies may clash…and on which compromise and cooperation may be sought. The budget process can hardly be expected to function without error if only because it is cre ated by the same conflicting interests which it must reconcile (Musgrave 1981)

Taxation is contentious

Tobacco farmers vs. increase of sin tax rates

Sumptuary shares the same root as the word "sumptuous," which means rich and luxurious. Thus, a sumptuary tax is a levy on items of luxury, frequently the object of an addiction

Sumptuary taxes have focused on products considered vices, such as alcohol and tobacco

The more colloquial term "sin tax" has evolved for these taxes

The term "luxury tax" is used for those high-end items characterized by an increase in demand as their price rises

Sumptuary, sin taxes

The art of taxation consists in so plucking the goose as to obtain the largest possible

amount of feathers with the smallest possible amount of hissing.

 --Jean Baptiste Colbert (attributed), c. 1665

French finance minister to King Louis XIV

Taxation is compromise

Coercion: state forces citizens to pay for public goods and then some

Volition: voluntary payment for public goods

Taxation as

Avoid payment of taxes

Reduce tax bite

Free ride on public goods

Development of tax culture counters these pathologies

Tax compliance is function of the state’s strength and legitimacy

Rational behavior of economic actors

Physical and temporal separation between payment of taxes and provision of public goods (hindi kaliwaan)

No assurance that taxes will be spent for public goods

No assurance that taxes will be spent efficiently

No assurance that taxes will not line private pockets

Taxation and provision of public goods: problems

Private enti ties can furnish public goods

Tax relief or a lower tax bite is a public good that can be supplied or obtained by an interest group for its constituents

A public official may be construed as a private actor when he actively works to provide public goods for private entities

Private actors and public goods

‘Sultans of Sin’: Tan and Cojuangco

Terms to remember

◦ Ad valorem tax: a percentage levy imposed on the monetary value (i.e., the manufacturers’ price) of a product

◦ Specific tax: a monetary levy on the quantity (or specified unit) of the product

Post-Marcos sin taxation

Ad valorem tax is inflation-proof

Specific tax is simpler and easier to administer

Comparison of taxes

Ad valorem tax induces price under-declaration and transfer pricing

Specific tax remains constant even if prices go up; revenue collections supposedly suffer

Downside of taxes

Fortune Tobacco Corporation (manufacturer of medium-priced domestic brands like Hope Luxury Menthols)

Asia Brewery Inc. (manufacturer of Beer na Beer, Colt 45, etc.)

Sin tax laws suited Lucio Tan since 1970s

La Suerte Cigar & Cigarette Company (manufacturer of Philip Morris and Marlboro cigarettes)

San Miguel Corporation (manufacturer of San Miguel Pale Pilsen beer)

Competitors of Lucio Tan

PD 69 (Nov 1972): classified cigarettes if imported or not for tax purposes

PD 753 (July 1975): imposed 50% additional tax on cigarettes with foreign brands

EO 924 (Nov 1983): imported cigarettes taxed as same rate as most expensive locally produced brand

Tan’s Hope brand was introduced in 1975, became Fortune’s best-seller and beat Philip Morris for market leadership

Favoring Tan during martial law

EO 22 (July 1986): imposed an ad valorem tax on cigarettes and reintro duced a higher rate (65%) on imported cigarettes while domestically produced ciga rettes were taxed at 40% and 50%, depending on whether the cigarettes carry a foreign brand or not

Economists argue that the promotion of domestic tobacco production is best done through tariff, not tax, measures

Did anything change after Marcos’ ouster?

Hope trounces Philip Morris due to tax advantages

Establishment of nine (9) marketing arms in August-September 1986

Fortune under-declares manufacturer’s price Fortune sells output to marketing arms Marketing arms sell the products at retail

prices that were many degrees removed from the declared tax base of Fortune

Marketing arms must also cheat on their value-added tax (VAT). They can avoid paying the VAT altogether

Response of Tan to EO 22

RA 6956 (July 1990): The ad valorem rates were further increased on domestically-produced cigarettes bearing foreign brands, from 50% to 55% per pack; and for those bearing local brands, from 15% to 20% for low priced cigarettes and from 40% to 45% for higher-priced cigarettes

With RA 6956, Tan’s cigarette products con tinued to enjoy a tax advantage vis-à-vis imported and locally produced cigarettes bearing foreign brands even if the rates were increased.

Advantage Tan

RA 7654 (June 1993): floor tax on low-priced cigarettes was removed

This category in cluded Champion Menthol Kings, one of the most popular brands of Fortune Tobacco

Senate and House bills were revised by pro-Tan solons like the members of the Northern Luzon Alliance and Senator Ernesto Maceda

Proponents of a tougher law were harassed

Still Advantage Tan

Hope and Champion are listed as foreign brands in respected industry directories

Tan simply added “luxury” and “international” to Hope and Champion and voila, they are local brands that must be taxed at a lower rate

Cheating on brands

Ratification of Uruguay treaty required non-discrimination between imports, domestically-manufactured products with foreign trademarks, and domestic products with local brands

Uniform taxation for same products

GATT-WTO and sin taxation

RA 8240 (Nov 1996)◦ Specific tax for cigarettes (four tiers)◦ Tan’s Hope avoids classification in higher-priced

tier◦ Specific tax for beer◦ No adjustment in tax rates since 1996 (16 years)◦ “The classification of each brand of cigarettes

based on its average net retail price as of October 1, 1996, as set forth in Annex D, shall remain in force until revised by Congress.”

◦ Indexation of tax rates to inflation was dropped

Advantage sin ‘good’ producers: this is becoming monotonous!

Advantage Tan under Erap presidency

Erap praised Tan as the country’s model taxpayer

Erap reportedly told Tan to choose who’s going to head BIR

BIR lost truckloads of evidence in tax evasion case vs. Tan

Advantage Lucio Tan

BIR under Beethoven Rualo decided on two tax evasion charges against Tan firms that his predecessor had a hard time prosecuting because of the resistance within BIR

One 1987 tax assessment filed against Allied Bank for P338 million was reduced to zero

Another cased filed in 1993 against Fortune Tobacco for nearly P8 billion was shrunk to P5 million.

Advantage Tan: I’m getting tired of this

GMA meets with key officials of SMC, Fortune & Philip Morris to facilitate passage of new sin tax measure

No indexation of sin tax rates

Specific tax rates were simply increased

GMA: Advantage sin products

In 2010, Philip Morris went into a joint venture with Fortune to control 90% of market

Previously, PM batted for a single tax rate while Fortune was for 3-4 tax tiers

The merged corporation now supports a multi-tier system

Aspiring entrant, British American Tobacco, is in favor a single tax rate

Join Tan if you can’t beat Tan!

Taxation is a political game involving players from government and the private sector

Consumers and CSOs are minor or even inconsequential players

Government is not a monolithic actor

Competing business firms will pursue different tax agendas

Lessons from sin taxation

President: generally focused on increasing revenues; cannot veto ‘bicam’ tax measure

Legislators look at tax reform process as opportunity to deliver ‘goods’ to financiers and other constituents

Members of the House more parochial on tax matters than Senators

Players from government

Market competitors with different tax policy preferences

Strong market power/presence/leverage (e.g. campaign finance)

Widespread networks up to government bodies (legislatures, courts, etc.)

Players from big business

Common pattern of adulteration, watering down, and compromise leading to the adoption of private-regarding tax policy

Pattern not affected by presidential strength

The President can ‘bribe’ legislators with pork

Can private business also do so?

Post-Marcos sin tax legislation

Tax policy is joint product of chief executives and legislators in a democracy

Chief executives are at a disadvantage vis-à-vis legislators

◦ They initiate tax reform

◦ They cannot veto tax measures approved by legislators (if they do, everything is for nought)

Tax policy as joint product

It is hypothesized that the nature of a democracy’s electoral system is a key variable in tax policy outcomes

Influence of political institutions on policy outcomes

Candidate-centered systems

Party-centered systems

Different electoral systems

Legislators in these polities face different incentives and constraints that those confronting politicians in party centered political systems

This difference is crucial in explaining the difference in the fiscal policies adopted by democracies in the developing world

Candidate-centered systems

When and where legislators need to develop individual reputations in order to get elected, their participation in the policy process is shaped by the need to take credit for divisible policy favors that could benefit their supporters and constituents

The party affiliation of the legislators is least useful in predicting their response to a tax measure even if they belonged to the President’s party or coalition

Candidate-centered systems

When the electoral and career trajectories of individual legislators depend on their adherence to party platforms and programs or at least to the preferences of party leaders, their participation in the policy process would differ accordingly

The constituency of these legislators is not really the electorate in their districts or their financial supporters but their party leadership.

Party-centered systems

If they belong to the ruling party, legislators will share in the goal of the country’s chief executive (also the ruling party leader) to improve revenue collections and economic performance

They would invariably support initiatives of chief executives for public-regarding fiscal policy

Party-centered systems

Whatever (sin) tax policy that exists at a given point is a temporary equilibrium agreed to by stakeholders identified earlier

In the Philippines, the (sin) tax reform that is possible at any one time is INCREMENTAL, not RADICAL

Thanks for your kind attention

Parting shots (Tagay tayo!)