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Raiders of the Taxpayer's Money

October 8, 2004

Tags Taxes and SpendingFiscal Theory

For a government as vast and powerful as America's, $60 billion is hardly a substantial amount of money, considering it boasts a large populace and economy to plunder; such a sum is a mere three-fifths of what the U.S. Army alone requested for fiscal year 2005.

In the case of the Philippines, an erstwhile vassal of America, $60bn is an exorbitant total that also happens to approximate the country's sovereign debt. Staring acute financial hardship in the face, government officials are imploring the nation, particularly Filipino taxpayers, to bail them out of a crisis of their own making.  

Mountains of Debt

Despite prior foreign investment bank prognostications and concerns, economists at the University of the Philippines (UP)—a state institution—ironically brought the country's impending fiscal crunch into sharp relief. Eleven academics, many of them senior economic officials in previous Philippine presidential administrations, collaborated to identify the causes of the country's rapid accumulation of sovereign debt[i]and predicted that if left unchecked, a genuine fiscal crisis would soon befall the country.

 

They found that between 1997 and 2003 approximately 2.01 trillion pesos ($36.4bn) were added to the national debt, which is almost 1.5 times the debt burden –1.35 trillion pesos ($25.4bn) that existed in 1997. The outstanding government debt is at a level well above what bond rating agencies consider as the median load for similarly rated sovereigns. Divided roughly half and half between domestically and externally-held financial instruments, government servicing of these obligations could become impossible to manage if global interest rates continue to rise and recurring budget deficits cannot be attenuated.  

 

Indeed, since 1998, the Philippines' budget balance has gone south, posting sizable budget deficits annually. The unmitigated deterioration of the government finances comes in spite of modest economic growth in the aftermath of the East Asian Financial Crisis of 1997 and 1998. Like other nations in the region, the Philippine currency suffered speculative attack, precipitating a rise in domestic interest rates by the Philippine Central Bank and a subsequent slowdown in the financial sector and wider economy.

 

Notwithstanding a rise in unemployment, currency depreciation and an attendant spike in inflation, the Philippine economy, relative to other East Asia countries like Indonesia, Malaysia and Thailand, rebounded rather quickly.  Wide-ranging structural reforms initiated at the beginning of the 1990s, including opening an exceedingly protected economy to foreign trade, provided the country the flexibility necessary to rebound from a recession.

 

However, the government also resorted to public spending to stimulate growth, tapping international capital markets to plug the resultant deficit. In fact Manila's March 1999 sale of a 350m-euro bond was Asia's first debt float in the new European currency.[ii]  What differentiates the period of modest economic growth in the Philippines between 1993 and the Asian Crisis and the period afterwards is an erosion of the government's finances, bulging budget deficits and burgeoning debt in the latter period.

 

As the UP economists enumerate, 43% of the increase in the national debt can be attributed to a surfeit of government expenditures over tax take, 19% to adverse currency movements and 37% to assumed liabilities and subsidization of state corporations.

 

Leaving aside the currency factor, Government Owned or Controlled Corporations (GOCCs) and the government's budget deficit merit closer examination. Beginning with the former, chronic loss-making state corporations pose an additional budgetary onus upon the government's coffers. Although its debts are not de jure obligations of the government, state enterprises can expect an implicit state bailout should it encounter financial difficulties, thus pushing the public sector debt load (as opposed to the national government) to 135.6% of GDP.

 

Chief among the beneficiaries of state largesse is the National Power Corporation (Napocor), a notoriously inefficient firm that lost $2.06bn last year and has had nearly $818m of debt absorbed by Manila over the past five years.

 

According to the country's Freedom from Debt Coalition[iii], Napocor's debt has grown from $2.2bn to $25.4bn between 1994 and 2003 and represents more than 40% of the $61.8bn debt.  Unable to borrow in global capital markets, the loss-making entity has had the national government purchase its bonds and then obtain financing from foreign lenders in the government's name, including a $400m sovereign bond flotation, part of Napocor's $27.3m borrowing requirement for 2004.

 

In addition to current or recent government absorption of quasi-public agencies' debts, it has volunteered to service the obligations incurred during the profligate Marcos era. Even the Central Bank required financial assistance, a notion nearly incomprehensible in America or Europe where such institutions are considered omnipotent. Of course, the heroic decision of Philippine officials to assume these excesses will not be paid out of the state's or their own ill-gotten assets, but by squeezing hapless taxpayers.

 

Show me the money

 

The discrepancy between government expenditures and the property it can coerce from the populace account for 43% of the upsurge in the nation's sovereign debt. Contrary to countries that have courted fiscal crises due to increased spending, the Philippines has actually experienced a slight decline in spending levels since 1999, attributable to president Gloria Malacañang Arroyo's (GMA) determination (so far marginally successful) to cull the country's budget deficit since assuming power in 2001. 

 

Rather, private property seizures are descending at a gait quicker then spending. The tax take has fallen from around 17% of GDP to 12.5% of GDP between 1997 and 2003. Investment banks estimate the country's rampant tax evasion totals in the billions of dollars per year.  Philippine enterprises are thought to pay only 60% of the Valued Added Tax (VAT) that the state demands as tribute, while domestic financial institutions rarely pay levies on interest income commensurate to what they purportedly owe. Corruption within the government, including the Bureau of Internal Revenue (BIR) contributes to disappearing receipts. Not to be outdone, the judiciary is inclined to issue a free pass to tax dodgers. GMA has publicly condemned the endemic tax evasion and has directed the bureaucracy and citizenry to wage a Kulturkampf against it.

 

As for the Philippine political system, it vindicates columnist H.L.  Mencken's characterization of elections as an advance auction of stolen goods. Washington's occupation of the Philippines from 1898 until 1946 imposed the American system of government on its client, complete with a president, bicameral legislature and Supreme Court. The U.S. legacy proved to be a boon to the leading families of a country encompassing thousands of islands and dozens of disparate local languages. Ambitious clans, already fluent in English (an essential in Manila) could establish provincial fiefs in the native tongue as a springboard to either house of congress and even the presidency.

 

Party affiliation is subordinate to filial ties; about three-fifths of the last Congress had relatives in office[iv] . Legislator loyalty can be bought (with taxpayers' money of course) to assemble majorities on any piece of legislation. What is more, elected representatives find time to grant themselves and connected friends tax exemptions (e.g. in the legal and medical professions) as well as augment their own pay for all of that taxing work. Specifically, Congress managed to almost triple its own budget over the past 15 years.  But then again, the 24-member Senate does need the extra funding to discharge the expense of 36 permanent committees and 16 ad hoc oversight committees (by contrast America's upper chamber has only 16 and four permanent and special committees, respectively). 

 

Granted, tax exemptions are always just—no matter who receives them (see Rothbard[v]) especially in the case of people who are forced to contribute to public services they themselves do not use.

 

 

Do I smell bacon?

 

Mounting a successful political campaign is prohibitively expensive, running into the tens of millions of dollars to conduct a serious legislative or presidential bid. In a country where a substantial portion of the population live in abject poverty, the sums expended on political campaigning is staggering. The prize, however, is lucrative:  command of discretionary funds, government perks, and the ability to influence legislation and appropriations favorable to congressmen, their families and business associates.

 

The chief tool of personal aggrandizement at the legislator's disposal is the aptly named pork barrel. A term gleaned from the American occupiers, "pork barrel" dates back to the United States's antebellum period when masters gave African slaves salted pork stored away in barrels. Like congressmen in America, Filipino legislators mob the pork barrel to secure government appropriations for pet projects.

 

Marcos actually abolished the pork barrel when he disbanded congress and imposed martial law in 1972. Not until a few years after the strongman stepped down did the personal legislative allotments resume and incrementally grow in value from 1990 onward. At present, senators and representatives receive an average pork barrel (officially referred to as the Priority Development Assistance Fund) of $3.7m and $1.2m, respectively.

 

Nominally earmarked for development projects (roads, schools, hospitals, etc.) of their choice, legislators do deliver the goods to their constituents, although not before enriching themselves. Former Finance Secretary Salvador Enriquez reckoned that up to 45% of the pork barrel is actually lost to so-called commissions, kickbacks or rebates. The stories of Filipino firms that have won pork barrel contracts illustrate the pervasive corruption.

 

Neophytes quickly learn that representatives are less interested in the sales pitch than the percentage cut in the transaction they will receive. A 40 to 50 percent rebate is an acceptable sum on anything from school supplies to medicines. Payments, made in cash, are usually transferred to the legislator or a designated third party at restaurants, hotels or homes. Despite the hefty discount incurred, contractors can frequently muster a marginal profit by skimping on materials, using inferior substitutes and doing a shoddy job.

 

Besides retaining considerable sway over the disbursement of government money to the legislative branch, the Philippine presidency commands its own pork barrel. Dwarfing the senators' discretionary allotment by five-fold, the executive's $18.2m allotment is evenly split between a  "social fund" and "intelligence fund." Although GMA has managed to keep her hands clean, her predecessor, Joseph Estrada, was impeached (but not convicted) and later ousted from office for accepting kickbacks in an illicit gambling ring and Marcos was thought to have pilfered millions.

 

In the same vein the civil service is bloated and inefficient; government expenditures on operating expenses and salaries constitute half the budget. Not only are Filipinos compelled to surrender their property to fund the country's bureaucracy, they receive shoddy public services from inept, indebted, and monopolistic state enterprises and government contractors as recompense, not before their "honorable representatives" lop off a portion of the tax receipts for themselves.

 

 

Dial "A" for austerity

 

How then is the Philippine government going to avert a looming fiscal crisis, which has been mounting for years? Of course, taxpayers will have to principally atone for the enormous debts run up by bureaucrats, legislators and managers of GOCCs.

 

"We are already in the midst of a fiscal crisis and we have to face it squarely wielding our courage, resourcefulness and solidarity as a nation of a people," said GMA when she laid bare the gravity of the situation on August 23, indicating that yet again the government would externalize its mistakes on the populace at large.

 

The federal government's medium term fiscal plan is designed to obtain solvency over the next six years. It plans to exact revenue (projected take) by implementing a two-step increase in the VAT rate ($362m); tax on telecommunications franchises ($91m); adoption of gross income taxation for corporate and self-employed payers ($305m), indexation of tobacco, alcohol, etc.  excises ($127.3m); augment excise on petroleum ($540m); rationalization of fiscal incentives ($91m) and a general tax amnesty. Failing legislative endorsement of these measures the executive has mooted reversing the 1997 income tax exemption granted to the country's 7m citizens working abroad.

 

Others have pointed out that the best performing (and lightly taxed) sectors of the economy—exports and agriculture—deserve to assume a greater share of the burden. Shame on these people who do not appreciate the connection between low taxes and high growth.  

 

The taxmen have been encouraged to vigorously collect all unpaid interest income withholdings that banks have declined to surrender. The ongoing professionalization of the tax bureaucracy will continue, albeit marred by imbedded corruption in the BIR. Recently some staff refused to collect taxes when one of their superiors tried to proscribe bribery in the ranks.

 

Moreover, public service user fees—specifically the electricity rate charged by Napocor—will climb. From 26 September onward, the price per kilowatt-hour will provisionally rise by 40%. Not only are Filipinos already forced to defray the debts of this tax-consuming monstrosity, but now are also compelled to devote a higher share of their income to the dismal services provided by this monopolistic entity.

 

Coupled with its proposals to coercively seize legitimately held property, the Philippine government has plans in the works to employ its stolen goods more efficiently. Administrative changes are to be implemented, requiring cost cutting in the bureaucracy on utilities, travel, supplies, etc. Superfluous offices are to be junked or consolidated and a voluntary trimming of the public payroll is in the works. GOCC creation—an oft-abused presidential prerogative—is to be frozen indefinitely and the 2005 budget proposal envisages reducing pork barrel allocations by 40%; the government is even preparing to privatize Napocor.

 

Furthermore, the executive is seeking to pass a fiscal responsibility bill, which will impose a debt cap on government borrowing and prohibit new spending without new taxes. Finally, the president will seek legislative authority to revamp executive departments and agencies as well as GOCCs. There is talk of limiting Internal Revenue Allotments (tax revenue transfers) to local governments by as much as 25% ($2.64bn) keeping that money in the federal government's accounts.

 

Taken together, the government's revenue and expenditure proposals promise by 2010 to balance the budget, increase the tax take, and reduce the public sector debt burden substantially.

 

 

Fuzzy math

 

Despite these ambitious measures, it remains to be seen if the supposedly radical rationalization measures evolve into something more than cosmetic reshuffling. Quite obviously the second element of the fiscal responsibility law is dreadful; the government's ability to tax and spend is at the root of the debt problem.

 

In the meantime, the government's projected 2005 budget of 907.6bn pesos ($16.5bn)—including $2.45bn in subsidies—is 5.3% higher than the previous year. Somehow an additional $2bn request for unspecified items and cash deficit has been left off the tender. Even GMA's promise to slash travel expenses fail to hold water, as the budget provides an extra $13.3m for this purpose.

 

Equally mysterious, the $6.26bn of principal payments due in 2005 has been left out of the proposal, which when added would allow the budget total to exceed the 1 trillion peso threshold for the first time ever. One of Asia's most spendthrift states owes $11.81bn in interest and principal repayments next year, an 81% increase since 2002[vi]. The budget deficit is projected to be another $9.31bn,  financed by domestic borrowing. Moreover, the current presidential administration—which in only three years was able to borrow more than its two most recent predecessors managed to do over a span of eight years—is preparing to spend more than it pilfers from the populace for the next four years, prompting it to amass further debt.

 

As appealing as the moratorium on GOCCs and the vague promise to limit government guarantees to these firms may be, it does not adequately address the chief culprit of the Philippines' gaping fiscal deficit and substantial debt: the GOCCs themselves. Records from the country's budget department indicate that state corporations are collectively expected to register at least a $2.4bn loss during Fiscal year 2004. Blithely ignoring their financial drain on the country, many top GOCC administrators have awarded themselves lavish pay packets and discretionary funds (by Philippine standards) and then asked the government for subsidies and bailouts.

 

In the case of Napocor, the 40% provisional rate increase, with another unspecified rise scheduled in another 6 months, will merely serve to help it pay off interest payments amounting to more than $1bn over the next year. A clutch of company executives were recently paid $218m in retirement and severance pay and then subsequently rehired with a higher salary. After a bout of obfuscation by Napocor's management a government audit of the firm's books in 2003 discovered $2.55bn of accounting irregularities. Quite rightly, the Senate's Ways and Means Committee has deplored the systematic waste at the power provider.

 

Indeed, Napocor's $2.06bn loss in 2003 far exceeds the $618m per annum (before the 40% reduction in pork barrel) spent on corruption-riddled congressional pork barrel and the legislature's budget. Before Napocor is privatized Philippine taxpayers are poised to assume $9.1bn of its debts.

 

Perhaps a more politically palatable and positively outlandish method of plugging the budget gap would be a plan floated by President Arroyo in early 2003. She claimed that more than $18bn-worth of gold rests within the island of Mindanao's Mount Diwalwal. The Japanese occupation forces during the Second World War are reputed to have left behind buried treasures all over the country, which have enticed several Filipino presidents (along with Thai and Indonesian authorities in their own countries) to launch abortive, Indiana Jones-like searches for the missing caches. Indeed, Estrada had the garden of a presidential residence overturned in search of loot[vii].  

 

Debt repudiation, not service

 

The aforementioned UP Economists reckon a debt crisis cannot be avoided for more than three years and that action must be taken within the next year to assuage financial markets. In April 2003, Standard & Poor's S&P lowered the Philippines long-term foreign currency rating (BB+ to BB), followed by Fitch in June 2003 and Moody's (Ba2 to Ba1) in January 2004. On September 8, S&P critisized the Philippine government's willingness to enact reforms and admonished authorities to reverse its negative fiscal trajectory in a fundamental and sustainable manner, lest it court an increasingly onerous debt burden.  

 

Rather than comparing Manila's plight to that of Argentina, which defaulted on its sovereign debts in late 2001, one need look no further than the crunch and contraction that the Philippines suffered between 1983 and 1984.  Spearheaded by the licentiousness of GOCCs and abetted by brisk petroleum price rises, the rapid accumulation of government debt during the late 1970s and early 1980s prompted the Marcos regime to default on its foreign obligations in 1983. An acute peso depreciation ensued, and the country plunged into economic and political turmoil for the rest of the decade.

On the heels of GMA's national announcement of impending fiscal difficulties, her subordinates quickly assured international capital markets that debt service would not be interrupted. They stressed that the definition of "fiscal crisis," as accepted by the IMF and credit agencies, is a situation that occurs only when: a country is in default, its deficit is unsustainable and the country does not have access to capital markets. S&P cautioned Philippine authorities that the recent 40% increase and future rise in Napocor's power rate would not save the company, much less the country, and urged authorities to introduce additional tax measures and enhance collection.

 

The S&P's advice indicates a proper method to resolve the Philippines debt situation, albeit not in the manner the rating agency advocates. Instead of devoting more of their income to Manila's debt problem, the Filipinos should press the government to repudiate all outstanding obligations to multilateral and private lenders alike.

 

To the casual observer this suggestion is anathema for it violates the sanctity of contracts.  However, as Murray Rothbard[viii] correctly explained, there is a fundamental distinction between private and public debt.

 

In the former case, where a low-time preference creditor lends money to a high-time preference borrower in exchange for repayment plus interest, to repudiate one's debts is tantamount to depriving the lender of his property, which is indefensible. In regard to public debt, governments do not pledge their own assets, but taxpayers' instead, with creditors cognizant that the principle and interest will be paid through the involuntary confiscation of private property—taxation.  In effect, both sides are complicit in the violation of property rights of a third party in the future, which scarcely deserves to be acknowledged as a contract.

 

Beyond the dodgy status of sovereign borrowing, debt repudiation is beneficial in that it immediately alleviates the citizenry of onerous repayments on obligations issued by present and previous governments. Politicians, bureaucrats, and their constituencies that receive succor at the public trough parasitically exist at the expense of productive tax-paying members of society.  Why should the latter be made to pay for the former group's livelihood, much less its mistakes?

 

More importantly, by denying the Philippine government credit, as lenders are wont to do, the state will be compelled to operate within the confines of a balanced budget, certainly an unorthodox but necessary development.

 

Undoubtedly, the Philippine economy will be buffeted by a severe downturn as the country's private sector incurs the wrath of international capital markets.  However, when the citizenry is relieved of massive tax-funded repayments on these obligations and no longer saddled with a credit-worthy government, foreign lending will return to invest in promising private enterprises.  Likewise, indigenous capital formation can emerge as the profligate public sector is reined in.  Fortunately, the estimated $7bn in annual remittances from Filipino workers abroad can serve as seed money for productive investments.

With respect to private creditors, as shameful as the blatant deprivation of the funds loaned to the Philippines may be, such arrangements clearly infringe third-party property rights and are an affront to liberty.  As Rothbard suggested, a government mulling unilateral cancellation of its debts could at least partially allay creditor contempt by selling state assets and channeling the receipts to servicing its obligations. Auctioning off ill-gotten properties would divest the government of its coercion-acquired and maintained ascendancy.

 

Hopefully, debt repudiation by the Philippines would serve notice to prospective lenders that states, the only entity in society besides criminals that exist at the expense of others, are parasitic and wasteful consumers of capital undeserving of investment.

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-Grant M.  Nülle is a Research Fellow with the Ludwig von Mises Institute. Contact him at grantn007@yahoo.com . Post comments on the blog.


[i]De Dios, Emmanuel S., et al. "The Deepening Crisis:  The Real Score on Deficits and the Public Debt." University of the Philippines.

[ii] Milo, Melanie. "Contagion Effects of the Asian Crisis, Policy Responses and Their Social Implications."  Philippine Institute for Development Studies. Discussion Paper Series No. 99-32. Dec. 1999.

[iii]"Past and Present Administrations Responsible for State-owned Power Firm's Heavy Loss."  Freedom from Debt Coalition. 4 May 2004. 

[iv]Democracy as Showbiz."  The Economist. 9 July 2004.

[v]Rothbard, Murray N.  Power and Market.  1970: 120–21. 

[vi] "RP's 'Real' Debt Service Not Indicated in 2005 Budget."  Manila Times.  28 August 04.

[vii] "All That Glisters..." The Economist. 16 January 2003.

[viii]Rothbard, Murray N. "Repudiating the National Debt."  Mises.org. 16 Jan. 2004.

 


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