Has the E-VAT Law Been Beneficial to the Philippines?

Looking back on 2005, one remembers the financial turmoil the nation was beset with. The average Juan de la Cruz may have read the news reports on the trillions of pesos - or dollars - worth of government debt. There were even estimates on how much one Filipino owes indirectly as a citizen of the country. Credit ratings were downgraded with outlooks, at one point, negative. Two words: Debt Spiral. One word: headache.

But what has happened since? Has the government paid off its debts already? How much do we still owe?

In 2008, then President Gloria Macapagal Arroyo said that the EVAT was one of her “hard choices" in 2005 but she faced with the need to raise government revenues. The Philippine EVAT was able to raise between P80 billion to P100 billion in revenues annually and Arroyo said that the revenue "saved" the country. Image source: Getty Images through www.independent.co.uk. Statement source: GMA News Network website.

Remembering 2005 is not complete without the controversial E-VAT Law where the VAT's coverage was not only broadened, an additional 20% was also added to the tax rate.

The E-VAT Law was so unpopular, its proponent, Senator Ralph Recto, lost in the succeeding elections of 2007. But the government had seen this as the "silver bullet" to the country's worsening financial crisis. It was the solution they crafted to curb the seemingly uncontrollable rise in government debts.

This article gives an answer to the very intriguing question framed by the title --- has the E-VAT Law been beneficial to the Philippines?

Outstanding Debt still rising but Debt-to-GDP ratio at all-time low

One of the pursuits of E-VAT Law was to pay off government's debts. We therefore need to look at the nation's outstanding debt to see if this objective was indeed carried through.

Data culled from the Bureau of Treasury shows that the outstanding debt is still rising. It is at an all-time high of 7.29 trillion pesos by the end of 2018. 

Nevertheless, the same data readily shows a decrease from 2005's 3.89 trillion pesos to 2007's 3.71 trillion pesos, the years immediately following the E-VAT's enactment.

In order to see if the government's objectives were satisfied, the relevant data were the years 2005 to 2007, and, in here, we can clearly see a decrease in the government outstanding debt, showing that, indeed, portions of our debts were paid off.

Perhaps, even more telling are the debts-to-GDP ratio through the years, which, according to economists, are a better measure in gauging the country's ability to pay its debts. A high ratio means a country isn't producing enough to pay off its debts. A low ratio means there is plenty of economic output to make the payments. (To understand the debt-to-GDP ratio better, read more from this article, "Debt-to-GDP Ratio, Its Formula, and How to Use It")

The debt-to-GDP ratio of the Philippines has reached an all-time high of 74.4% in 2004, the year before the E-VAT Law was enacted, but went down continuously since. By the end of 2018, it has gone down to the historic low of only 41.9%.

The most remarkable portion of the nation's debt-to-GDP ratio is, again, the years immediately following E-VAT's enactment, 2005 to 2007. In 2005, it fell to 68.5% before sliding down to 61.4% in 2006 and further dropping to 53.9% in 2007.

Today, we are at a comfortable stage where our government has a strong ability to pay off its debts despite the fact that the figures are still rising. It is therefore not so shocking anymore why we just received another credit rating upgrade from Standard & Poor's last April 2019 to BBB+.

However, this begs the question: was the E-VAT the reason for the strengthening of our nation's ability to pay off its debts? 

We must remember that E-VAT was not the only tax reform of 2005. One remembers that the corporate income tax rate was also increased from 32% to 35% effective July 1, 2005 and was automatically decreased to 30% on January 1, 2009.

Solely attributing the decrease in debt-to-GDP ratio to the E-VAT may not be so precise considering that another tax reform was put into place in the very same year, or to be more specific, in the very same law, RA 9337.

The effectiveness of E-VAT and the Corporate Income Tax Rate of 35%

To determine the E-VAT's effectiveness or if it has substantially contributed to the nation's coffers, one needs to take a look at the revenue collections. The better gauge, it seems however, are the tax efforts.

The tax effort is the ratio of revenue collections to GDP. It is necessary to take a look at this ratio because economic growth surely affects tax collections, i.e., a stronger economy may bring in higher revenues for the government.

Data culled from the DOF shows that sales tax effort (sales taxes include VAT) has increased from 2.1% to 2.9% in 2006 but slid to 2.7% in 2007 before further dropping to 2.3% in 2008. The sales tax efforts for the succeeding years played along the 2.4% to 2.7% levels or higher than 2005's record of 2.1%.

Meanwhile, the income tax effort similarly increased from 5.4% in 2004 to 5.7% in 2005 to 6.0% in 2006. But unlike the sales tax effort, the income tax effort continued to rise to 6.2% in 2007 and was sustained at the same level in 2008.

The income tax effort slid to 5.4% in 2009 but this is understandable considering that the corporate income tax rate was decreased to 30% effective that year. It is notable, however, that, over time, the income tax effort eventually grew to 6.2% in the years 2013 and 2014 despite the decrease in corporate income tax rate.

These figures show that collections for VAT translated to higher revenues indeed but they also exhibit that adjustments in corporate income tax rates actually played a stronger role.

Cost-cutting Measures

The tax reforms of 2005 played crucial roles in bringing down our nation's debt-to-GDP ratios but they're not the only driving factors.

Some time in 2004, then President Gloria Macapagal-Arroyo issued Administrative Order No. 103, ordering government agencies and similar entities to adopt a set of austerity measures.

Incidentally, the expenditures-to-GDP ratio has fallen from 18.5% in 2003 to 17.5% in 2004. By the year 2008, this has fallen further to 16.5%, or a whopping 2.3 percentage points lower than the historic high of 2002's 18.8%.

The same data from DOF shows that the said ratio maintained similar levels in subsequent years but was, in fact, as low as 15.7% in 2014.

Considering the more drastic decreases in expenditure levels, the cost-cutting measures were therefore even more effective than the tax reforms of 2005 in curtailing the country's so-called debt spiral.

Nevertheless, expenditures are not necessarily bad for the country. They drive the economy to greater heights and are, in fact, included in computing the nation's GDP. Adopting austerity measures must not be used in ways adverse to the nation's well-being for, when expenditures are too low, the tax collection's purpose of raising funds to serve the needs of the constituents is defeated.

Hence, austerity measures must be coupled with revenue-raising policies to help buoy the nation's financial positions to comfortable levels in a way that will avoid compromising the welfare and needs of the people.

Summary

In conclusion, the E-VAT was indeed beneficial to the country for it contributed to the continuous reduction of the nation's debt-to-GDP ratio. However, it was not the only contributing factor to this development, and the stronger factors, as shown above, were evidently the adjustments to corporate income tax rates and the adoption of austerity measures.

Since the debt-to-GDP ratio has reached the all-time low of only 41.9% in 2018, the E-VAT's purpose was already served. It is perhaps about time to reconsider its coverage and rate. Some commodities should now be excluded from its coverage and the rate may now be brought back to 10%.

Sources

1. Statistical Data from DOF website. Link: https://www.dof.gov.ph/index.php/data/statistics-bulletin/

2. Data from the Bureau of Treasury taken from Rappler's site.