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TRJ 2008 Vol XX No 6-a: The Impact of Internal Revenue Allotment on Philippine Provinces, November-December 2008

The study focuses on the IRA in the Philippines and its impact on the behavior of provinces in general. Specifically, this paper aims to determine the existence of the flypaper effect on the spending behavior of provinces. This flypaper effect is an empirical phenomenon which literally means money sticks where it hits. If there are any, its magnitude and consequence will be examined. Moreover, this paper ascertains whether IRA has successfully addressed its major role in filling the horizontal gap among provinces. The impact of IRA on provincial development will be investigated. According to the existing theory of the flypaper effect, its presence in local fiscal behavior has negative implications, not only on local governments but also on the community as a whole, since without the flypaper effect, a rise in transfers would have an equivalent increase in spending as well as in private income. Thus, being regarded as an anomaly, the tendency of local governments to expand their budgets as triggered by the provision of grants would create a huge vertical imbalance. Given the fixed nature of most grants, increasing expenditure might worsen local governments financial status. Moreover, following the veil hypothesis, the provision of transfers would not transform into beneficial programs for the public like lowering tax rates if the flypaper effect is present. This, as a result, defeats the purpose of giving grants to local governments. This study tried to test whether the empirical evidence of the flypaper effect in the literature exists in the context of Philippine provinces. Similar to other flypaper effect studies, the existence of the flypaper effect in provincial governments for the period 2001 to 2006 is verified. Some of its possible causes are, as follows: The flypaper effect can be attributed to the substantial local autonomy given to local governments since the advent of decentralization in 1991. During the LGC period, LGUs exercised utmost budgetary discretion in distributing funds for various local services. The unconditional nature of the IRA also strengthens the discretionary power of local chief executives. Though the 20% of IRA received by local governments is mandated to be allocated for local development projects, a facility for monitoring this provision is not currently in place. The significant contribution of the political affiliations of governors to the expansion of provincial budgets cannot be ignored. Thus, it can be assumed that provincial bureaucrats tend to maximize spending with the perception that they could manage to spend substantial sums as long as they are allies of the President. This study also investigated the consequences of the flypaper effect on the revenue effort of provinces. The bureaucratic model assumes that the existence of the flypaper effect might reduce local governments revenue effort since local managers would rely on grants in financing their expenditures. However, this scenario is not happening in the Philippines. Both rich and poor provinces exhibited stronger stimulative effects in the presence of the flypaper effect. Based on the flypaper effect matrix, this combination would lead to uncertain interpretation of revenue effort. However, the actual computation of reveff reveals that revenue efforts in first and second class provinces are higher than the third, fourth and fifth classes. This finding is confirmed by the significant positive correlation between revenue effort and IRA. Nevertheless, the varying magnitude of the flypaper effect could affect revenue efforts of local governments. Furthermore, the equalization role of IRA was again verified by looking at its influence in managing the existence of horizontal fiscal gap among provinces. Similar to Manasans (2004) findings, IRA is found to be counter-equalizing. This only proves that the 23% IRA allocation of provinces has failed to address the growing income disparity in the country. Lastly, the impact of IRA was examined in this empirical study through the analysis of taxable assessed value of properties. Results show that the IRA positively affects the level of provincial development since taxable assessed value rises with the IRA. The study by proving the flypaper effects existence in the provincial governments points to the need for re-evaluating current local policies, not only those pertaining to IRA but also other related provisions of the LGC, as follows: On the IRA Formula and 23% IRA Share of Provinces The national government should provide a policy for the proper allocation of grants. At present, there is an on-going study to reformulate the existing IRA formula on the grounds that criteria such as population, land area and equal sharing are inequitable. According to the proponents, the current formula only considers the fiscal needs of the LGU. Thus, a fiscal capacity criterion has been proposed to be incorporated, given the unequal distribution of resources among local governments. However, the determination of an appropriate indicator of fiscal capacity is conceptually and empirically difficult (Shah, 2007). Thus, careful examination of possible reforms to the IRA formula should be considered, to reflect the actual ability of LGUs to raise their own revenues. Moreover, Shah (2007) noted that any provision for fiscal effort undermines efficiency and equity, thus should be avoided in designing unconditional grants. What may be proposed is to have a simple and transparent design for an allocation scheme that focuses on objectives and is suitable to the countrys situation. The 23% share of provinces in IRA is perceived to be inadequate for financing devolved functions. According to a World Bank study, the expenditure requirements were determined only after the IRA allocation was approved in Congress. Hence, it can be deduced that there was no evaluation made as to whether the 23% was sufficient to cover the devolved functions given to provinces. Hence, this LGC provision should also be reviewed. On the Discretionary Power of Provinces in the Budgeting Process According to the flypaper effect theory, expenditure growth is greatly influenced by the behavior of local bureaucrats. In the case of the Philippines, this can be intensified with the power of local chief executives in the budgeting process. Account manipulations can be a common activity to accommodate the preferences of local chief executives. In this light, the bureaucratic model of the flypaper effect is applicable in understanding the unexplained growth of provincial spending. Although provinces may lack financial resources based on a revenue and expenditure mismatch, local officials could still influence the priority programs and projects significantly using the modest available resources. Thus, instead of an annual post-audit by the COA on local governments budgets, a pre-audit is proposed to minimize excessive and/or fraudulent spending. Careful consideration of the abovementioned recommendations could attenuate the existence of the flypaper effect in the country. Moreover, important policies for securing higher accountability and transparency should be enhanced. Since it is verified that the source of flypaper effect in the country is the monopolistic, budget maximizing local politicians and bureaucrats, strategies to improve accountability and transparency would minimize altruistic activities of local governments since transfers should be utilized to pursue the interest of the residents and not for other purposes. In this regard, the Government Procurement Act (GPA) should be strictly implemented. In June 2003, the GPA was passed which redefines methods and procedures in government purchasing. The GPA is viewed as a means to enhance transparency and public accountability in government procurement. Moreover, the new government accounting system (NGAS) which was implemented in January, 2002 should be strengthened to improve public financial accountability of local governments. Lastly, the Department of Budget and Management (DBM) is currently using performance budgeting through the Organizational Performance Indicator Framework (OPIF). The OPIF is an approach to expenditure management that directs resources towards results and accounts for performance. This can also be utilized to monitor whether local governments are able to deliver basic services to intended beneficiaries.

National Tax Research Center
Authors Keywords
National Tax Research Center; Philippines; tax; Internal Revenue Allotment (IRA); Local Government Units (LGUs); flypaper effect;
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