The Philippines boosts public spending and increases revenues

“Tax more, spend more” is the clear-cut recommendation of the IMF to the Philippines, delivered in no uncertain terms in its September 2015 annual report on the country’s economy and economic policies. The IMF “welcomed the government’s plan to step up infrastructure investment and social spending” and “encouraged further efforts … to mobilise revenue to meet the large social and infrastructure needs”.

Low Spending

As the IMF points out, the Philippines has long had a small government relative to the size of its economy, even compared to other countries in South-east Asia, where small government is the norm. General government spending in 2014 came to just 18.4% of GDP by the IMF’s count, the lowest figure in East Asia. General government is the entire public sector, including local bodies, except for state-owned businesses. In most ASEAN member states, the general government share of GDP is in the mid-to-high 20s, although Indonesia has a similarly small government, at 18.8% of GDP in 2014. Globally, emerging markets averaged 31.1% and advanced economies averaged 40.5%, according to IMF data.

Although the IMF also stresses that spending should be transparent and efficient, its central message is that the Philippines could grow more quickly if it collected more taxes and invested more in infrastructure, education and social programmes that help people escape poverty and invest in their families’ futures. “The revenue and expenditure ratios are still very low. The clear recommendation is to raise those ratios to spend more on infrastructure, education and social protection,” Shanaka Peiris, the IMF’s resident representative in Manila, told OBG.

Infrastructure

In an appendix to its 2015 report, the IMF argued that even assuming that 40% of infrastructure spending is wasted, a sustained increase in public infrastructure spending to 5% of GDP would add a total of 5-6% to GDP after 15 years. If waste is 20%, the long-term boost to GDP would be another 5% on top of that. The calculations were made with an economic growth model that mimics how “improved public infrastructure raises the overall productivity, akin to an increase in total factor productivity from the perspective of the private sector”, said the IMF.

Infrastructure is especially crucial for an archipelagic country, and the government has begun to deliver on long-standing plans to boost infrastructure spending. State budgets allocated P307bn ($7.4bn), or 2.7% of GDP, for infrastructure in 2013 and P442bn ($10.7bn), or 3.4% of GDP, in 2014. However, actual spending came to P262bn ($6.3bn), or 2.3% of GDP, in 2013 and to P276bn ($6.7bn), or just 2.2% of GDP, in 2014. Besides public spending, President Benigno Aquino III planned to boost spending on infrastructure through an ambitious programme of public-private partnerships (PPPs), which fund infrastructure from private savings rather than by using the government’s fiscal powers. However, these also got under way slowly. As of September 2015 only P84bn ($2bn) of projects had been completed or were under construction, according to the country’s PPP Centre.

A turnaround finally appeared to be taking place in late 2015. After setting a goal of boosting infrastructure spending to P570bn ($13.7bn), or 4% of GDP, in 2015, and then falling short of targets in the first half of the year, public infrastructure spending suddenly accelerated and hit the monthly target in July.

Some P201bn ($4.8bn) of recently awarded PPP projects were expected to get under way by early 2016, and another P392bn ($9.4bn) of PPP projects were in the bidding or pre-qualification stages. The 2016 budget included a plan to push infrastructure spending up further to P767bn ($18.5bn), or 5% of GDP, in line with the IMF’s recommendation. “In 2016 and 2017 you could see a quite large increase as public spending and PPPs both pick up,” Peiris told OBG.

It may seem peculiar for a government to persistently not be able to spend as much money as it intended. The government’s explanation is that it needed time to develop public administrative capacity to handle large infrastructure projects properly. Public infrastructure spending has a chequered history in the Philippines, having, for example, been used by President Ferdinand Marcos in the 1970s to line the pockets of military leaders and secure their support. President Aquino was elected in 2010 with a strong mandate to clean up corruption, and officials in his administration say it was worth going slowly with infrastructure spending until procurement reforms were in place and bad practices were rooted out.

Tax Collection

Another reason for low public spending levels is relatively weak revenue collection, due to a combination of evasion, loopholes in tax laws and liberal granting of tax incentives to investors. The burden of taxation became especially light under the administration of Gloria Macapagal-Arroyo, who left office in 2010 with public revenues at just 16.8% of GDP. The ratio has gradually strengthened to 19% of GDP in 2014, according to IMF data. The most telling statistic is that 94% of personal income taxes collected in 2014 were withholdings, which shows how little tax is collected on personal incomes other than salaries and wages. Personal income tax rates run from 5% to 32%, but the burden falls heavily on the middle of the income range. Minimum-wage earners are exempt, and many high-income professionals shun salary status. Collections of personal income tax in 2014 totalled P247bn ($6bn), or just 2% of GDP, according to the Bureau of Internal Revenue (BIR).

Corporate income is taxed at a rate of 30%, compared to 20-25% in most ASEAN countries. But there are many ways to legally reduce payments, and there is also widespread evasion. Corporate income tax collections in 2014 came to P455bn ($10.2bn), or 3.6% of GDP. Meanwhile, value-added tax, at 12%, is the highest in ASEAN. It is also the Philippines’ largest source of revenue, with collections of P558bn ($13.4bn), or 4.4% of GDP, in 2014, according to BIR and Bureau of Customs data. Excise taxes, mostly on alcohol, tobacco, oil and oil products, are also an important revenue source at P166bn ($4bn), or 1.3% of GDP. Import duties are relatively small at P56bn ($1.3bn) in 2014, and there are numerous other taxes.

Tax reform is a hot political topic, and there is strong popular pressure to reduce income tax rates on the working class. Proponents plan to put forward such a bill in Congress in 2016 after an attempt in 2015 failed due to presidential opposition. The administration has pushed bills enabling tougher enforcement, such as letting tax authorities look at personal bank deposits and making tax evasion a predicate of money laundering. Promoters are promising the new bill will be revenue neutral. The Joint Chambers of Commerce supported the 2015 bill, arguing that the Philippines should follow the ASEAN trend of lowering corporate and personal income tax rates to attract investment.

Where Aquino has been very successful is in bringing down the government’s interest expenses, freeing up revenue to spend on public services and social protection. Government interest expenses fell from 3% of GDP in 2010 to 2.2% in 2014, according to the IMF. Aquino’s strict control of government deficits and high growth rates during his term brought the ratio of government debt to GDP down from 44.3% in 2009 during the previous administration to 37.3% in 2014, according to Department of Finance data. Major international credit ratings agencies upgraded the Philippines’ sovereign debt rating from two or three rungs below investment grade in 2010 to the minimum investment grade or a notch above by 2014.

The IMF argues that the Philippines has been too fiscally conservative. It approves of the Aquino administration’s target of a 2% of GDP national government deficit, but recent results have been tighter than that, at 1.4% in 2013 and 0.6% in 2014. After consolidating with public social security funds and local governments, the IMF calculates the 2014 general government balance was 0.5% of GDP in surplus.

Social Spending

Besides infrastructure, the IMF is urging the government to continue to boost spending on education and social programmes. In another appendix to its 2015 annual report, the IMF argues that poverty rates in the Philippines have begun to respond more strongly to increases in social spending, which indicates that government programmes are working and deserve to be better funded.

Poverty fell by 3 percentage points in 2013, twice the cumulative decline over the previous 12 years, showing that growth is becoming more inclusive. The poverty rate rose by 1 percentage point in 2014, which the IMF blamed on Typhoon Yolanda and restrictions on rice imports. The IMF concluded that the government’s focus on health care and support for family spending on education and health was appropriate, and that further steps could include ensuring rice prices do not rise above international markets, expanding access to primary education and training, and simplifying tax rules for small businesses.