Taxing your sins a few lessons from postMarcos

Taxing (y)our sins: a few lessons from post-Marcos tax reform episodes Professor Amado M. Mendoza, Jr. Department of Political Science University of the Philippines Diliman

Typical ‘taxable’ sins

Taxable sins II

Touch but do not tax!

May be tax free; not kotong-free

Taxation is contentious � Fiscal policy, on both its tax and expenditure sides, should be among the most controversial of policy issues. The fis calprocess…occupies the middle ground between anarchy and absolute rule. It provides the forum on which interest groups and ideologies may clash…and on which compromise and cooperation may be sought. The budget process can hardly be expected to function without error if only because it is cre ated by the same conflicting interests which it must reconcile (Musgrave 1981)

Tobacco farmers vs. increase of sin tax rates

Sumptuary, sin taxes � � Sumptuary shares the same root as the word "sumptuous, " which means rich and luxurious. Thus, a sumptuary tax is a levy on items of luxury, frequently the object of an addiction Sumptuary taxes have focused on products considered vices, such as alcohol and tobacco The more colloquial term "sin tax" has evolved for these taxes The term "luxury tax" is used for those high-end items characterized by an increase in demand as their price rises

Taxation is compromise The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing. --Jean Baptiste Colbert (attributed), c. 1665 French finance minister to King Louis XIV

Taxation as � Coercion: state forces citizens to pay for public goods and then some � Volition: voluntary payment for public goods

Rational behavior of economic actors � Avoid payment of taxes � Reduce � Free tax bite ride on public goods � Development pathologies � Tax of tax culture counters these compliance is function of the state’s strength and legitimacy

Taxation and provision of public goods: problems � Physical and temporal separation between payment of taxes and provision of public goods (hindi kaliwaan) � No assurance that taxes will be spent for public goods � No assurance that taxes will be spent efficiently � No assurance that taxes will not line private pockets

Private actors and public goods � Private enti ties can furnish publicgoods � Tax relief or a lower tax bite is a public good that can be supplied or obtained by an interest group for its constituents �A public official may be construed as a private actor when he actively works to provide public goods for private entities

‘Sultans of Sin’: Tan and Cojuangco

Post-Marcos sin taxation � Terms to remember ◦ Ad valorem tax: a percentage levy imposed on the monetary value (i. e. , the manufacturers’ price) of a product ◦ Specific tax: a monetary levy on the quantity (or specified unit) of the product

Comparison of taxes � Ad valorem tax is inflation-proof � Specific tax is simpler and easier to administer

Downside of taxes � Ad valorem tax induces price underdeclaration and transfer pricing � Specific tax remains constant even if prices go up; revenue collections supposedly suffer

Sin tax laws suited Lucio Tan since 1970 s � Fortune Tobacco Corporation (manufacturer of medium-priced domestic brands like Hope Luxury Menthols) Brewery Inc. (manufacturer of Beer na Beer, Colt 45, etc. ) � Asia

Competitors of Lucio Tan � La Suerte Cigar & Cigarette Company (manufacturer of Philip Morris and Marlboro cigarettes) � San Miguel Corporation (manufacturer of San Miguel Pale Pilsen beer)

Favoring Tan during martial law � PD 69 (Nov 1972): classified cigarettes if imported or not for tax purposes � PD 753 (July 1975): imposed 50% additional tax on cigarettes with foreign brands � EO 924 (Nov 1983): imported cigarettes taxed as same rate as most expensive locally produced brand � Tan’s Hope brand was introduced in 1975, became Fortune’s best-seller and beat Philip Morris for market leadership

Did anything change after Marcos’ ouster? 22 (July 1986): imposed an ad valorem tax on cigarettes and reintro duceda higher rate (65%) on imported cigarettes while domestically produced ciga rettes were taxed at 40% and 50%, depending on whether the cigarettes carry a foreign brand or not � EO � Economists argue that the promotion of domestic tobacco production is best done through tariff, not tax, measures

Hope trounces Philip Morris due to tax advantages

Response of Tan to EO 22 � Establishment of nine (9) marketing arms in August-September 1986 � Fortune under-declares manufacturer’s price � Fortune sells output to marketing arms � Marketing arms sell the products at retail prices that were many degrees removed from the declared tax base of Fortune � Marketing arms must also cheat on their value-added tax (VAT). They can avoid paying the VAT altogether

Advantage Tan 6956 (July 1990): The ad valorem rates were further increased on domestically-produced cigarettes bearing foreign brands, from 50% to 55% per pack; and for those bearing local brands, from 15% to 20% for low priced cigarettes and from 40% to 45% for higher-priced cigarettes � RA � With RA 6956, Tan’s cigarette products con tinued to enjoy a tax advantage vis-à-vis imported and locally produced cigarettes bearing foreign brands even if the rates were increased.

Still Advantage Tan � RA 7654 (June 1993): floor tax on low-priced cigarettes was removed � This category in cluded Champion Menthol Kings, one of the most popular brands of Fortune Tobacco � Senate and House bills were revised by pro. Tan solons like the members of the Northern Luzon Alliance and Senator Ernesto Maceda � Proponents of a tougher law were harassed

Cheating on brands � Hope and Champion are listed as foreign brands in respected industry directories � Tan simply added “luxury” and “international” to Hope and Champion and voila, they are local brands that must be taxed at a lower rate

GATT-WTO and sin taxation � Ratification of Uruguay treaty required nondiscrimination between imports, domestically -manufactured products with foreign trademarks, and domestic products with local brands � Uniform taxation for same products

Advantage sin ‘good’ producers: this is becoming monotonous! � RA 8240 (Nov 1996) ◦ Specific tax for cigarettes (four tiers) ◦ Tan’s Hope avoids classification in higher-priced tier ◦ Specific tax for beer ◦ No adjustment in tax rates since 1996 (16 years) ◦ “The classification of each brand of cigarettes based on its average net retail price as of October 1, 1996, as set forth in Annex D, shall remain in force until revised by Congress. ” ◦ Indexation of tax rates to inflation was dropped

Advantage Tan under Erap presidency

Advantage Lucio Tan � Erap praised Tan as the country’s model taxpayer � Erap reportedly told Tan to choose who’s going to head BIR � BIR lost truckloads of evidence in tax evasion case vs. Tan

� BIR Advantage Tan: I’m getting tired of this under Beethoven Rualo decided on two tax evasion charges against Tan firms that his predecessor had a hard time prosecuting because of the resistance within BIR � One 1987 tax assessment filed against Allied Bank for P 338 million was reduced to zero � Another cased filed in 1993 against Fortune Tobacco for nearly P 8 billion was shrunk to P 5 million.

GMA: Advantage sin products � GMA meets with key officials of SMC, Fortune & Philip Morris to facilitate passage of new sin tax measure � No indexation of sin tax rates � Specific tax rates were simply increased

Join Tan if you can’t beat Tan! � In 2010, Philip Morris went into a joint venture with Fortune to control 90% of market � Previously, PM batted for a single tax rate while Fortune was for 3 -4 tax tiers � The merged corporation now supports a multi -tier system � Aspiring entrant, British American Tobacco, is in favor a single tax rate

Lessons from sin taxation � Taxation is a political game involving players from government and the private sector � Consumers and CSOs are minor or even inconsequential players � Government � Competing is not a monolithic actor business firms will pursue different tax agendas

Players from government � President: generally focused on increasing revenues; cannot veto ‘bicam’ tax measure � Legislators look at tax reform process as opportunity to deliver ‘goods’ to financiers and other constituents � Members of the House more parochial on tax matters than Senators

Players from big business � Market competitors with different tax policy preferences � Strong market power/presence/leverage (e. g. campaign finance) � Widespread networks up to government bodies (legislatures, courts, etc. )

Post-Marcos sin tax legislation � Common pattern of adulteration, watering down, and compromise leading to the adoption of private-regarding tax policy � Pattern not affected by presidential strength � The President can ‘bribe’ legislators with pork � Can private business also do so?

Tax policy as joint product � Tax policy is joint product of chief executives and legislators in a democracy � Chief executives are at a disadvantage vis-àvis legislators ◦ They initiate tax reform ◦ They cannot veto tax measures approved by legislators (if they do, everything is for nought)

Influence of political institutions on policy outcomes �It is hypothesized that the nature of a democracy’s electoral system is a key variable in tax policy outcomes

Different electoral systems � Candidate-centered � Party-centered systems

Candidate-centered systems � Legislators in these polities face different incentives and constraints that those confronting politicians in party centered political systems � This difference is crucial in explaining the difference in the fiscal policies adopted by democracies in the developing world

Candidate-centered systems � When and where legislators need to develop individual reputations in order to get elected, their participation in the policy process is shaped by the need to take credit for divisible policy favors that could benefit their supporters and constituents � The party affiliation of the legislators is least useful in predicting their response to a tax measure even if they belonged to the President’s party or coalition

Party-centered systems � When the electoral and career trajectories of individual legislators depend on their adherence to party platforms and programs or at least to the preferences of party leaders, their participation in the policy process would differ accordingly � The constituency of these legislators is not really the electorate in their districts or their financial supporters but their party leadership.

Party-centered systems � If they belong to the ruling party, legislators will share in the goal of the country’s chief executive (also the ruling party leader) to improve revenue collections and economic performance � They would invariably support initiatives of chief executives for public-regarding fiscal policy

Parting shots (Tagay tayo!) � Whatever (sin) tax policy that exists at a given point is a temporary equilibrium agreed to by stakeholders identified earlier � In the Philippines, the (sin) tax reform that is possible at any one time is INCREMENTAL, not RADICAL � Thanks for your kind attention