Sponsorship Speech of Sen. Ralph G. Recto
On Committee Report No. 81 (Senate Bill No. 2411)
Rationalization and Harmonization of Fiscal Incentives

Mr. President, more than two hundred years ago the great American statesman and writer, Benjamin Franklin, wryly paraphrased the lament of every private individual and entity since humankinds first brush with governance.

In this world nothing is certain, Franklin said, except death and taxes. These two constants forever raise consternation and puzzlement; today I can almost hear the questions: Are new taxes being proposed? Hasnt the government raised enough new revenues from our labors? Do Filipinos really need yet another tax reform initiative?

To the first question, the answer is no. And yes, the legislatures efforts have raised badly needed funds for the state. The reformed value-added tax and the increase in excise taxes on alcohol and tobacco products, both sponsored by your Committee on Ways and Means, have the potential to raise almost P100 to 120 billion annually for the national government.

RA9337, the reformed VAT, channeled P38 billion to the national coffers from January to July 2006. This helped reduce the budget deficit and allowed bigger allocations for infrastructure and development projects and for basic social services.

Still another fiscal initiative institutionalizing a rewards and attrition system in the Bureau of Internal Revenue and the Bureau of Customs encourages improved performance. The lure of 30% in bonuses for meeting and exceeding revenue targets is an incentive equally potent to the threat of sanctions, the latter remain in place for hard-case miscreants.

The glass is, indeed, half full. Yet it is not time for us to sit back and relax, not when myriad problems threaten to empty that glass as fast as we can replenish it.

Let us not even talk of GNP growth; the countrys 5% to 6% performance still lags behind those of its neighbors. Let us just focus on basic services, a bog of unmet needs where the government fails from the demands of a population growing at an annual rate of 2.3% 1.8 million Filipinos yearly.

Our children need 50,000 classrooms, 42,000 teachers and 4 million desks and chairs. The Philippines has the highest childhood mortality rate in the region, at 40 per 1,000 live births, and the highest number of maternal deaths. As of last year, a third of the country's 1,500 municipalities were still waterless, with half of their population deprived of access to potable water. It is easy to rattle off pledges. But government does not craft social programs from thin air. If we aspire to genuinely serve an already cynical public, we will need to plug the fiscal gap.

We can do this not by imposing new taxes, but by rationalizing the prevailing system of tax incentives, a task neglected for decades.

Let us go back to 1946, to the enactment of Republic Act No. 35, otherwise known as An Act Authorizing the Exemption of New Industries from the Payment of Internal Revenue Taxes which encouraged corporations and individuals to invest in new and necessary industries by exempting them from all taxes. This was just after World War II; the times called for reconstruction.

Today, year 2006, 146 laws have been enacted extending various tax holidays, tax allowances and tax exemptions.

Let me stress that tax incentives are basically good policy tools -- when applied properly. Tax incentives can promote investments in the economic and social sectors. They can ease the negative effects of some government policies. Tariffs, for example, protect domestic industries but penalize exports with costly inputs. A duty exemption for exporters enables them to compete better in the global market.

The Philippines, like many developing countries, dangles tax incentives to attract more private, specifically foreign, investments to develop exports, provide more employment and skills-upgrading opportunities, increase incomes, generate taxes, enhance the environment or reduce the poverty incidence. Tax incentives can also induce investors to locate in less developed countryside areas, broadening the countrys growth base.

Many of the 146 tax incentive laws are not bad. Many channel investments to socially beneficial but financially unrewarding activities. There are laws that promote cooperative development, campus journalism, or the interests of the elderly and the disabled, or the development of micro-enterprises. There are laws that address housing issues. Tax incentive laws with a social dimension are not covered by our reform proposal.

What this initiative targets are tax incentives that provide unwarranted multiple benefits to already rich and powerful business concerns, siphoning off government revenues and depleting budgets for social reform programs.

This early, we hear howls from certain business sectors. The Philippines is changing the rules of the game mid-way, they charge. They warn the proposed law will scare off investors and bring the economy to its knees.

But this is not about robbing the rich. This is all about getting back what has been stolen from our people through policy neglect, wasteful expenditures and tax shields.

The findings of your Committee show the hemorrhage of resources from a bureaucratic maze that exists to allow some of the most profitable domestic and multinational firms to avoid taxes.

Franklin talks of constants. Well, tax shields, some irrational and redundant, have been a policy staple in the last six decades. And what is lost in this fiscal shadow play has meant the death of aspirations for so many of our poorer brethren and the explosions of social conflicts that have laid waste to so many lives.

Let me detail the woes of the Philippines tax incentives system.

To start with, a promiscuous mindset has legislated tax incentives for virtually every economic goal or activity. Executive Order No. 226 or the Omnibus Investments Code was enacted in 1987 and is implemented by the Board of Investments. Republic Act 7916 as amended gives the PEZA its mandate to oversee the development of ecozones in the country and grant tax incentives to locators.

Other laws have created special economic zones and freeports. Still others offer preferential tax treatment to specific sectors like mining, geothermal, oil and coal explorations, jewelry, leather and tanning industries, iron and steel, and many others.

We know the maxim, too many cooks spoil the broth. Too many tax incentives can work at cross-purposes, turning government agencies into rival fiefdoms. And so the BOI competes with PEZA, though both are attached to the Department of Trade and Industry.

In the government game of one-upmanship, more and more perks are hurled at investors, often negating the very benefits forecast from the influx of new businesses. And yet, investors are not always happy. The deluge of incentives can confuse a locator. The time and energy and resources spent spinning from one agency to another could be better used for activities directly linked to production or the generation of services.

The cornucopia of tax incentives breeds red tape. Every unnecessary rule, as we know, only increases the discretionary powers that often lead to corruption. Few of the tax incentives were crafted to pick winners. Instead, a succession of administrations chose the path of least resistance and gave everyone a piece of the pie!

Our tax incentive laws are inconsistent and the rules on dual registration leak like a sieve. We have ecozone locators, already enjoying an abundance of incentives, registering with the BOI to avail of that agencys unique offer -- the preferential taxation of dividends declared to the parent companies of foreign investors.

We need to get our fiscal house in order. Harmonizing major investment incentive laws will be investor-friendly, create tighter tax administration and streamline investment promotions strategies. For this, we need to repeal several laws that weigh down the whole fiscal incentives system.

For instance, the BOIs annual Investment Priorities Plan (IPP) does not mirror priority investment activities based on general development plans. Neither has it resulted to significant and sustained investments, foreign exchange earnings and employment. In fact, jobs generated by BOI registered investments do not even represent 1% of total national employment levels and this figure has been declining from 1995 (0.25%) to 2004 (0.11%).

Aside from saddling the IPP program with complex and not easily quantifiable criteria, administrators hardly consult with the key fiscal and economic planning agencies like the Department of Finance or the National Economic and Development Authority. The DOF, whose fiscal programs are most affected by tax incentives, is not even a member of the BOI Board.

The IPP was born of a desire to jumpstart preferred and pioneer industries. After six decades, these terms have lost their meaning. How long do industries remain in their infancy?

In the last 15 years, IPPs have included automotive parts and components, mining, tourism, leather and tanning industries, textile, petrochemicals. Is it appropriate to give tax breaks to the automotive parts and components industry for 15 years? Have tax incentives developed our textile or iron and steel industries these last 15 years? And what, pray, justifies 15 years of tax exemptions to firms providing tourism bus services?

The IPP, introduced in 1968 via RAs 6135 and 5186, no longer reflects the reality of a nation striving for competitiveness. After 37 years, it has become a burden, an incentive to maintain an inefficient status quo among favored but undeserving industries.

Why do we train a harsh spotlight on tax incentives? Why do we demand a review of their rationale? Why do we seek to know how they have performed vis a vis the countrys economic needs?

On the matter of tax incentives, the contract is clear. The government foregoes of a substantial amount of revenues for the promise of concrete economic growth. The DOF has told this Committee that total tax and duty exemptions in 2004 came to P282.76 billion. This figure represented 5.85% of the countrys gross domestic product, 40.41% of national government revenues and 151.18% of national government deficit!

Around 55% or P156.25 billion of the total tax incentives went to BOI and ecozone investors. About P219 billion were in VAT exemptions, P34 billion were in duty exemptions and P27 billion were in income tax exemptions.

A government determines what tribute to exact and what privileges to extend, with the explicit trust to ensure that benefits from these measures redound to the public good. Too many privileges left unaccounted in the hands of a small powerful group begets oligarchy. The difference between a robber baron and a wise statesman lies in his use of the states power and resources.

Before I pinpoint who benefits most from tax incentives, let me note the other implicit, unquantifiable costs.

There are more than 10 investment promotion agencies (IPAs) and a host of other offices managing investment activities and administering tax incentives. All of these have their manpower and budgets.

Worse, loopholes like the BOI laws cloak of confidentiality provision over investor-related documents make it hard for tax authorities to do audits. This glaring dearth in accountability means a weak review process, whether for oversight or the drafting of policy.

The absence of a clear tax incentives monitoring and evaluation system not only open the doors to corruption, it also creates a poor policy climate. The BOI, for instance, does not have statistics of actual investments registered or actual employment generated. Its available data are only the amounts of investment proposals or projected employment. The PEZA, on the other hand, says building a statistical database on investments generated and tax incentives granted is not a priority concern.

The DOF is always hard-pressed to quantify the annual levels of tax and duty exemptions, evaluate how these affect the countrys fiscal position and determine whether the benefits are really worth the costs. The DOF cannot impose the submission of incentives data, and no inter-agency committee like the Development Budget Coordinating Council or the DBCC has taken up the cudgels for the department.

This is negligence of the highest order. How can we give away the equivalent of almost half the national government revenue -- an amount that in one swoop could wipe out the fiscal deficit -- and not even have the wherewithal to find out whether or not these tax incentives are necessary?

The most onerous losses are borne of redundant tax incentives breaks that government did not even need to offer because investments would have been made anyway. An example is the P2.86-billion worth of tax exemptions granted Globe Telecoms 3G mobile wireless project, and P7.96-billion given to rival Smart Communications. I am not accusing either Globe or Smart of engaging in shady deals. I simply underscore the illogic of providing gigantic sweeteners to firms that are already engaged in a cutthroat race to control the telecommunications 3G market.

Redundancy is a prevalent practice in the dispensation of tax incentives, according to Dr. Renato Reside of the UP School of Economics. He has quantified the redundancy rate of BOI investments at 83% -- P44.07 billion, a figure explained by the agencys focus on companies that target the domestic market instead of exports.

Of PEZA incentives, 10% or P15.7 billion were redundant. At the SBMA, 17.5% of investments enjoyed redundant incentives, at P826.7 million. The figure was 36.3% or P1.6 billion at the CSEZ.

Redundant. That means superfluous, a duplication of an already available perk. How much waste in real terms does the practice generate?

There are 16.6 million Filipinos who live on a P56 daily subsistence allowance. The P826.7 million redundancy in SBMA the smallest in Dr. Resides list would allow 14.7 million Filipinos to double their daily subsistence allowance.

The P15.7 billion lost to redundancy at the PEZA could easily cover the P14 billion needed to treat the 16 million Filipinos afflicted with tuberculosis, a preventable disease linked to poverty and poor living conditions. A six-month treatment regimen costs only P900 but TB remains the sixth leading killer of Filipinos, at the rate of 75 a day. Think about that when you ponder the costs of redundancy.

Or think of it this way. Taking back what has been lost to BOI redundancy could build 8,737 elementary and secondary school buildings of the basic one-classroom type, pave 10,000 kilometers of national roads, and pay for the increase of the basic pay of 1.1 million lowly-paid government workers.

The list of redundant incentives is long: In terms of the income tax holiday, a total of P17.80 billion out of the P18.64 billion total ITH granted to BOI registered firms; in terms of the tax and duty exemptions on capital equipment importations, P1.87 billion of the P1.96 billion total tax and duty waivers; in terms of the tax and duty exemptions on raw material importations, P24.40 billion of the P25.55 billion tax and duty waivers.

These figures run counter to the national governments fiscal consolidation program. These are wasteful expenditures or tax subsidies. They have no place in an economy that, in 2005, had a 13.09% tax effort -- still way off the Medium-Term Plan target of 17%. They have no place in a country that runs a budget deficit of around 2.7% of GDP, a country where national debt to GDP ratio stands at 93%, and where total public sector debt is about 102% of GDP.

The centerpiece of the Philippine tax incentives system, the income tax holiday (ITH), is the most redundant type of tax incentive. It is the biggest stumbling block to a rational fiscal incentives system.

The ITH benefits the investor who expects high profits from his investments in the first place and thus, would have made such investments even without this perk. Conversely, the ITH is useless to the long-gestating investment project that is not expected to earn profits in its early years of operation. Isnt the unprofitable investment -- with greater social benefits -- the one deserving of government assistance? (site examples)

Freeing all profits from tax from four to eight years also compromises the equity principle of taxation. If one earns profits, appropriate taxes are due the government. Even the lowly schoolteacher, policeman, military personnel, government employee, and minimum wage earner pays income taxes to government. Why cant big, profitable businesses do? (And since I have mentioned the schoolteacher, the income tax proposal of your Committee on Ways and Means will address the problem through tax breaks to the needy sectors of society.)

The ITH is prone to abuse. It attracts more the footloose projects instead of the longer-run ventures that are more beneficial to the economy. As an ITH nears its end, any of the following can happen: the firm simply closes down at the expiration of the incentive; the firm infuses additional investment -- a new equipment, perhaps -- on the same project to qualify for a one to three-year extension; the firm invests in a new, complete line of the same project to qualify for a new round of ITH; or the firm closes down and restarts the same project under a different name with basically the same owners. This has been termed creative redesignation of existing investment.

Revenue losses from the ITH are difficult to establish unless a tax audit is done. The tax administrator often balks at this costly exercise; no revenues are forthcoming anyway. The tax administrator simply accepts and records the amount of income tax holiday declared/claimed in the annual information return,

This oversight encourages tax avoidance. Transfer pricing techniques could be employed, with profits diverted to the untaxed firm while another firm claims expenses.

To address all these structural weaknesses and administrative gaps, to plug the massive wastage of government resources and to strengthen the institutional framework in the grant of tax incentives, Senate Bill No. 2411 under Committee Report No. 81 proposes to rationalize the fiscal incentives system.

In its proposed restructuring of tax incentives, the bill stipulates who will be granted tax incentives and what tax incentives to give.

The bill proposes to abolish the annual Investment Priorities Plan and focus tax incentives on exports. The export sector brings in foreign exchange earnings, creates jobs, enhances income opportunities, and spurs technological advancement. Philippine exports are the best way to advertise Filipino ingenuity to the world.

The bill seeks to provide registered export enterprises a uniform set of tax incentives regardless of location. Tax incentives to exports are necessary to make them cost-effective. Tax incentives to exports are not redundant; they do not represent real fiscal costs to government. Unlike the domestic-oriented firms that enjoy the presence of a ready market, exporters compete in the global market and have to be freed of unintended penalties on inputs, like tariffs that protect domestic industries, in order to be competitive.

The bill does not shove aside domestic entrepreneurs. If empirical studies show that tax incentives to domestic market-seeking and resource-seeking ventures are redundant and unnecessary, the Senate bill offers a middle-ground solution by utilizing the tax incentives system as a tool for industry dispersal, countryside development and employment-generation. The bill proposes tax incentives for registered domestic enterprises that locate in any of the 30 poorest provinces, bring in investments of P500 million and above, or generate at least 200 jobs. No IPP or preferred list will govern the types of investments to be given tax incentives. Government should not play God and pick winners and losers. Let the market forces determine how investments will be made.

The bill seeks to overhaul the tax and duty incentives package and make it more relevant to business cycles of profit and loss. It proposes to abolish the income tax holiday for reasons already discussed, and replace it with a reduced income tax of 15%, an accelerated depreciation deduction and an extended period for carry-over of net operating losses. This is the basic tax incentives package offered in the Senate bill.

Specifically, registered exporters will be granted:

• Reduced income tax rate of 15%

• Extended NOLCO, wherein net operating losses during the first 5 years of commercial operation shall be carried over as a deduction from gross income for the next 10 years following the year of such loss. Effectively, this enhanced NOLCO will run for 15 years. Thereafter, the registered firm can avail of the regular NOLCO in the Tax Code (i.e., operating losses in any year can be carried over within 3 years immediately following the year of the loss).

• Accelerated depreciation as provided in the Tax Code.

For registered domestic enterprises, they will be granted:

• Reduced income tax rate of 15%

• Extended NOLCO, wherein net operating losses during the first 5 years of commercial operation shall be carried over as a deduction from gross income for the next 5 years following the year of such loss. Effectively, this enhanced NOLCO will run for 10 years. Thereafter, the registered firm can avail of the regular NOLCO in the Tax Code (i.e., operating losses in any year can be carried over within 3 years immediately following the year of the loss).

• Accelerated depreciation as provided in the Tax Code.

Exporters will receive a premium through additional tax incentives, in the form of:

• Duty-free importation of capital equipment and raw materials to be used in the manufacture, processing or production of their export products.

• Duty-free importation of source documents by IT-registered export enterprises

• Option to choose between the preferential tax of 15% or a 5% tax on gross income earned in lieu of all national and local taxes except VAT and real property tax on land. At present, only ecozone enterprises can avail of the 5% tax on gross income earned. The Senate bill extends this tax incentive, as an option, to all registered exporters.

In lieu of an outright VAT exemption on importations of capital equipment and raw materials, exporters will be asked to pay the VAT upfront and apply for a tax refund the moment they can show proof of exportation. The Senate bill does not intend to tax the exporter but to plug the leakages in the existing process, of outright tax and duty exemption upon importation, that have been abused and given rise to smuggling activities. The Senate bill intends to put in place a tighter mechanism, to protect government revenues as well as the interests of the domestic industries and consumers affected by rampant smuggling of goods into the country.

The Senate bill makes sure that the cost of money equivalent to paying the VAT upfront will be manageable for the exporters, and provides a 30-day window within which processing, clearance and release of VAT refunds must take place. The bill establishes a special Trust Liability Account in the Bureau of the Treasury for the purpose. All VAT payments shall be deposited in the TLA, and as soon as an application is processed and approved, a VAT refund, in cash or managers cheque shall be issued.

In seeking to restructure the tax incentives system, the Senate bill repeals 35 investment-related tax incentive laws. Foremost of these are EO 226 or the Omnibus Investments Code that grants tax incentives to BOI registered enterprises and RA 7916 as amended or the law that governs PEZA and the grant of tax incentives to registered enterprises in PEZA zones.

Other laws to be repealed are special laws governing investments in specific sectors, such as the tax incentive provisions of the Mining Code, the Export Development Act and the Fisheries Code. This is not to say that these activities cannot enjoy incentives. They can, but within the proposed framework of the Senate bill. With the proposed repeal of 35 investment incentive laws, the Senate bill takes a major step in the right direction of consolidating, harmonizing and simplifying the fiscal incentives system.

The Senate bill, however, will not amend the tax incentive statutes governing the Subic Bay ecozone and freeport, the Cagayan special economic zone and freeport, and the Zamboanga special economic zone and freeport, these being both ecozones and freeports. They will be allowed to continue to operate under a different tax regime.

The Senate bill overhauls the two investments promotion and tax incentives administering bodies the Board of Investment and the Philippine Economic Zone Authority - - by merging them and creating a new body to be called the Philippine Investment Promotions Administration.

The Senate bill seeks to institutionalize a tax incentives policy-making, monitoring and evaluation system. It proposes to make a member of the PIPA Board the DOF, BIR and BOC. The boards main concern would be the fiscal policy and revenue implications of tax incentives. The PIPA Board will also have representations from other Departments deemed essential in attaining the goal of investments promotion and growth (such as NEDA, DOLE, DPWH, DOST and DENR).

The Senate bill also requires all the Investment Promotion Agencies or IPAs to submit their annual tax expenditures/tax subsidies to the PIPA and DOF for monitoring and review purposes. The DTI, DOF, NEDA and the IPAs including PIPA shall be required to submit an annual report to the President and to Congress on the investments and incentives granted.

Revenue savings or at best, additional revenues, are expected from the proposed rationalization of fiscal incentives. The Senate bill proposes to earmark all revenue savings or gains for infrastructure (50%) and for education (50%). Better physical infrastructure and a well-educated labor force will undoubtedly attract capital into the country, more than anything else, including tax incentives. Investing in infrastructure and education are keys to sustainable growth and are the best factors in luring investments.

In conclusion, please allow me to reiterate that the proposal to rationalize the Philippines tax incentives system is neither anti-business nor anti-investment. It is a growth-oriented but equity-driven tax and trade policy reform.

It lays the groundwork for effective but efficient promotion of businesses and investments in the country. Effective, because it focuses on providing appropriate tax incentive tools to deserving parties. Efficient, because it does not allow room for unnecessary and costly fringes.

It is a policy and structural reform tempered by equity. Wasteful use of public resources has, time and again, taken out the opportunity for government to address the needs of the low sectors of society. Why must the Juan dela Cruzes continue to suffer if public resources can be generated well, and spent well?

Are tax incentives worth the cost? Yes but only if we can put rhyme and reason and harmony into the tax incentives system.

Let the Senate bill on the rationalization of tax incentives pave the way for this realization.