This Policy Memo was submitted to the Harvard Kennedy School as part of the author’s final requirement in his API 121 Recession, Growth and Macroeconomic Policy course under Professor Karen Dynan.
While contractionary monetary policy seems to be the preferred method of controlling inflation, a cyclical slowdown in economic growth to avoid recession (or what economists refer to as ‘soft landing’) is hard to pull off. Thus, fiscal policy tools are recommended to ease the task of monetary policy (i.e., increasing interest rates) in reducing inflation. This is owing to the fact that high inflation tends to worsen inequality and poverty because it hits income and savings harder for the poor and low-income earners.
According to the Philippine Statistics Authority (PSA), our Gross Domestic Product (GDP) posted a growth of 7.6 percent in the third quarter of 2022. In spite of the 14-year high inflation of 7.7 percent in October 2022 (See Figure 1), our economy continues to expand. Household consumption, which represents more than 70 percent of GDP, remains robust and gross capital formation by businesses continues to rise rapidly .
High inflation for food and non-alcoholic beverages, at 9.4 percent, contributed to the strong October inflation reading. Price growth was also very rapid for housing, water, electricity, gas and other fuels, with a 7.4 percent increase.
Following the US Federal Reserve’s (Fed) aggressive stance against high inflation, the BSP further increased its policy rate from 5 to 5.5 percent making the cost of borrowing in the Philippines more expensive. The BSP is now targeting inflation of 5.8 percent in 2022 and 4.3 percent in 2023. Prior to the expected policy rate increase in December to 5.5 percent, BSP Governor Felipe Medalla already offered forward guidance, saying the BSP would prefer to match any rate increase by the Fed to maintain a 100 basis points differential between the BSP interest rate and the Fed’s policy rate.
With the November annual inflation surging to 8 percent, both fiscal and monetary policies may be needed to temper the increasing prices of food, electricity and agricultural products. In many emerging markets and developing countries (EMDC), fiscal restraint can lower inflation while reducing debt.
Supply shocks like high fuel prices, natural disasters, Russia-Ukraine conflict and the continuing impact of COVID-19, among other factors, can disrupt supply chains and production, resulting in lower productivity and higher costs. Initial data shows that these supply shocks may be causing the ‘cost-push’ inflation and that contractionary monetary policy may not be enough to temper it—notwithstanding the responsive policy rate adjustments made by BSP, inflation has continued to rise.
In view of this, the following fiscal policy tools are recommended to the Philippine government through the Department of Finance with the aim of easing the hardship brought by high inflation especially to the poor and low-income earners: (1) increasing excise taxes on non-essential goods, (2) imposing corporate income tax to non-resident foreign tech giants, (3) improving tax collections through digitalization, (4) cut government spending, and (5) other government interventions.
While increasing taxes may be politically challenging, Congress can enact law to increase taxes on non-essential goods like luxury cars, alcoholic drinks, cigarettes including vapes which are not considered basic commodities. Revisiting the Tax Reform for Acceleration and Inclusion (TRAIN) law to further increase excise tax on luxury cars from 60 to 200 percent will generate more revenues from the top 10 percent of households in terms of income as this is a highly progressive tax. There may be an initial slowdown in the sales of cars, alcohol and cigarettes but it will quickly recover as it did in the past once the inflation is brought back down to healthy levels .
Imposing corporate income tax
Congress is presently considering the imposition of the 12 percent value added tax (VAT) on digital services, expecting that it will generate an estimate of P19 billion in revenues or less than 0.1 percent of GDP. Instead of doing that, however, imposing income tax or digital service tax to non-resident foreign tech giants and digital transactions including cryptocurrency may yield higher revenues without burdening the low-income earners. How it will be collected may still be a question but it’s worth pursuing rather than simply imposing a 12 percent value added tax on digital services which will burden local consumers.
Improving tax collections
Revenue collections from audit and investigation contribute less than 2 percent of the total tax collections. The government must prioritize full digitalization of the Bureau of Internal Revenue (BIR) so they can catch up with the fast paced development in the eCommerce and digital economy. This will require at least an additional 10 percent of their P11.12 billion FY 2022 budget and reallocation of Personnel Services which comprised 72 percent of its total budget. This can be used to fund full digitalization and hiring of software engineers, developers and data analysts to support its new IT infrastructure.
Implementing a general tax amnesty and lifting of bank secrecy law will also generate more revenues without relying on regular audit and investigation. This will equip the BIR to run after big time tax evaders since they can no longer hide behind bank secrecy law However, both legislations will require more political will from the President to make it a priority bill of his administration.
A risk-based audit will also generate more tax collections than random audit. Using data analytics and industry benchmarking, the BIR can allocate their resources in auditing high risk industries and taxpayers especially large corporations which contribute more than 60 percent of the total tax collections.
Cut government spending
While checks and balances are in place, the government must cut spending and address loopholes in budget allocation and procurement issues that led to an average of P1 trillion unused and misused/abused annual budget from 2010-2020. Rationalization of government budget to cut unnecessary spending of other agencies while providing targeted subsidy and financial support to farmers and fisher folks must be prioritized to increase domestic productivity which will reduce prices and importation of agricultural products.
Transparency and accountability must be upheld given the approved P5.268 trillion budget for 2023 and increasing debt at P13.5 trillion as of November 2022.
Other government interventions
While subsidies are helpful, it is high time to revisit the Oil Deregulation Law in order to give the government the power to intervene when there is a prolonged increase of oil prices.
Addressing high inflation requires a whole government approach. It requires fiscal consolidation through budget rationalization and more tax revenues. While BSP uses monetary policy to temper inflation with the least possible job loss, the government must exercise fiscal restraint to lower inflationary pressures:
First, lower government deficits and debts. Rationalizing government budget will not only cut unnecessary spending but also reduce budget deficit. Private-Public Partnership may also be helpful in funding infrastructure projects to avoid incurring more foreign debts.
Finally, increase revenue efforts through tax policy and administration reforms. Increasing excise tax on non-essential goods will serve as revenue and health measures while imposing corporate income tax or digital service tax on non-resident foreign tech giants will generate more collections from the digital economy.
Fiscal consolidation aimed at taxes and spending that help the rich can help reduce inflation. There could be trade-offs in terms of jobs to a slower economy but inflation is already hurting the poor and vulnerable. Thus, keeping targeted subsidy will help ease their hardships while the government continue to address high inflation.
Originally Published in BusinessWorld.