Cablegate: Proposed 2006 Budget: A Taxing Proposition

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 06 MANILA 004528

SIPDIS

STATE FOR EAP/PMBS, EAP/EP, EB/IFD

STATE ALSO PASS EXIM, OPIC, AND USTR

STATE ALSO PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE

TREASURY FOR OASIA

USDOC FOR 4430/ITA/MAC/ASIA & PAC/KOREA & SE ASIA/ASEAN

Sensitive

E.O. 12958: N/A
TAGS: EFIN ECON EINV PGOV RP
SUBJECT: Proposed 2006 Budget: A Taxing Proposition

Refs: A) 04 Manila 4545, B) Manila 4112

Sensitive But Unclassified

1. (SBU) Summary: President Arroyo's proposed 2006
budget call for a 30 percent increase in funds for
infrastructure, health, and education while continuing to
reduce the budget deficit for a fourth consecutive year.
The 1.05-trillion peso ($18.8 billion) budget proposal
represents 7.5% year-on-year growth in real terms and to
4.1% growth with respect to real per capita spending.
The GRP hopes to reduce its budget deficit by 30.6% to
125 billion pesos (2.1% of GDP) this year and as it moves
to eliminate the deficit by 2008. Although non-
discretionary budget items (government salaries and
benefits, legally-mandated transfers to local government
units, and debt servicing) will consume the bulk of the
proposed budget. The 2006 proposal relies heavily on
more than 80 billion pesos ($1.46 billion) in incremental
revenues from the legislated, but yet to be implemented,
amended Expanded Value Added Tax law. With public
resistance to new and higher taxes reinforced by
political challenges, improvements in tax collection
efficiency and anti-corruption efforts will be
increasingly critical to restoring longer-term fiscal
stability. End Summary.

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PRESIDENT ARROYO SUBMITS 2006 BUDGET PLAN
-----------------------------------------

2. (U) On August 24, President Gloria Macapagal-Arroyo
submitted to the Philippine Congress a proposed 1.05
trillion pesos ($18.8 billion) obligation budget for the
National Government for calendar year 2006, a 14.7%
(134.7 billion pesos) nominal increase from 2005. The
2006 budget proposal translates to 7% growth in real
terms after factoring in the Government's 7.5% inflation
forecast and to 4.1% real per capita growth after
factoring in the Philippines 2.4% annual population
growth rate. It is more expansionary than 2005's tight
budget program (Ref A), which provides for a nominal
expansion of less than 6% (51.6 billion pesos) and
translates to a 2% contraction after inflation and to a
4.1% decline in real per capita terms.

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BATS FOR HIGHER NON-DISCRETIONARY BUT ESSENTIAL SPENDING
--------------------------------------------- -----------

3. (U) We estimate the non-discretionary portion of the
2006 budget proposal -- i.e., the sum of government
personnel expenses, legally mandated transfers to local
government units (LGUs), and debt-service payments -- to
expand by 11% (82.8 billion pesos) in 2006, from about
9.7% (66.5 billion pesos) in 2005, and to account for
more than 60% of 2006's overall budget increase. Nearly
half (41.3 billion pesos) of the envisioned year-on-year
expansion for non-discretionary expenditures reflects
higher outlays for personnel salaries and benefits,
including a pay hike for Government workers for the first
time in four years. The higher personnel budget also
includes an estimated 10 billion pesos for
separation/retirement benefits to fund Government efforts
to rationalize the bureaucracy.

4. (U) An estimated 8.5% (26.6 billion pesos) increase
in interest payments and 9.8% (14.9 billion pesos)
expansion in legally mandated revenue transfers to LGUs
would account for 29.9% and 16.7%, respectively, of the
overall year-on-year increase for non-discretionary
spending. (Note: Aggregate budget levels include
interest payments only. Principal payments are treated
as part of the financing program. From 12% in 2005, the
Government estimates total principal and interest
payments to increase by a slower rate of 7.1% to 721.7
billion pesos. End Note.) Both the 2005 and 2006
budgets include 18 billion pesos in additional interest
payments to service 200 billion pesos in debts assumed by
the National Government from the National Power
Corporation in December 2004, as provided under the
Electric Power Industry Reform Act of 2001. The assumed
NPC debts will also add an estimated 35 billion pesos to
principal payments falling due next year.

5. (U) Non-discretionary budget items will still consume
the bulk (about 79.5%) of the 2006 budget plan, although
a somewhat smaller share than in 2005 (81.4%). However,
the Government hopes that a larger budget would allow it
to hike spending for non-discretionary but essential
expenditure items by over 30% (52 billion pesos),
following an 8.3% (14.9 billion pesos) contraction this
year. This includes a planned 38% (21.8 billion pesos)
expansion for infrastructure (following a 2.4% decline in
2005) and 19.7% (17 billion pesos) increase for
maintenance and other operating expenses.

--------------------------------------------- ------------
Proposed 2006 Obligation Budget By Type of Expense
--------------------------------------------- ------------
Growth
Billion Pesos (%) % Share
2005 2006 2005 2006 2005 2006
Program Proposal

Total 918.6 1,053.3 6.0 14.7 100.0 100.0

Non-Discretionary
Expenditures a/ 754.2 837.0 9.7 11.0 82.1 79.5
Personnel 289.2 320.5 1.2 14.3 31.5 31.4
Allotment
to LGUs b/ 151.6 166.5 7.5 9.8 16.5 15.8
Debt Serv. c/ 313.4 340.0 11.6 8.5 34.1 31.7

Discretionary
Expenditures a/ 164.4 216.3 -8.3 31.6 17.9 20.5
Maintenance
& Operating 86.5 103.5 7.7 19.7 9.4 9.8
Support to
Gov't Firms d/ 11.6 14.2 -47.0 22.4 1.3 1.2
Infrastructure 57.2 79.0 -2.4 38.1 6.2 7.5

a/ Embassy estimates from available GRP statistics
b/ Internal revenue allotments mandated under the Local
Government Code
c/ Interest payments; principal payments are treated as
part of the financing program
d/ Subsidies, equity contributions, and net lending to
government-owned and controlled corporations
--------------------------------------------- ------------
Source of Basic Data: Dept. of Budget and Management

6. (U) Net of interest payments and revenue transfers to
LGUs, a sectoral breakdown of the 2006 budget proposal
envisions expenditure hikes mainly for communications,
roads and transport networks; health care delivery;
education and manpower development; defense and peace and
order; and social security and employment (which includes
the 10 billion pesos targeted next year for personnel
rationalization efforts, para 3). Spending for most of
these sectors either declined or barely expanded under
the 2005 expenditure program.
--------------------------------------------- ------------
Proposed 2006 Obligation Budget By Type of Allocation
--------------------------------------------- ------------
Growth
Billion Pesos (%) % Share
2005 2006 2005 2006 2005 2006
Program Proposal

Total 918.6 1,053.3 6.0 14.7 100.0 100.0

Economic Serv. a/ 104.9 138.9 -11.7 32.4 11.4 13.2
Agriculture &
Agrarian Ref. 25.9 27.5 -9.1 6.2 2.8 2.6
Communication,
Roads, Transport 53.8 71.8 -19.3 33.5 5.9 6.8
Social Serv. a/ 198.2 232.3 -4.5 17.2 21.6 22.1
Education &
Manpower Devt 135.4 146.4 5.1 8.1 14.7 13.9
Health 12.9 13.7 -11.0 6.2 1.4 1.3
Soc. Security
& Employment 40.1 58.6 -10.5 46.1 4.4 5.6
Defense 44.2 52.4 3.5 18.6 4.8 5.0
Gen. Pub. Serv. a/ 99.4 114.9 -0.4 15.6 10.8 10.9
Gen. Admin 41.3 48.4 -9.5 17.2 4.5 4.6
Public Order
& Safety 54.4 60.5 2.1 11.2 5.9 5.7
Net Lending b/ 6.9 8.3 21.1 20.3 0.8 0.8
Allotment to LGUs 151.6 166.5 7.5 9.8 16.5 15.8
Debt Service c/ 313.4 340.0 11.6 8.5 34.1 32.3

a/ Net of legally-mandated internal revenue allotments to
LGUs
b/ Net advances to government-owned or controlled firms
(mainly to service loan obligations)
c/ Interest payments; principal payments are treated as
part of the financing program
--------------------------------------------- ------------
Source of Basic Data: Dept. of Budget and Management

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SMALLER FISCAL DEFICIT DESPITE LARGER BUDGET
--------------------------------------------

7. (U) Despite a more expansionary budget, the National
Government is targeting a fourth consecutive year of
declining fiscal deficits. For 2006, the goal is to
narrow the National Government's budget gap to 124.9
billion pesos (2.1% of GDP), from the 197.8-billion peso
(3.4% of GDP) deficit ceiling programmed for 2005. The
Government hopes to expand revenue collections by 23.7%
(185.4 billion pesos) year-on-year, nearly double the 12%
revenue growth rate targeted for 2005. Over 90% of the
targeted revenue increase reflects a 23.8% (168.1 billion
pesos) growth in tax collections. The envisioned 14.6%
tax-to-GDP ratio in the 2006 fiscal program represents an
improvement from 2005's 13.3% goal, although it remains
short of the peak 17% tax-to-GDP ratio achieved in 1997.

--------------------------------------------- ------------
National Government Fiscal Program a/
--------------------------------------------- ------------

Billion Pesos Growth (%)
2004 2005 2006 2005 2006
Actual Program Proposal

REVENUES 699.8 783.2 968.6 11.9 23.7

Tax 598.0 706.2 874.3 18.1 23.8
As % of GDP 12.6% 13.3% 14.6%
Nontax 101.8 77.0 94.3 -24.4 22.5
DISBURSEMENTS a/ 886.8 963.2 1,093.5 8.6 13.5

SURPLUS/DEF - 187.1 -180.0 -124.9 -3.8 -30.6
As % of GDP -3.9% -3.4% -2.1%

a/ Cash basis (disbursements therefore differ from
obligation budget)
--------------------------------------------- ------------
Source: Department of Finance

8. (U) The budget/fiscal program discussed in this cable
refers to that of the National Government and focuses on
a subset of the Consolidated Public Sector Deficit
(CPSD). The consolidated deficit includes the finances
of government corporations, social security agencies and
local government units. The Government hopes to reduce
the consolidated public sector deficit (CPSD) -- which
peaked at 5.3% of GDP in 2003 -- from 3.4% of GDP in 2005
to 2.1% of GDP in 2006. This calls for a 29% (52.2
billion pesos) decline in the CPSD level. Narrowing the
deficit of the National Government will therefore be
crucial to significantly reducing the overall deficit of
the consolidated public sector.

-----------------------------------------
EVAT: ICING IN 2005 BUT CRITICAL IN 2006
-----------------------------------------

9. (U) The Government did not impute incremental
revenues from the amended Expanded Value Added Tax (EVAT)
law in the 2005 budget. This centerpiece revenue-raising
legislation was not implemented as scheduled on July 1
due to legal challenges filed before the Supreme Court.
However, implementation becomes critical in 2006, with 83
billion pesos in full-year incremental revenues estimated
in the 2006 fiscal program. That amount would represent
about 1.4% of 2006 GDP, without which there would be no
improvement in the tax-to-GDP ratio; 9.5% of total 2006
tax revenues; about half of the targeted year-on-year
expansion in tax collections; and nearly 64% of the
envisioned expansion in cash disbursements. With EVAT,
the National Government hopes to balance the budget by
2008, two years ahead of the original target. (Note:
The Philippine Supreme Court recently upheld the legality
of the amended EVAT law in a decision issued on September
1. However, the Court has yet to lift its Temporary
Restraining Order and provided a fifteen-day waiting
period before the decision becomes final - Ref B. There
could be further delay if petitioners file a motion for
reconsideration within that fifteen-day period. End
Note.)

10. (U) Implementing the EVAT law will also affect the
Government's goal of financing a larger budget while
keeping the fiscal deficit in check and tempering the
pace of debt accumulation. With the amended EVAT, the
National Government envisions that tax revenues will be
able to finance a larger 80% share of 2006 disbursements,
up from 73% during 2005. As a result, the GRP estimates
that it will need to borrow 7.8% (44.5 billion pesos)
less year-on-year from domestic and foreign capital
markets to plug the fiscal deficit and to service
principal payments on its debt obligations. It hopes to
reduce the ratio of the National Government's outstanding
debts to GDP to about 73% by the end of 2006 (from over
80% in 2004 and 79% in 2005) and to reduce this ratio
further to under 55% by the end of 2010. As it has done
in recent years, the National Government plans to tap the
larger share (i.e., 60%) of its 2006 borrowing program
from domestic capital markets in an effort to temper
foreign exchange risks arising from the significant share
(47% as of May 2005) of foreign-denominated obligations
in its loan portfolio.

--------------------------------------------- ------------
National Government Borrowing Program
--------------------------------------------- ------------

Billion Pesos Growth (%)
2004 2005 2006 2005 2006
Actual Program Proposal

Borrowings 583.3 576.4 531.6 -1.2 -7.8
Domestic 383.8 348.7 310.2 -9.1 -11.0
Foreign 199.5 222.7 221.4 11.6 -0.6
US$ (Bill.) 3.6 4.0 4.0 11.1 0.0

To Finance:
Budget Def. 187.1 180.0 124.9 -3.8 -3.6
Principal 340.8 360.7 381.7 5.8 5.8
Domestic 222.4 231.4 262.6 4.0 13.5
Foreign 118.4 129.3 119.1 9.2 -7.9
US$ (Bill.) 2.1 2.3 2.1 9.5 -8.7
Others a/ 55.4 35.7 25.0 -35.6 -30.0

a/ Mostly for cash buffer
--------------------------------------------- ------------
Source: Department of Budget and Management

11. (SBU) Implementation of the EVAT raises many
important questions about future fiscal health.
Increased spending on non-discretionary items will depend
largely on additional revenues that the GRP expects the
EVAT to generate. Estimates of 83 billion pesos from
EVAT in 2006 might be overly optimistic, and the 30
percent planned increase in infrastructure, education and
health care might never materialize.

12. (SBU) The debate continues within the GRP and in
Congress over EVAT exemptions for oil and electricity,
especially with prevailing high oil prices. If
exemptions for these items are maintained through the
first half of 2006, the GRP would have to reduce
discretionary spending by 20 billion pesos ($360 million)
or more in order to maintain fiscal balances.

13. (SBU) The GRP track record for revenue generation in
the first year of new taxes has been weak. Officials had
estimated that the sin taxes on alcohol and tobacco
products, for example, would improve revenues by about 10
billion pesos or more in 2005, but the latest data
indicate that these taxes generated no new revenues.
Major producers of low-price cigarettes front-loaded
production and sales prior to the imposition of these
taxes and employed other non-transparent methods to
circumvent the tax. Observers indicate that novel
methods could be used to circumvent the EVAT, especially
since the GRP has launched no new programs or
countermeasures to ensure compliance.

-------
COMMENT
-------

14. (U) The Government deserves credit for progress
made since 2003 to pass new tax measures (i.e.,
increasing excise taxes for tobacco and alcohol,
institutionalizing a system of rewards and penalties in
revenue collection agencies, and the amended EVAT),
prevent a further deterioration in the tax-to-GDP ratio,
and reduce the fiscal deficit. However, the GRP also
recognizes that squeezing expenditures is not a
sustainable long-term strategy and hopes to continue
narrowing the deficit while spending more on vital budget
items. Despite new tax measures and the more
expansionary budget envisioned for next year, more
resources are required for the Philippines to compete
effectively with neighboring economies for investments
and capital. Neighboring countries, for example, have
already been spending more heavily on infrastructure
relative to the barely 1.5% to GDP ratio of the National
Government and less than 2.5% to GDP ratio of the
consolidated public sector.

15. (SBU) Resistance to new and/or higher taxes is high
-- reflecting public perception of corruption, wastage,
and inefficiency -- and has increased further in the
midst of current economic and political challenges.
Despite recent improvements, the Philippines' tax-to-GDP
ratio remains among the lowest in East Asia and is likely
to come under increasing public scrutiny. Sustained
efforts to combat corruption and boost collection
efficiency, such as those outlined in the GRP's concept
paper for the Millennium Challenge Account Threshold
program, will be increasingly important to GRP efforts to
reduce deficits and address the debt problem while
improving the delivery of vital social and economic
services.

Johnson

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