FEDERALISM 101 LECTURE 3: Fiscal Federalism
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This lecture, the third of a 4-part serries, explored the principles and practices in taxation, equalization and transfer systems, and wealth sharing. A policy report on the proceedings will be issued in a separate publication. The lecture series is a joint undertaking of IAG and the Congressional Policy and Budget Research Department (CPBRD) of the House.
The forum titled, "Fiscal Federalism: Principles and Practice in Taxation, Equalization and Transfer System, and Wealth Sharing" was held last 23 August 2016 at the Speaker Belmonte Hall, House of Representatives. This was the third of the four-part lecture series on federalism that is jointly organized by the Congressional Policy and Budget Research Department (CPBRD) and the Institute for Autonomy and Governance (IAG). Total registered participants reached 268—of which 16 were House Members. Other attendees were House Secretariat officials and employees, Congressional staff, and guests from other public institutions.
The CPBRD and IAG put together a panel of experts to discuss the concepts and practices particularly relating to taxation, transfer systems, natural resource management and wealth sharing under federal systems. Lessons from the experience of the Autonomous Region in Muslim Mindanao (ARMM) on fiscal autonomy were also discussed. The resource persons were Dr. Romulo E.M. Miral, Jr. (Deputy Director General, CPBRD), Atty. Marlon J. Manuel (National Coordinator, Alternative Law Groups), Dr. Herwig Mayer (Program Manager, German Development Cooperation), and Atty. Laisa Masuhud Alamia (ARMM Executive Secretary). Highlights of each presentation are discussed briefly in the following sub-sections.
Relevance of Fiscal Federalism
The discussion of Dr. Romulo Miral titled, “Fiscal Federalism: Its Relevance to the Philippines” revolved around two major questions, specifically: (1) what are the country’s issues and challenges, and (2) what is the relevance of federalism to these issues and challenges. At the end of his presentation, he drew important lessons from the Switzerland experience that may be applicable to the Philippine situation.
One major challenge that confronts the Philippines is that for almost three decades (1980-2010), except in recent years, the country's economy performed poorly compared with its peers in the ASEAN. Statistics also show that the Philippines has not been as successful as other ASEAN countries in reducing poverty and inequality. Economic growth and poverty are highly uneven across regions in the country.
Sixty-two percent of the country’s economic activities (measured by gross domestic product or GDP) is concentrated in the National Capital Region (NCR), CALABARZON and Central Luzon (Region III). Citing Balisacan and Hill (2006), Miral said that one characteristic of these so-called “enclaves” is that they are better connected to the global economy than with the rest of the domestic economy. The Philippine government has invested more in internationally-oriented infrastructure (ports and harbors) and less in domestic transport networks and corridors. Thus, these enclaves grow more rapidly with little connection to the hinterlands.
The decentralization program in the Philippines may have transferred some administrative and political authority to the regions (and have led some LGUs to perform well), but there is apparently no decisive shift of power and resources out of the center. The national government continues to be directly involved in the provision of devolved services. Government expenditures and revenues remained highly centralized as well—thus, the vertical fiscal imbalance. The centralization of revenuescreates a common pool resource with its attendant problems:(1) weakening of fiscal discipline, (2) deterioration of government accountability and operational efficiency, (3) greater tolerance of corruption, and (4) strengthening of patronage politics and political dynasty. Meanwhile, Internal Revenue Allotment (IRA) does not appear to promote equity as it fails to take into account differences in revenue capacities and expenditure needs of LGUs.
According to Miral, there are three major lessons from the discussion of fiscal federalism and the Switzerland case. First, the taxing powers of sub-national governments must be increased commensurately to the assigned expenditure functions. Second, fiscal transfers from the national government should be limited to the goal of reducing disparities in fiscal capacities of LGUs. Finally, it is important to recognize the critical role of middle-level government.
Natural Resources and Wealth Sharing
Atty. Marlon Manuel initially presented the legal framework that governs natural resource ownership, utilization and wealth sharing under our unitary system. While the Constitution provides that all lands (and practically all resources) belong to the State, autonomous regions have legislative powers over ancestral domain and natural resources within their territorial jurisdiction. Atty. Manuel underscored that the overarching goal of the national economy and patrimony, as enshrined in the 1987 Constitution, is the "equitable distribution of opportunities, income and wealth". The 1991 Local Government Code (LGC) also provides for the equitable share of LGUs and local communities in the proceeds from utilization of national wealth based on a prescribed formula.
The presentation also briefly discussed some of the variations in practices of federal systems in terms of ownership and control of natural resources, and the wealth sharing. Some federations have kept natural resource ownership/control (including revenue collection) centralized with an accompanying wealth sharing arrangement, while others have left the policy or standard setting at the federal and the administration of such policies to the state. The issue of natural resources becomes complicated when resources (like water) traverse political boundaries.
Atty. Manuel enumerated some wealth sharing goals, such as: (1) to compensate local communities for the negative impacts of exploitation of the natural resource; (2) to mitigate violent conflict; (3) to respond to local assertion for benefits based on claims of local ownership; and (4) to promote regional income equality between resource and non-resource rich regions. Furthermore, wealth sharing considers how revenues are to be distributed vertically (as linked to cost of delivering public services) and horizontally to address uneven development across states.
The natural resource issue is critical primarily because it is a major source of national income, particularly for resource-rich countries like the Philippines. However, natural resources can also be a source of conflict and political instability especially when there is disparity between where the resources are and where the political power lies. Investors are less likely to take business risks unless there is a clear natural resource management policy or regime in the country. Atty. Manuel emphasized the need for consensus-building especially in clarifying the allocation of ownership, control and wealth from natural resources. The Constitution should be clear with enough details on this matter so as to avoid future conflicts or division.
Taxation and Equalization
According to Dr. Herwig Mayer, fiscal decentralization is vitally important to achieve real political decentralization. He emphasized the need for a functional assignment that will eventually determine how funds/revenues may be allocated. On the revenue side, there are four aspects in taxation that need to be considered: (1) which level controls the tax base and rates; (2) which level administers the taxes: (3) which level gets proceeds related to taxes from the location; and (4) which level gets how much from a common source. Meanwhile, it is important that fiscal autonomy on the spending side is governed by principles of transparency, participation, accountability, auditing, and performance-monitoring.
In his presentation, Dr. Mayer discussed the revenue assignment between the central government and the sub-national governments. In Germany, the federal government has almost no taxing power although tax policies are passed by both Houses of Parliament. Major tax types such as personal and corporate income and VAT, which account for about 70% of the revenue, are shared on a pool basis.
Under a highly decentralized taxation system, states with broader tax bases generate much higher revenues—resulting in fiscal disparities across states or Landers. However, it is enshrined in the Basic Law of Germany that citizens shall have uniform living conditions. This is only possible through a horizontal equalization system whereby richer states contribute to a pool for redistribution to poorer states—thus, narrowing the unevenness in living conditions. Such equalization arrangement, however, has perverse effects of potentially making poor states dependent on the richer ones because there is no incentive to improve on their financial condition as well as to reduce the cost of service delivery.
ARMM Fiscal Autonomy
Atty. Laisa Alamia provided the context for some fiscal challenges experienced by the ARMM. First, there are two governing laws, namely the ARMM Organic Act (RA 9054) and the LGC, that complicate the relationship between ARMM-LGUs and the regional government. RA 9054 devolved certain functions like education, health and agriculture to the regional government, but program funds for these devolved functions remain with the national government. Meanwhile, ARMM-LGUs do not use their IRA to support devolved functions in their respective localities—invoking that the responsibility rests with the regional government under the Organic Act.
Second, even though RA 9054 provides the regional government the power to create its own sources of revenues and to levy taxes, fees and charges, its taxing powers are rather limited because of a host of exceptions. Among the exceptions are major taxes such as on income (except when levied on banks and other financial institutions) excise tax, and VAT. Section 7 (Article IX, RA 9054) provides a complete listing of taxes that the ARMM cannot impose.
Third, the ARMM receives annually a lump sum appropriation but these are largely spent for personal services and some MOOE. The regional government depends on national government agencies (NGAs) for program funds. The NGAs release program funds for ARMM to regional offices that are operating in areas near the autonomous region, but the release is often too late in the year. Finally, the ARMM regional government has no control over how LGUs utilize their IRA. The national government through the Department of Budget and Management (DBM) has the power to review the budgets of ARMM provinces. Regional Government is not privy to the utilization, provision, and the reports that ARMM-LGUs submit to the Bureau of Local Government Finance (BLGF).
Atty. Alamia recommends the following measures to address fiscal-related problems in the ARMM: (1) complete the devolution of powers from national to regional governmental levels and from regional level to LGUs; (2) decentralize taxing powers to the autonomous region, particularly on productive broad-based taxes such as the personal and corporate income tax; (3) strengthen intergovernmental relations between the ARMM and NG; and (4) carry out fiscal horizontal equalization through comprehensive release of program funds direct to the ARMM instead of to the NGAs’ regional offices.
Issues Raised During the Open Forum
The Open Forum provided the participants the opportunity to clarify some points raised during the presentations, and to exchange views with the panelists on the different aspects of fiscal federalism. Some of the major concerns relate to the following:
- how a federal setup would change the current wealth sharing arrangements;
- the need to clearly state in the Constitution the allocation of authority to "control" natural resources so as to avoid future conflicts;
- the assignment of taxing powers between the national and regional governments;
- the option to amend the LGC instead of shifting to federalism;
- the need for disaggregated tax data based on the situs of taxation;
- the absence of a middle-level government;
- the need to reconcile the LGC and RA 9054 as they apply to ARMM-LGUs; and
- the difficulty for ARMM to consolidate as a state because of the presence of different sultanates.