Tuesday, April 25, 2006

Oil Price Stabilization Tax

What's going on? As oil prices go up, legislators in the Philippines are again calling for suspension of the value added tax on petroleum, which is 12%.

I remember the good old days of the Oil Price Stabilization Fund. (This is what passes for sarcasm among economists.) It worked as a variable subsidy: at a given domestic price, when the foreign price went up, the oil firms would be subsidized by the fund; when the foreign price went down, oil firms would put money back into the fund. Well it might work if the regulated domestic price equalled the long run equilibrium price. It doesn't take an ijit to guess that the regulated price was set way lower than that, so that the "fund" was perpetually in the red, burning holes through government coffers.

What the legislators are proposing is in effect a variable levy. Foreign price up: suspend tax; foreign price down: impose tax. It is more feasible to implement because government doesn't actually have to cough up financing for a subsidy. But the idea is as flawed as the Stabilization Fund, and the effects are more insidious.

First, does anyone really know the long run trend in the world price of oil? Is US$ 65 per barrel it, as Rep. Salceda is guessing? Nobody knows. If anyone did, they would make a killing in the futures market. (If it were different, that is.) Suppose the oil price hold steady at today's high levels. Does anybody seriously think this tax can be reimposed?

Which brings us to the second point: suspension of the tax would forego, by some preliminary estimates, revenue of about 40 billion pesos. Representative Salceda recommends restrictions on spending and the scrapping of the rationalization program. But these are truly lousy ways of meeting government borrowing targets.

How about the "hardship to the people"? Well excessive government borrowing, or restrictions on public spending, are themselves sources of "hardship to the people." I am pleasantly surprised with Senator Recto, who shows lots of good sense, by claiming that the suspension would hurt people more.

Another way to approach the problem is this: suppose you are foregoing 40 billion in tax revenue anyway. Compared to repealing the VAT on oil, is there a better way to structure the tax system? My (very preliminary) simulations with the updated PhilCGE suggest there is. For example, halving the sales tax rate on petroleum products has about the same revenue loss as removing 5% off the sales tax rate across-the-board. However the latter involves a welfare improvement of about 30% more. This confirms that a more uniform tax structure tends to be less distortionary on the economy. Unfortunately the suspension of the EVAT moves towards a less uniform (and more distortionary) tax regime.

The de facto oil price stabilization tax is only good for one thing: political mileage. Yep, I can hear 'em downshifting to high gear all over.


Peter said...

Good one. "Coincidentally" those people most interested in removing the VAT on oil just so happen to own several gas hungry SUVs.

Amadeo said...

Here in the US, there is now a proposal to suspend gas taxes for a while, to create a "gas tax holiday".

To get some perspective, average gas price now hovers almost at $3.00/gal. And total taxes amount to over 60 cents per gallon, representing about 20% of pump price.

Econblogger said...

Well it seems Malacanang has backpedalled on the idea. Maybe GMA asked Mike Defensor to test the waters. The main reasons given however are disappointing: more in the nature of "investors-will-be-scared-off", rather than the actual (de)merits of the proposal. Oh well, better than ramming it through anyway.