Walking on a Knife's Edge

THE ECONOMY

by MAITET DIOKNO-PASCUAL and CLARENCE PASCUAL

MAKE NO mistake about it: The Arroyo government has focused its energies on improving its fiscal situation. But it is doing so primarily to address the concerns of international creditors and credit-rating agencies, as well as to survive the political challenges to Gloria Macapagal Arroyo's presidency. And while it has been hailed by the creditor community as a "success," the Arroyo administration's fiscal policy now poses a major obstacle to economic growth, job creation, poverty reduction, and the attainment of the Millennium Development Goals (MDGs).

In 2005 the present administration was able to lower the fiscal deficit, both in absolute terms and as a proportion of the gross domestic product or GDP. In the first nine months of this year it reduced the deficit by P70 billion. That, however, was less than half the target deficit for the period.

A closer look at the fiscal balance also shows that the lower deficit was achieved primarily through spending cuts rather than improved revenue mobilization. Spending cuts accounted for 92 percent of the improvement in the January-to-September deficit vis-à-vis targets, while increased revenues contributed a meager eight percent. In fact, the Arroyo government failed to meet its tax targets in 2005 and this year. In 2005 it had to resort to a 10-percent cut in non-interest, non-IRA (Internal Revenue Allotment) spending to produce an "acceptable" deficit. This year, the spending cuts are deepening: 18 percent in the first nine months.

This pattern of fiscal management has certainly made the bottom line look good to creditors and credit rating agencies. But it is unsustainable. The weaknesses in the fiscal management by the Arroyo government will become more difficult to hide in the next three years, and may even erase the gains already made.

On the revenue side, efforts to raise tax revenues will fall short of expectations. For one, the Arroyo government does not have the credibility, the moral suasion, or the political will to compel big business and the elite to pay more taxes. This year, it failed to meet targeted increases in taxes paid by professionals such as doctors and lawyers. And it is halfhearted about removing tax holidays and other fiscal incentives for big business and investors who, studies show, would have invested anyway even without the incentives.

Subsequently, the government relies more and more on workers and ordinary consumers. Shifting the tax burden on those who have less and earn less is at the core of the Arroyo government's tax strategy. Raising the value-added tax (VAT) rate from 10 percent to 12 percent may do the trick for one year — the tax effort (taxes as percent of GDP) improved from 13 percent in 2005 to 14 percent in the first nine months of this year. But to achieve a tax effort of 20 percent and higher in the coming years, the government must rely on a tax base with steady jobs and rising real incomes — two basic conditions missing today.

Wage and salary workers are the primary source of personal income-tax revenues, contributing nearly 90 percent of close to P100 billion in 2004. They form the "critical mass" as far as income taxes are concerned. But they are an endangered species under the Arroyo government. Of the employed, only about half are salaried employees — a narrow base from whom to draw income taxes. Job creation has been weak and a significant number of new jobs are found in the informal sector, where earnings are outside the income-tax net.

Ordinary consumers with shallow pockets and mounting personal debts make another cluster of unwitting taxpayers who form the government's tax base. By the government's own estimate, average family incomes in real terms fell by 10 percent between 2000 and 2003. A base that is as severely income-challenged as this cannot possibly contribute to a rapid rise in the tax effort.

ONE PIECE of the unsustainable tax puzzle merits attention: the reliance on debt for revenues. Every time the Bureau of Treasury sells government debt papers, the national government collects a tax on the interest it pays its lenders. In other words, whenever the government borrows in the domestic market, such borrowing boosts its tax revenues. The more it borrows the more taxes it earns.