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Books on The Philippines
REPUBLICAN REFERENCE
Area (sq.km)
300,000
Population
84,619,974
Capital
Manila
Currency
Philippine peso (PHP)
President
Gloria
Macapagal-Arroyo
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Update No: 017 - (27/05/05)
The final version of the value-added tax (VAT bill) has
emerged from the bicameral committee of Congress and was signed into law on 23
May. What started out as a simple measure designed to increase the VAT rate from
10 percent to 12 percent in order to provide additional revenue to government
has become an omnibus tax bill that will change in a fundamental manner the tax
structure of the Philippines insofar as it affects the corporate and
professional sectors.
The bill does not, of itself, raise the VAT rate to the requisite 12 percent but
it does give the president the authority to do so. Most of the press comment so
far has focused on the fact that Congress appears to have ducked this unpopular
measure (as far as its acceptance with the general public is concerned) and has
transferred the odium from the increase onto Malacañang. But this may in fact
be a clever strategy since by providing the president with a directive, it may
make the increase immune to constitutional challenge (although this is not to
say, that interest groups will not test this aspect.)
The new law is far from ideal and as some have pointed out, it will hurt
compliant taxpayers while doing little to address the problems caused by those
who do not comply. Yet, as commentators have also pointed out, "politics is
the art of the possible" and that given all the circumstances, the bill may
be (with one exception) as good as it gets.
The new tax bill is already being criticised within the business community by
those who fear that the increase in the corporate tax rate may act as a
disincentive to investment into the Philippines. However, the new law contains a
sunset clause and by 2009, the corporate tax rate will actually reduce to 30
percent. The pain is relatively short term and, as other commentators have
pointed out, may be part of the short-term pain necessary in the interest of
achieving a consensus. Given that much of new investment will be covered by
various tax incentives that would normally carry newly established businesses
beyond the 2009 deadline, the new rules may actually assist investment insofar
as the ground rules are now being clarified - assuming that the tax bill is
signed into law and that the president exercises the powers that have now been
granted to her.
On the positive side, the Department of Finance has estimated that on a full
year basis, the incremental yield from the changed regime be in excess of 100
billion pesos and brings the primary surplus to the level needed for public debt
to be sustainable and for more funding to be made available for service
delivery. This was one of the main concerns of the UP-11 who have pointed out
that the first 80 billion raised does no more than tread water as far as debt
servicing goes and that additional revenue needs to be generated above and
beyond this amount if government services in health, education and general
poverty reduction are to be improved.
Therefore provided the government stays the course and provided that the courts
do not introduce a wild card into the equation, the overall effect of the new
law should be "investment positive". Much will depend however on
allied measures such as the fiscal incentives bill to clarify the overall
investment framework and the manner in which the new regulations will be
administered.
Not everyone is happy though. The Philippine Chamber of Commerce and Industry is
lobbying to have the rate hike in corporate taxes repealed. However, the chances
of that happening are slim.
The real "fly in the ointment" is actually a provision that introduces
the concept of a minimum VAT in a manner that distorts the system away from a
pure tax on consumption and towards a tax on business turnover. This is done by
placing a cap on input VAT claims at only 70 percent of output VAT. What this
means in practice is that businesses that have a profit margin of less than 30
percent may not be able to fully offset their VAT inputs from their VAT output.
In other words, any company where the input VAT is more than 70 percent of the
output VAT will not be allowed to deduct the "excess" input VAT from
the output VAT. Although, a carry-over is allowed chances are such companies
will not recover in full the differential, until such time as the business
ceases to trade. As such it represents a minimum 3 percent VAT on each and every
transaction. For companies operating on the basis of low margins-high turnover,
the 3 percent cannot be absorbed and prices will have to increase to compensate.
When first introduced into the floor of the Senate, the intent of the minimum
VAT proposal was to address the under-reporting of output VAT and the
over-reporting of input VAT by non-compliant taxpayers. The original suggestion
was for a 90 percent cap, a level that would not impact too adversely on
compliant taxpayers while compensating for the problem of the non-compliant one.
At the 90 percent level, the measure can be defended as a rough proxy for the
VAT. However at a level of 70 percent, many believe the level to be punitive.
Although the cap on VAT is not consistent with a "best practice" VAT
system, the idea can be considered to have merit in a country such as the
Philippines where evasion is widespread. The skill is to set the cap at a level
so as not to encourage compliant taxpayers to opt out of the system. A level of
between 90-95 percent is considered to be an appropriate range. A number of
business organisations are seeking to have Congress, with presidential backing,
sponsor a further bill tidying up the drafting of this particular section of the
tax code through a legislative amendment that could be passed before the new VAT
bill takes effect on July 1 2005. At this time it is not known how receptive the
president would be to such a solution but if not rectified, it does threaten to
undo much of the good work contained in the rest of the bill.
Not another Argentina
The fact that the government finally pushed through the most important piece
of legislation in its efforts to overcome the fiscal problems of the country has
not prevented the usual detractors to once again sowing fear and doom. The
latest such warning of dire consequences for the country came from a highly
publicised report from an analyst at Moody's Investor Services which once again
compared the Philippines with Argentina.
The Philippines is not Argentina of course and the structure of the debt is
quite different in both countries: Filipino debt is mostly long-term whereas
Argentina got into trouble because it had too much short-term debt to service.
And as the Secretary for Trade and Industry was quick to point out, the
Philippines is making headway in closing the fiscal gap, with the implementation
of new revenue measures. A balanced budget is now seen as a possibility as early
as 2008. The economy remains buoyant. The Philippines has registered improving
economic growth conditions since 2001 while Argentina had a three-year economic
recession before it defaulted on its obligations. Even in 2005, with both the
IMF and the OECD (and others) ramping back their forecasts for the global
economy this year, the Philippines is likely to still do pretty well, expanding
at a 5 percent clip. The problem of course is in the quality of growth which
continues to be consumption led on the back of increasing inwards remittances
from overseas Filipino workers.
Remittances are up
According to the Bangko Sentral ng Pilipinas (Central Bank), the total of
dollar remittances in the first quarter was up 17 percent from US$1.96 billion a
year ago, exceeding the government growth forecast of 10 percent for the whole
year. Remittances coursed through banks reached US$8.5 billion in 2004 and are
expected to reach US$9.4 billion in 2005, based on the 10-percent growth target.
If the first quarter growth becomes a trend throughout the year, there are
reasons to believe that cash remittances through banks would breach easily the
US$10-billion mark for the first time in 2005.
Tax collections start to rise
The government's monthly revenue collection reached a high of US$1.5 billion
(PhP82.8 billion) in April, enabling the government to post a budget surplus for
the first time in four years. With expenditures standing at only PhP79.5 billion
in the same month, the government was able to realise a PhP3.3 billion budget
surplus during April. However, April's surplus, while pleasing was not
sufficient to make a dent just yet in the huge accumulated budget shortfall that
occurred in the first quarter.
The accumulated budget deficit from January to April this year amounted to
PhP60.1 billion (US$1.1 billion), although the figure was below the
government-set deficit ceiling of PhP77.8 billion. Expenditures hit PhP315.5
billion on revenues of PhP255.4 billion in the four-month period.
In April, the Bureau of Internal Revenue (BIR) reported that tax collection was
up 18.7 percent to PhP62.9 billion, signifying that its campaign against large
tax evaders such as movie celebrities is paying off. At least 17 famous
individuals face tax evasion charges. Meanwhile, the Bureau of Customs, which
collects import duties and other charges, reported a 17.5 percent increase in
monthly collection to PhP12.43 billion in April. The Bureau of Treasury's
revenue stood at PhP4.74 billion.
For the whole of 2005, the BIR is seen collecting a total of PhP551.4 billion
while the Bureau of Customs is expected to raise PhP146.7 billion. Both agencies
are "under new management" and seeking to plug system leakages that
have caused underperformance in recent years. Finally, new management appears to
be having some effect although it is early days yet and there is no room for
complacency.
Inflation remains a concern
Minimum Wages in Selected Asian Countries
Daily Rates in US Dollar Equivalents
Singapore 14.25-44.80
Korea 20.04
Malaysia 4.24-9.10
Philippines 5.54
Thailand 3.36-4.25
Indonesia 1.36
China 0.31-1.28
Vietnam 0.93
Source: National Wages and Productivity Commission
There are a few storm clouds on the horizon - principally concern over inflation
and export growth, which has suffered a severe and early downturn from the high
point of 2004. As elsewhere in Asia, exports are dependent (many would claim -
"over-dependent") on a buoyant electronics sector and electronics
shipments have declined rapidly as consumers in OCED countries rein in their
spending on consumer items to pay for higher prices at the petrol pumps.
As the government attempts to improve its fiscal situation by raising tax rates
and increasing electricity charges, the Philippine economy is entering a crucial
stage. The combination of measures proposed by (or supported by) government
could lead the inflation rate to double-digit levels in the coming months if not
handled with care. This is the possible outcome if the additional tax measures
are combined with a new round of transport fare increases and the proposed wage
adjustments. Many think the result could be a 20-percent inflation rate and a
discontented public demanding a change in government. While each hike will
represent a one-time shock, in reality there are likely to be several such
events, the combined effect of which will represent a significant increase both
in consumer prices and in the cost of doing business. How much can the general
public (not to mention the business community) take?
In the first four months of 2005 alone, the year-on-year inflation rate averaged
8.5 percent, the highest in Southeast Asia. So heavy was the burden of high
prices on consumers that labour groups are now demanding an increase in the
daily minimum wage by a range of PhP78 to PhP125 (US$1.4 to US$2.3). Business
groups appear to be amenable for a maximum wage increase of PhP30 (55 cents).
Even this amount equates to a 10 percent increase in the daily minimum wage
(based on Metro Manila).
According to the National Statistical Coordination Board (NSCB), the same
government agency that releases the GDP figures, a proposed PhP125 increase in
the daily minimum wage would push up consumer prices by as much as 15.1 percent,
on top of the "normal inflation". Even the more moderate PhP30-wage
increase proposed by employers, the NSCB said this would result in a 3.6 percent
increase in prices, on top of the normal inflation. The total cost of production
in that case is seen climbing 3.7 percent and the total cost of personal
consumption by 3.6 percent. The NSCB said any wage increases without
commensurate productivity gains would also make the cost of labour in the
Philippines more expensive than in many other Asian countries.
Economic Planning Secretary Romulo L. Neri, made the right call when he said
that the daily minimum wage should be adjusted at reasonable levels that would
keep the country's economic competitiveness. Neri warned that granting a minimum
wage beyond the capacity of local companies would affect the country's
competitiveness and hurt the export sector.
Exports continue to decline
In fact, the export sector is already hurting. The latest trade figures show
that in March, Philippine exports fell for the second consecutive month, by 2.8
percent year-on-year as demand for electronic products showed signs of further
weakening. Exports were down 0.6 percent in February.
The government has set a 10-percent export growth target in 2005. This is even
higher than the actual 9.3 percent growth registered in 2004, but data show that
Philippine exports managed only a 3.6-percent increase in the first quarter of
the year. The government target continues to look overly optimistic. With global
growth forecasts being continually revised downwards, it must surely be time for
a reality check by those responsible for issuing the local forecasts.
Exchange rate concerns
Measured against its own yardsticks, the Philippines is now doing much
better than in the recent past. Yet, when compared to other Southeast Asian
countries, this country continues to bring up the rear. In essence costs,
especially manufacturing costs, are rising but the productivity of the workforce
is not increasing at the same rate. The peso continues to be one of the few
Asian currencies (apart from those pegged to the US dollar) that has so far not
seen any real appreciation. Indeed, it is still considered the one currency in
Southeast Asia that is under significant downward pressure.
It is the inward remittances - this year likely to top US$10 billion - that is
the salvation here but the reality is that the peso is over-valued at the
present time if the country is to restore its export competitiveness. A slow
slide is more likely than a fast drop but if inflation spins higher then we
could see some instability develop, the consequences of which are hard to
discern. Remittances might slow appreciably if overseas workers feel that by
holding off, they can get more pesos per dollar for their families at home and
of course, what a significant fall in the value of the peso might do to the
repayment schedule of government on its foreign borrowings would be of major
concern. At this stage, there are no immediate signs of the currency being under
significant pressure other than to note that there are some clouds building on
the horizon that need to be watched.
Consumption remains the principle driver
Despite signs of an upturn in foreign direct investment, most of it is in
the form of investment commitments rather than actual inwards remittance and for
the time being, consumption expenditure, buoyed by the increasing level of
inwards remittances will continue as the principle growth driver. With El Nino
affecting agricultural output throughout much of Southeast Asia, including the
Philippines, any further growth input from this sector of the economy is
unlikely this year.
Government economists say they are keeping the economic growth forecast of 5.3
to 6.3 percent in 2005, in spite of rising prices, impending wage adjustments
and the proposed two-percentage point increase in the value added tax (VAT).
Government forecasters are also expecting that at this level of growth, the
poverty incidence in the country, which fell to 30.4 percent of the population
in 2003 from 33 percent in 2000 (based on official figures) would decline
further this year.
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