Philippines faces painful taxes

By SONIA KOLESNIKOV-JESSOP, UPI Business Correspondent  |  July 1, 2004 at 11:00 AM
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SINGAPORE, July 1 (UPI) -- Newly reelected Philippines President Gloria Arroyo's inaugural speech Wednesday aimed to create a feel-good atmosphere for her electorate as she promised to create 6 million jobs and improve infrastructure amongst other things. But necessary painful tax and power tariff hikes are on their way and likely to be announced in her July 26 State of the Nation Address.

Having won a mandate by a thin margin to govern but a majority in the Senate to help the government push through its policy, the Arroyo administration has now an opportunity to make significant inroads in dealing with the fiscal policy and governance problems.

Arroyo won the May elections with 40 percent of the votes against 36.5 percent for her opponent Fernando Poe Jr.

Her slim victory margin is reminiscent of the narrow win of then-president Fidel Ramos in 1992, when he beat Miriam Santiago by a margin of less than 4 percentage points. Ramos also had the disadvantage of getting only 24 percent of the votes as there were seven presidential candidates then.

Yet, he has been widely acknowledged to have been the Philippines' best president since the restoration of democracy in 1986, which indicates that a narrow margin can be overcome, Tim Condon notes.

Populist promises ran high Wednesday, as Arroyo pledged to leave as a legacy when she steps down in six years a 6-10 million new jobs; a balanced budget and peace in Mindanao. She also promised linking the entire country with a transportation and digital infrastructure program initiated three years ago and reducing the concentration of economic activity in Manila in favor of other regions, including making the Subic-Clark corridor the most competitive logistics center in Southeast Asia.

She pledged to collect taxes and cut wasteful expenditures, reduce corruption and tax fraud and spend more on areas where the government can make a difference. However, reflecting the narrow margin of victory perhaps, she spent much of the speech calling for unity and asking the opposition to support her policies.

"Investors and voters will be looking to her to act quickly to use her mandate to pass legislation on tax reform and to privatize Transco, items that have been on her agenda for years in some cases," said Michael Spencer, head of research for Asia at Deutsche Bank.

"Failure to exploit the improved political backdrop by making headway on fiscal policy tightening could see the Philippines' rating strengths start to wither again, following the downgrade in 2003," warned Brian Coulton from rating agency Fitch Ratings earlier this week.

Although the government has managed to arrest the sharp fiscal deterioration seen in 2002, with the national government deficit declining to 4.7 percent of GDP in 2003 from 5.3 percent a year earlier, the fiscal gap remains a sword of Damocles which needs to be sorted.

Despite the improved fiscal deficit last year, the underlying trend is still one of deteriorating fiscal health as reflected in five consecutive years of deficits of 4 percent of GDP or more, a sharp fall in tax revenues since the late 1990s and a rise in national government debt to 78 percent of GDP at end-2003 from 58 percent.

So far this year, the government appears broadly on track to meet the annual deficit target of 4.2 percent of GDP, despite fears of a pre-election spending boom. But the budget performance in May, with collections from the Bureau of Internal Revenue disappointing again, has increased the need for the new Arroyo administration to rapidly pass new tax measures, economists said.

"We expect her to detail her deficit and debt reduction strategy in her State of the Nation Address. This is expected to include 50 billion pesos or 1.0 percent of GDP worth of new tax measures, power tariff increases, and plans to cut the size of the bureaucracy," said Ray Farris, analyst at CSFB in a research note.

Farris pointed that Energy Secretary Perez commented the country would have to live with the proposed 80 percent hike in power tariffs. "Perez's early lobbying for this hike says to us that the government will push through with it," he said.

This hike would reduce sharply the national power corporation's losses, which is seen as possibly the most important requirement for returning the public sector to fiscal sustainability.

Many economists and investors alike believe the Arroyo's government has to show a strong commitment to tax increase in light of diminishing flexibility on expenditure as interest payments increase and of the Philippine's clear development needs for higher public infrastructure investment.

An IMF team currently in Manila has just suggested that the authorities raise the Value Added Tax (VAT) to 15 percent from the current 10 percent, and also approves of the move to a gross income taxation system. This is not the first time the IMF suggests raising VAT, a move the Arroyo administration has always refused so far, but this time around, local newspapers are reporting the government is open to raising the VAT to 11-12 percent.

Under the current net income tax system, the Bureau of Internal Revenue has to make sure that all expenses of corporations and professionals are tax-deductible. This creates a system that is potentially subject to bureaucratic inconsistency, says Sin Beng Ong, economist at JPMorgan.

A move to a gross income tax, a system adopted by Hong Kong, could reduce the potential for discretion by the tax officers and would also reduce the bureaucratic procedures for collection by creating a system whereby taxes are automatically deducted from monthly paychecks, Sin points.

Meanwhile, the authorities are also trying to put on track a previously stalled bill to create a National Authority for Revenue Administration (NARA) that would effectively see an overhaul of the Bureau of Internal Revenue. The BIR in its current form has been accused of widespread corruption and inefficiency that has led to a significant shortfall in its tax collection effort.

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