US embassy cable - 05MANILA4528

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. 
 
----------------------------------------- 
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. 
 
--------------------------------------------- ----------- 
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 
 
-------------------------------------------- 
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