Over the past few decades, the Philippines has enjoyed stellar economic growth but its poverty rates have remained unacceptably high. Its newly appointed finance secretary explains how his tax reforms will bring an end to this situation.

Carlos Dominguez

Governments everywhere are trying to grapple with the problem of uneven growth: patterns of economic development that deepen inequality and exclude large sections of the population. 

This is a problem that market forces alone cannot solve. The solution requires creative fiscal management that aims to bring the marginalised into the mainstream. 

Uneven growth – that is, growth that disenfranchises – underpins today’s movements of the alienated. Such movements tend to be radical but unreasonable: among them are Occupy Wall Street and the undercurrent of the disillusionment that brought about Brexit.

Growth in the Philippines

The Philippines, as is the case with many emerging economies, exhibits uneven growth principally through persistently high poverty rates. The engorged ranks of the poor, in turn, bring forth other problems such as armed insurgency, the proliferation of patronage politics, high incidence of crimes against property and, yes, the scourge of drug abuse. 

In the second quarter of this year, the Philippines recorded a 7% gross domestic product (GDP) growth rate. It is now the fastest growing economy in east Asia, eclipsing China’s decelerating growth rate. For 16 years, through the 2008 global financial crisis, the Philippines has posted sustained quarter-on-quarter growth. In August 2016, the country posted the highest level of foreign currency reserves ever. In the past few years, rating agencies granted the country successive upgrades.

The Philippines has come a long way since its economy buckled under a severe debt crisis in the early 1980s. Under a regime of fiscal discipline, the country worked down its debt to eminently manageable levels. The currency is strong even as the interest rate environment is low. Inflation has been tamed. 

All these might suggest the Philippines should simply coast along. 

However, despite the country's best efforts, its poverty rate remains stubbornly high. In 2015, some 26% of the population lived below the official poverty rate, hardly changed from a decade earlier. Inequality is also high and increasing. The average income of the richest 10% of households is some 25 times that of the poorest 10%. Unemployment, while falling towards 6%, remains high by regional standards, and of bigger concern is the structurally high underemployment rate at 20%. The country’s infrastructure and human capital backbone remains weak. Massive investment is needed to improve human capital, public health and the country’s logistics system.

Outside influence

In the recently concluded presidential elections, Filipino voters expressed their discontent by choosing a complete outsider to be their leader. Voters chose Rodrigo Duterte, who served as mayor of the country’s southern-most major city, by an unprecedented landslide.

Upon assuming office, Mr Duterte promised to continue the macroeconomic policies that fostered growth but drastically reform everything else that caused this growth to be so unevenly distributed. This meant improving on the ease of doing business while strengthening competition policies; lowering the oppressive tax rates while increasing public revenues; and ending the armed insurgencies while improving public order. 

A comprehensive programme of reform has been laid out. It includes rapidly modernising agriculture, improving the delivery of public services by stamping out graft, instituting a more progressive tax system, and the promotion of science and the arts to help build a more innovative population.

Tax reforms

As finance secretary, my specific area of responsibility is the reform of the tax system. At present, we have a tax system that imposes the highest personal and corporate income tax rates but teeters on the narrowest tax base. Our tax effort lags behind the rest of the south-east Asia region. The complicated tax system encourages corruption in the revenue agencies and dissuades compliance.

While we impose 12% VAT, the revenue generates as much a share of GDP as Thailand does – even though it has a VAT rate of only 7%. Our VAT coverage accounts for only half the GDP, due largely to the many exemptions inserted by law. This in turn leads to significant leakages by those who take advantage of the VAT’s complexity. Our ability to raise revenues is further hampered by numerous indefinite tax breaks granted to select businesses over the years. 

Over the next few years, my mission is to lower tax rates, simplify tax procedures, close the loopholes in the VAT system and introduce new revenue measures designed to improve equity. All of these will have to be done while raising public revenues to fund an ambitious infrastructure programme, and raising the quality of our public education and health system. 

This is a challenging mission, to be sure. But it must be accomplished. Otherwise, the country will remain in the rut of high but uneven growth. Disillusionment at the grassroots will continue to fester.

Perfect timing?

We have the most perfect convergence of factors at the moment to undertake substantial reforms. The economy is poised to move to a higher growth path. The fiscal situation is as stable as it has ever been. Consumer and investor confidence is strong. Most important, we have a broadly supported national leadership with both political will and political capital to push the reform programme forward.

This is a rare convergence. We will not let this opportunity pass. 

The tax reform programme we have on the table is not merely about improving revenues by encouraging compliance. More importantly, it will be the best tool for making our economic progress more responsive to the people’s expectations. A more adept fiscal policy will open the way to broad-based participation in our nation building. 

In the medium term, we expect the country to achieve not only a dynamic, inclusive economy but also a social order that is just.

Carlos G Dominguez is the finance secretary of the Philippines.

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