Part I -- Objectives, History and the Deficit Problem
Part II -- Confronting the Fiscal Problem
Part III -- The Revenue Program
Part IV -- The Expenditure Program
Part V -- Legislative Measures
Part VI -- The Debt Management Plan

Part I -- Objectives , History and the Deficit Problem

Introduction

FOR over two decades, the Philippine government has been operating on a fiscal deficit, except in the years 1994, 1995, 1996, and 1997, when we posted budget surpluses mainly attributable to the privatization proceeds we raised during this period.  Since then, our total expenditures, to include our debt payments, were more than the revenues we could raise.

Our program for fiscal strength is premised on the painful fact that the government could, very soon, no longer afford to subsist on borrowed funds.  Any government expenditure that is financed by borrowing is a contribution to the budget deficit.  If we persist in sustaining national growth through relentless borrowing from foreign and domestic creditors, the interest payments will eat up the share of the budget not earmarked for debt servicing.

If this happens, public services and social reforms, as we know these, would slow down or come to a full stop.  The poor will suffer, in greater numbers and deeper magnitude.

It is critical for our national survival that we bridge the widening chasm between our national debt and our capacity to pay before we surrender our economic future to the judgment of our creditors.

We are determined to put our fiscal house in order. We have a six-year plan to balance the budget and deliver institutional reforms for a more financially viable and progressive Philippines.

Policy Objectives:

Our Medium-Term Fiscal Program has three policy objectives:

(1) Balance the national government budget in six years;
(2) Reduce the ratio of Consolidated Public Sector Deficit (CPSD) to GDP from 6.8% to 3% of GDP for the same period;
(3) Reduce the ratio of Public Sector Debt to GDP from 136.5% in 2003 to 90% of GDP by 2010.

A Brief History

For over two decades, the Philippine government has been operating on a fiscal deficit, except in the years 1994-1997.  The budget surpluses we posted in those years were mainly attributable to the privatization proceeds raised during this period.  

Our revenue efforts peaked in 1994 and again in 1997 when the impact of the 1996 Comprehensive Tax Reform Law as at its highest.  Since then, however, there has been a steady decline in revenue ratios, indicating the inability of our revenue effort to keep up with our growth needs.

In 1986, expenditures were 18.1% of GDP.  There was a sharp rise in expenditure in (20.2%) 1990 when the power crisis resulted in heavy government support for the energy sector.  Since then, however, expenditure-to-GDP ratios ranged from 19.8% to 19.2%, before its marked decline in 2004 resulting from a stronger effort to cut down costs.

National Government Deficit

Our expenditure ratio declined since 1990, but our revenue collection rates dropped even more sharply.  From 1997 to 2004, we have been spending much more than we could earn.  The decline was most pronounced from 1997 to the year 2000.

As the gap between revenues and expenditures grew, so did the national government's deficit rise.  From 1986 to 1993 and then 1998 to the present, our budget has been in the red.  As a percentage of GDP, our deficit has started to become smaller after 2002.

We annually set since 2001 an annual deficit ceiling referring to the acceptable limit for our deficit for the year.  We were within our deficit ceilings in 2001 and 2003.  Given our program for more prudent spending, we are optimistic about meeting our deficit target in 2004.

Similarly, since 1986, our Consolidated Public Sector Financial Position has always been in deficit except in 1996. There has been a steady downward trend since 1996.  

In the past ten years, our Public Sector Debt-to-GDP ratios and National Government Debt-to-GDP ratios have likewise steadily increased.  The increases are due to the widening fiscal gap from 1994 to 2004.

The measures to balance the national budget in six years; reduce the Consolidated Public Sector Deficit to a more manageable 3% of GDP; and reduce the Public Sector Debt to 90% of GDP—are crucial not only to avert a looming financial crisis but also to support our medium term growth.

Immediate fiscal consolidation will improve our credit ratings for sovereign issues—such as Standard and Poors and Moodys.  Any improvement in our credit rating would result in lower cost of borrowing.  This would enable us to justify to our creditors a roll back of our maturing debts to a few more years.

Admittedly, borrowings are still necessary to finance the programs most crucial to sustain our growth.  By putting our fiscal house in order, investors are assured of a more conducive investment environment.  A positive investment climate would translate to increased foreign and domestic capital, infusion of new technologies, and more jobs generated.

Part II -- Confronting the Fiscal Problem

Balancing the Budget: Targets and Action Plans

Our objective to balance the national budget within six years requires a gradual reduction of our deficits every year until we reach a zero deficit in 2010.

Our plan is to reduce both the Consolidated Public Sector Deficit and the National Government Deficit so that the CPSD will be down to 3% of GDP in 2010 while the National Government Deficit will go down to .2% in 2009 and finally be totally wiped out in 2010.

National Government Debt will be reduced from its current 78% of GDP to 58% of GDP from 2004 to 2010, while Public Sector Debt is targeted to go down from 135.6% of GDP to 90% of GDP in the same period. Both can be achieved with the implementation of fiscal reform strategies, particularly the adoption of revenue-generating measures.

Confronting the Fiscal Problem

Fiscal discipline, austerity, rationalization, these are the bywords of the executive branch of government. The country's fiscal problem requires the sharing not only of goals, but also of burdens. It cannot be denied that in undertaking fiscal discipline while generating revenues, sacrifices would have to be made by both the public and private sectors.

National government must start implementing revenue generation measures; prune expenditures, leaving only the programs that are most necessary and those that have the greatest impact on our people, without reducing the quantity or quality of basic services delivered; and implement an effective debt management program.

Government-owned and/or controlled corporations (GOCCs) and Government Financial Institutions must undergo rate adjustments; rationalization through streamlining or privatization or outsourcing; and have their debt guarantees regulated.

Local Government Units (LGUs) are also enjoined to undertake austerity measures and finance more of their development from their Internal Revenue Allocations rather than relying on the national government.

Our financial system requires much needed reforms to stabilize the country's fiscal position.

We also need to modernize the domestic financial system to give small and medium businesses (SMEs) more access to funds and develop our capital markets.

Part III -- The Revenue Program

Revenue Program

Our revenue effort, which has never gone higher than 20% of GDP in the past 18 years and has dropped to 14.1% of GDP, is the second lowest in Asia. We lag behind our ASEAN neighbors: Indonesia posted a 19.1% revenue effort while suffering a negative deficit of -2.1% of GDP, but better than our 4.2%; Malaysia has a high revenue effort of 22.7% but also a high deficit of -5.3%; and Thailand has a revenue effort of 16.6%, which is better than ours, and also enjoys a slight surplus of .6%.

Our target is to generate additional revenues of over P180 billion a year. This we plan to do through executive reforms, which could lead to earnings or savings of around P100 billion. The remaining P80 billion or more is expected from legislated revenue measures.

Our goal is for a steady increase of our revenue stream in the next six years through a combination of administrative and legislative measures.

Over the medium term, excluding new legislative measures and given favorable economic conditions, total revenues are expected to grow at an average rate of 11.3%, with tax receipts growing more vigorously at 12.8%, through a more rigorous implementation of administrative measures.

With the proposed measures in Congress, revenue effort is estimated to climb steadily and reach as high as 185% of GDP in the medium term, with tax effort projected to reach 17.6% in 2010. BOC's collection to GDP ratio will moderately improve to 3.5% by 2010, relying mainly on improved administrative efficiency. The impact of this upward trend towards increasing revenues on our creditors and potential investors will be positive and encouraging.

Action Plan: Revenues

The Action Plan for Revenues consists of:

(a) Improving Administrative Efficiency and
(b) Proposed Legislative measures.

Improving administrative machinery shall be achieved through:

(a) Periodic adjustment of fees and charges;
(b) Rate adjustments;
(c) Innovative sources of wealth creation;
(d) Improved enforcement mechanisms to increase efficiency.

For the BIR, the latter consists of computerization/automation of operating systems; enhancement of audit programs; intensified enforcement procedures; and the conduct of taxpayer compliance verification drives. For the BOC, administrative measures consists of modernization of information systems, strengthening of anti-smuggling powers, strengthening of internal audit service; and purchase of container x`rays for ports.

Wealth creation will come from the following activities:

- Privatize the National Power Corporation
- Mobilize investors for Mt. Diwalwal gold mine
- Explore and develop more oil/gas wells
- Relaunch massive reclamation projects
- A major nationwide reforestation program
- Create HK-type enclaves to capture long-term investors

The privatization of the National Power Corporation (Napocor), through the sale of its generation assets and the Transco concession, is among the most urgent of our important non-tax revenue-generating measures. Cleaning government's books entails putting an end to the fiscal drain caused by inefficient corporations. Napocor's privatization is expected to bring in $4-5 billion.

The proceeds from Napocor's sales will be free government resources from subsidizing Napocor towards public services and social reforms. Napocor's privatization will also save government P20-30 billion in interest payments alone and free that amount for public services and social reforms. The sale of Napocor will involve the buyer's assumption of Napocor's net debt of P200-300 billion. Conversely, if government is unable to privatize Napocor, it will cost an additional P30 billion in the national budget to cover the company's interest payments.

Therefore, a determining factor in the achievement of our fiscal targets is the successful sale of Napocor. If this privatization effort falls through, we would need to generate additional revenues to P30 billion on top of what we initially aim to raise.

An Executive Order (EO) has already been signed increasing duty on petroleum products from 3% to 5%. The positive effect of this EO on our revenue-generating program is contingent, however, on the price increases of crude oil.

Our legislative revenue agenda consists of eight (8) measures. These are fair and equitable and would most affect the sectors that could afford to pay more:

1. Adoption of gross income taxation. This measure will replace the current net income tax system with gross income taxation of corporations and self-employed individuals through payment of a fixed percentage or a fixed amount. It will lead to a fairer taxation scheme by correcting the discrepancies in the present system that imposes the greatest burden for individual tax on salaried employees.

2. Indexation of excise tax on tobacco and liquor. The current specific tax for tobacco and liquor does not allow for adjustments due to inflation, thus the tax rates collected from them have remained the same since 1997 despite the increase in their prices. An estimated P7 billion is expected on its first year of implementation.

3. Excise tax on petroleum products. This will increase the specific tax rates on petroleum products by P2 across the board, except for LPG which will be increased by no more than 50 centavos, to adjust taxes to the price increases of these products.

4. Rationalization of fiscal incentives. This streamlines the fiscal incentive system by putting together all the special investment incentives provided in several laws; withdrawing all inefficient, irrelevant and duplicative special investment incentives schemes; limiting the time frame for granting incentives; selecting the investments that can avail of them; and abolishing fiscal incentives not consistent with the WTO.

5. General Tax Amnesty with Submission of SAL. This generates immediate revenues and broadens the tax base by granting amnesty to delinquent individual and corporate taxpayers through the payment either of 3% of the taxable income or a fixed scheme. To broaden the tax base, the amnesty would also require every taxpayer of a given income threshold to file a Statement of Assets and Liabilities. We expect around P10 billion from this amnesty program.

6. Lateral Attrition System. This measure institutionalizes an attrition system for revenue-collection officials and employees, whereby incentives are granted to those who meet targets while sanctions are imposed on those who fail.

7. Franchise tax on telecoms. This measure reimposes the franchise tax on telecom companies to enable government to share in the tremendous growth of the industry without significantly hurting the pockets of individuals or corporations. The additional revenues, estimated at P5 billion, can be used for important social services such as health and education.

8. Review of the Vat System. Pending a review of the entire VAT system, a two-step increase in the VAT rate increases it from the current 10%, which is one of the lowest in Asia, to a still relatively small 12%. We are aiming for a modest VAT-to-GDP ratio of 4% in 2005 and 5% in 2006.

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Part IV -- The Expenditure Program

Expenditures

From 1992 to 2004, interest payments have increasingly eaten up shares of the national budget. Interest payments accounted for 28% of the national budget in 1992 and rose to 32% in 2004 due to the increase of the national debt. These are monies that could have gone to development projects to build roads and fight poverty.

During the same period, the Internal Revenue Allotment share of local government units has more than doubled in terms of the percentage of the budget, from 7% in 1992 to 16% in 2004, in keeping with the mandate of the Local Government Code.

The net result of the increases in debt servicing and IRA payments has been the contraction of capital spending and other productive expenditures. In 1992, with interest payments at 28% and IRA at 7% of the budget, the allocation for infrastructure as 9% of the national budget. In 2004, interest payments stood at 32% and IRA took 16% of the budget, leaving only 6% for infrastructure.

We need to increase our capital outlays to prepare for future growth and remain competitive. While we were at par with Singapore in the ratio of capital outlays to GDP in 1995, we already have the lowest Capital Outlay-to-GDP ratio now at 2.9% while Singapore's ratio has almost doubled.

We also need to rationalize the personal services cost of government. Our Personal Services-to-GDP ratio, at 6.6%, is the highest of five ASEAN countries. Thailand's ratio is 5.9%; Singapore's is 5.3%; Malaysia's is 5.2%; and Indonesia has 1.8%. As a percentage of tax collection, we also spent more for personal services — 48.8% in 2001.

Action Plan: Expenditures

Our expenditure pattern from 2004 to 2010 targets a reduction of the following as a percentage of GDP: 1) interest payments, from 5.8% in 2004 to 3.7% in 2010; and 2) expenditures for personal services. We also aim to increase the ratio of capital outlays to GDP from the current 2.1% to 4% in 2010.

Capital expenditures for infrastructure will be strictly prioritized to those with the greatest economic returns for the country in terms of linking the entire country with a network of transport and digital infrastructure; providing competitive power and water to the entire country; decongesting Metro Manila and spreading economic activity to new centers of government, business and community; and having the most competitive international service and logistics center in the region.

Our Action Plan for Expenditures also consists of Administrative Measures and Legislative Measures.

Under Administrative Measures are: (a) Austerity programs; (b) Rationalization of Personal Services; (c) Improvement of Management of GOCCs; (d) Full implementation of the devolution provision of the Local Government Code; (e) Increase in social safety program within the budget; and (f) Transfer to the General Fund of all balances of Dormant accounts.

The reduction of personal services expenditures shall be achieved through belt-tightening measures aimed at reducing the cost of utilities, supplies, travel and other items and the reduction of hiring of casual and contractual employees. This necessitates a comprehensive program to rationalize personnel. To improve the quality and efficiency of public service, the government shall adopt institutional improvements in the bureaucracy by deactivating irrelevant functions, consolidating duplicated functions while reinforcing the most vital functions.

Administrative Order 103 was issued on August 31, 2003 "directing the continued adoption of austerity measures in government." The salient features of this order are the following: (1) Suspension of all foreign travels, except for ministerial meetings and scholarship trainings that do not entail any cost to the government; (2) Suspension of the purchase of motor vehicles, except ambulances and patrol cars; (3) Reduction of at least 10% in consumption of utilities; (4) Suspension of all expenditure subsidies to GOCCs, OGCEs and LGUs except those approved by the FIRB; (5) Conduct of training, seminars and workshops, except if funded by grants, or if the cost may be recovered through exaction of fees; (6) Expansion of organizational units and/or creation of positions, except those following "scrap and build" policy or matched by the deactivation of existing units/positions of the same cost; and (7) Conduct of celebrations and cultural and sports activities.

All government departments shall conduct a strategic review of their operations to identify the functions, activities, programs and projects that need to be scaled down, phased out, or abolished and indicate the areas where to channel more resources.

Employees whose functions are found to be redundant may opt to retire, or, if qualified, remain in government. Separation from the service shall be voluntary. Those who retire or are separated from government service are guaranteed their retirement/separation benefits, plus applicable incentives. The government shall also implement a livelihood program for those who want to venture into business after retirement.

Over the medium term, the Personal Services program will provide for salary adjustments only from the savings of the departments who have initiated the bureaucratic reform. The program will also not provide for new hires, except for peace and order and defense.

The government shall impose a moratorium on the establishment of GOCCs and their subsidiaries, except the Philippine Infrastructure Corporation (PIC). The PIC will operate like an infrastructure fund to jump-start the strategic infrastructure projects crucial to our development program.

All projects directly assisting LGUs will be transferred to the Municipal Finance Corporation, except for certain projects like the Countryside Bridge Program, Agriculture and Agrarian Reform projects, and the Kapit-Bisig Laban sa Kahirapan-Comprehensive and Integrated Delivery of Social Services (KALAHI-CIDSS) which continue to be administered by their respective implementing agencies.

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Part V -- Legislative Measures

Legislative Measures to Reduce/Regulate Expenditures

A separate legislative program is proposed to regulate and reduce expenditures, consisting of: (a) The Fiscal Responsibility Bill; (b) The Omnibus Reengineering Law (Part Five); (c) Rationalization of Government Retirement and Pension Schemes (Part Five); (d) Rationalization of the Government Compensation System (Part Five); and (e) Removal of the Automatic Guarantee Provisions in Certain GOCCs.

The Fiscal Responsibility Bill provides that no new expenditures shall be enacted without accompanying new revenue measures. If enacted, the bill will impose discipline in our legislative process and minimize the proliferation of unfunded laws. As of September 2003, we have 69 various Republic Acts and Executive Orders whose funding requirements, if they are implemented, amount to P337 billion.

The proposed Omnibus Reengineering Law seeks authority for the President to reorganize the Executive Branch, including GOCCs, and offer appropriate incentives.

The proposed Rationalization of All Retirement and Pension Schemes Law shall ensure the sustainability and claim on the budget for all pensions. This measure will suspend the payment of all retirement benefits by GSIS, select veterans' payments that can be reasonably funded, and make pension benefits commensurate to premium contributions.

The Rationalization of the Government Compensation System Act will simplify position classification, improve compensation for highly competitive posts and implement a performance-based compensation system. The DBM shall work with the CSC to put together a performance-based and financially sustainable compensation scheme to address the inequity of pay scales between the private and the public sectors. Salary adjustments may be funded from savings resulting from the voluntary early retirement scheme and other reform proposals on personal services.

The bill removing automatic guarantee provisions in certain GOCCs will ensure that GOCCs engaged in borrowing will have the capacity to pay and will further set a limit on rampant GOCC borrowings.

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Part VI -- The Debt Management Plan

Debt Management

The total debt of the national government reached its peak in 1993 when it was close to 80%. The power crisis during that period forced the government to enter into obligations to resolve the crisis. After 1993, the national debt steadily again declined until 1996 when the government had a budget surplus. Clearly, there is a direct connection between government surplus and a reduction in debt.

The National Government Debt rose from P375.4 Billion in 1986 to more than P3 Trillion by end 2004.

The government accumulated debt at a rate of 20.3% between 1999 and 2000, mainly due to high interest rates and the sudden depreciation of the peso from P39.09 to a dollar in 1999 to P44.19 to a dollar in 2000. This sudden and sharp depreciation was attributed to loss of investor confidence and the perception of political stability. As a percentage of GDP, debt stock increased from 56.1% in 1998 to 64.6% in 2004.

Before the National Government deficit becomes insurmountable, we must take the necessary steps to reach a balanced budget position. This is why the administration is pushing for these expenditure and revenue reforms to be implemented as soon as practicable. The Government aims for a lower ratio of about 50% of GDP.

Action Plan: Debt Management

The Action Plan for Debt Management entails the implementation of a debt reduction plan through (a) bond exchange to lengthen debt maturity; (b) making more use of Official Development Assistance (ODA) over commercial borrowings; and (c) limiting guarantees for GOCCs; (d) a debt cap; and (e) limiting borrowings to high priority projects.

The success of bond exchange to extend the maturing of a loan hinges on several factors, including the sovereign ratings accorded by investment houses and the creditors' assessment of the country's investment attractiveness.

We do remain creditworthy before our foreign and domestic creditors. Our domestic market remains liquid. Our Eurobonds to enhance our debt maturity profile are twice oversubscribed. Our investment growth of 493% in the first seven months of 2004 and the 6.2% GDP growth we posted for the second quarter of 2004 attest to the continued investor confidence. But if we fail to bridge the fiscal gap, we could just as easily find ourselves suddenly teetering on the edge of rapid economic decline.

ODA is our preferred source for financing large infrastructure projects that require huge funds, as it is relatively soft with its lower interest rates and longer maturity period. However, unless it is a grant, ODA is usually a loan and increases the budget deficit as other loans do, only with better terms of payment. Government has carefully chosen its ODA-funded projects in the past three years. But to minimize borrowing and increasing the deficit in these times of fiscal constraints, government must be even more selective of the projects to be funded by ODA. We must choose only the projects that will have the most positive impact on most people or those that will generate the most revenues.

The programs prioritized for ODA funding are those that will directly contribute to the 10-point legacy agenda of the Arroyo administration, which has the acronym BEAT THE ODDS.

B is for a balanced budget. E is for education for all. A is for automated elections. T is for transport and digital infrastructure to connect the entire country. That is B-E-A-T for BEAT.

T is for terminate the MILF and NPA conflicts in favor of lasting peace. H is for healing the wounds of EDSA. E is for electricity and water for the entire country. That is T-H-E, THE.

And finally, ODDS. O is for opportunities for 10 million jobs. D is for decongesting Metro Manila by developing new centers for government, business and housing in Luzon, Visayas and Mindanao. DS is for develop Clark-Subic.

The administration also proposes a debt cap, which can be implemented with an enabling measure from Congress, to limit future debts to programs deemed crucial for our growth.

The losses incurred by GOCCs shall be reduced with legislative measures that will limit these GOCCs' capacity to enter into debts. Pending the passage of this law, administrative measures have been passed phasing out redundant and non-performing GOCC's to cut down on their losses.

A Prescription for Stability

Our fiscal program is a prescription for stability put forward by our country's economic managers. It is imperative that Filipinos in the Philippines and abroad act as one in addressing our fiscal problem.

We are acting swiftly to stem the threat of a financial crisis by calling for austerity, discipline and rationalization.

Every Filipino must understand government's need to raise more revenues as an issue of national survival. If we continue to support growth by borrowing from both foreign and domestic creditors, our interest payments will catch up with us. Time will come ` and we already see it on the horizon ` that we will use our budget to pay debt interests rather than build infrastructure, deliver basic services, educate our children and promote peace and order. Where will that leave the poor? We need these revenues, not only for growth, but to fight poverty.

Filipinos are free to differ on the best paths for change and reform, but only one flag stands before us, and waves above us, wherever our fortunes lead.

Our fiscal program shall be implemented solely with the flag and the best interests of our people in mind.

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