Wednesday, October 19, 2005

Go signal for expanded VAT

The Supreme Court of the Philippines has finally resolved all legal challenges to the Expanded Value Added Tax law (EVAT). The Executive can now start implementing it.

Wikipedia has an informative (but badly written) article on VAT here. Think of a product going through stages of production, from raw material to final pick-up by the consumer. At each stage value is added to the product. Government slaps an VAT rate on all sales (whether business-to-business or business-to-consumer). The business is able to subtract the VAT it has paid for its inputs (input VAT), from its output VAT, so that it only pays the net VAT, i.e. effectively the tax is levied only on value-added.

In the Philippines there was a lengthy debate a few years back about shifting from sales tax to the VAT. That hubbub has died down, as everybody realized that the VAT - which is the norm in EU and many other countries - is superior to the sales tax from the administrative viewpoint. (An excellent discussion of VAT is found here.) Since a tax is slapped at multiple stages of production, the scope for tax evasion shrinks (whereas under the sales tax, if a retailer evades payment, the entire product goes untaxed.) However unlike the simple turnover tax, there is no "cascading effect", i.e. tax upon a tax.

The debate is actually about the VAT rates. In the Philippines the standard rate was 10%, with some key sectors being "zero-rated" (i.e. zero output tax, but able to claim input VAT.) The new law enacts a new standard rate of 12% (under certain conditions) effective next year, and removes zero rating of key sectors such as power and fuel.

Of course, there will be some short-term repercussions on prices (due to the increase in tax rate, and consequent increases in energy prices). Well, what do you expect, silly, if government collects 70 billion additional revenues from VAT, then of course households need to fork over that 70 billion in the form of higher prices. Duh. Moreover, VAT rates around the world (from the Wikipedia entry) are worse: 12.5% for India and New Zealand, 15% for Mexico, 17% for China, 18% for Russia and Turkey, to a whopping 24.5% for Iceland. So there is no clear-cut prognosis of economic disaster from raising VAT rates.

In fact, as the expanded VAT is the only significant revenue measure that has been enacted while the country's public debt balloons (now at 70% of GDP), economic disaster - on the scale of financial debacles of our neighbors in 1997, and Argentina recently - would have been a sure thing had the High Court voided the law.

As usual, we've escaped by the skin of our teeth.

3 comments:

Greg said...

Could you help explain the dissenting opinion of SC Justice D. Tinga regarding the 70%/90% cap. He quotes people like Monsod, Wallace, and the PWC head in his dissent.

While I am all for VAT, I just want to understand what the dissent was all about so that I get the whole picture.

A copy of the dissent is in the Inq7.com website (as well as a copy of the decision).

Thanks!

P.S. Also, when you have time, I think readers would probably like you to post something on Philippine economic history - -what is the evolution of philippijne economic history lets say starting from the beginning of the 20th century and what has been the results of such policies.

For example, I do know that in the late 40's-50's, the Philippines imposed high tariff barriers on imports and adopted a policy of import substitution. Our growth rates though at the time were in the double digits and tapering off to somewhere in the 5-7% range. Soon though, this policy had run its course and we soon experienced problems. While this Latin American model has been discredited to a large extent against industrialization through export and free trade, so-called Philippine nationalists still advocate this kind of economic philosophy and may use the high growth rates of the 50's to support their views.

Hope you can write something on that in the future. Thanks!

Econblogger said...

Greg,

I'll take up input VAT in my next post.

As for econ history - seems you know a lot already! But definitely the "nationalist" rhetoric is a theme I will return to repeatedly. Mercantilist-type thinking is one of the most pernicious viruses of economic thought ever perpetrated. I'm sure you'll agree!

Greg said...

Thanks for the post. I'm sure a lot of your readers appreciate it. I'll be reading right after I post this.

You're right. Mercantilist-type thinking. Something that has somehow captured the imagination of a lot of the so-called nationalists. Unfortunate.