The Combined Incidence of Taxes and Public Expenditures in the Philippines

November 1995 In the Philippines, the combined effect of taxation and spending policies is progressive, because the incidence pattern of spending is progressive while that of taxation is neutral. Indirect taxes, the main source of government revenue, are only slightly regressive. Although the poor consume taxed goods such as energy directly, the rich consume them indirectly by purchasing goods whose production requires energy and other taxed goods. Incidence studies of fiscal policy in developing countries typically examine either the distribution of tax burdens or the incidence of public expenditures. But the central issue for policymakers is the combined or net incidence of fiscal activities. Even if a tax is regressive, the impact of increasing it may not be, if the revenue raised is spent in a progressive manner. But even if the beneficiaries of public spending are the poor, the net effect may not be pro-poor, if the spending is financed by a highly regressive tax. One reason that combined incidence studies are so rare: they require detailed data on both taxation and public spending. Most analysts consider themselves lucky if they have data on either. Devarajan and Hossain show that the net incidence of fiscal policy in a country with average data --- the Philippines --- can be estimated using a variety of data sources and tools, using simplifying assumptions. For 20 years, the Philippine economy has experienced a series of balance of payments crises triggered by fiscal crises. It has had an unsatisfactory record of poverty alleviation. As the government tries to maintain fiscal discipline by raising taxes and cutting spending, how will poverty be affected? Devarajan and Hossain examine net fiscal incidence to find out. Their findings: ° The incidence pattern of taxes is basically neutral. Contrary to expectations, indirect taxes are only slightly regressive. The poor consume taxed goods such as energy directly, but the rich consume them indirectly by purchasing goods the production of which requires energy and other taxed goods. ° It is the pattern of expenditures that drives the combined incidence, which is progressive. This paper --- a product of the Public Economics Division, Policy Research Department --- is a revised version of Chapter 15 of the World Bank report, The Philippines: An Opening for Sustained Growth.