review of the fiscal provisions of the 1991 local government code

REPUBLIC OF THE PHILIPPINES

DEPARTMENT OF THE INTERIOR AND LOCAL GOVERNMENT

DILG-NAPOLCOM CENTER EDSA corner Quezon Avenue, Quezon City

REVIEW OF THE FISCAL PROVISIONS OF THE 1991

LOCAL GOVERNMENT CODE

FEBRUARY 2015

TABLE OF CONTENTS

I. Review of the Fiscal Provisions of the 1991 Local Government Code: Summary Report

II. Results of Consultations on Amending the Fiscal Provisions of the 1991 Local

Government Code: Power Point Presentation

III. Matrix of Proposed Amendments to the Fiscal Provisions of the 1991 Local Government

Code, by Topic and by Stakeholder Support

IV. Technical Papers

1. Reform of Local Taxing Powers Under the 1991 Local Government Code

2. Philippine Decentralization: The Chance for a Local Personal Income Tax

3. Reform of the Regulatory Framework for Local Government Debt and Credit

Financing under the 1991 Local Government Code

4. Strengthening Inter-Local Cooperation and Alliances in the Philippines

5. Improving Local Fiscal Administration

V. POSITION PAPERS

1. Position Paper of the Department of Budget and Management (DBM)

2. Position Paper of the Union of the Local Authorities of the Philippines (ULAP)

3. Position Paper of the European Chamber of Commerce of the Philippines

4. Consolidated Proposals of Business Sector from the 21 November 2014 and 04

December 2014 Consultations

REVIEW OF THE 1991 LOCAL GOVERNMENT

CODE: SUMMARY REPORT

JANUARY 2015

TABLE OF CONTENTS

I. BACKGROUND ....................................................................................................... 1

II. CONSULTATION PROCESS ................................................................................. 1

III. SCOPE OF THE LGC REVIEW ........................................................................... 2

IV. PROPOSED AMENDMENTS TO THE 1991 LGC.............................................. 2

1. Revenue Assignment .................................................................................................... 2

2. Functional/ Expenditure Assignment ......................................................................... 4

3. Intergovernmental Transfers ...................................................................................... 5

4. LGU Borrowing ........................................................................................................... 6

5. Creation of LGUs ......................................................................................................... 7

6. Inter-local Alliances and Cooperation ....................................................................... 7

7. Fiscal Administration and Financial Management .................................................. 7

List of Table

Table 1. Proposed Amendments to the Local Government Code of 1991, by Topic/ Issue and

by Stakeholder Support ............................................................................................... 1

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REVIEW OF THE 1991 LOCAL GOVERNMENT CODE: SUMMARY REPORT

I. BACKGROUND

As part of the 2014-2015 work plan of the Cabinet Cluster on Good Governance and Anti-

Corruption, the Department of Interior and Local Government (DILG) is tasked to lead a

substantive review of the 1991 Local Government Code (LGC or the Code). The enactment of

the Code in 1991 ushers in a new era of local governance, one that is characterized by a marked

increase in local autonomy. It includes far-reaching provisions affecting the assignment of

functions across different levels of government, the revenue sharing between the central and

the local governments, the resource generation/utilization authorities of local government units

(LGUs) and the participation of civil society in various aspects of local governance.

The Code is landmark piece of legislation that has inspired and served as some kind of exemplar

for the decentralization initiatives in other countries in the region. However, many stakeholders

believe that amendments to the Code are long overdue 23 years after its passage. While

acknowledging that the LGC is a good law, there is widespread agreement among stakeholders

that the LGC suffers from a number of structural deficiencies, including lack of clarity in

functional assignment, limited and unproductive sources of local revenue, inadequate and

inequitable intergovernmental transfer mechanisms, and weak LGU debt regulatory

framework, among others.

There had been several attempts in the past to review the LGC. The LGC itself calls on

Congress to undertake a mandatory review of the Code at least once every five years. The

present review is different from previous ones in that it is (i) government-led, (ii) inclusive,

following a consultative process involving national government agencies (NGAs), LGUs and

the various leagues of local governments, business sector organizations, civil society

organizations, subject matter experts, and Congress, (iii) transparent, (iv) evidence-based, and

(v) time bound.

II. CONSULTATION PROCESS

As part of the LGC review, three island-wide consultations in Luzon, Visayas and Mindanao

were held in Manila, Cebu City and Davao City between September 11 and October 1, 2014

with the participation of some 400 LGU chief executives, local council members and other

local officials. In addition, smaller meetings with selected officials of the Union of Local

Authorities of the Philippines (ULAP), the League of Provinces, the League of Cities, the

League of Municipalities, the League of Vice-Governors, the League of Vice-Mayors, the

League of Provincial Board Members and the League of Councilors were also held. On the

other hand, the LGC review team met with key officials with the fiscal oversight agencies

(namely, the Department of Finance [DOF], the Department of Budget and Management

[DBM] and the National Economic and Development Authority [NEDA]) individually and

jointly before and after the consultations with LGU officials. The private sector stakeholders

who were consulted as part of the current effort to review the LGC include representatives from

the Philippine Chamber of Commerce and Industry (PCCI), Filipino Chinese Chamber of

Commerce, Joint Foreign Chambers of Commerce of the Philippines, the Makati Business Club

(MBC), the National Competitiveness Council, the Bankers Association of the Philippines, the

Tax Management Association of the Philippines (TMAP), and the BPO sector. The broad-

based character of the LGC review consultation process and the engagement with key leaders

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in Congress like Congressman Pedro Acharon Jr. (chairman of HOR Committee on Local

Government), Senator Ferdinand Marcos Jr. (chairman of Senate Committee on Local

Government) and Senator Aquilino Pimentel III (chairman of Senate Oversight Select

Committee on the Local Government Code) early on in the process augurs well for the success

of the present efforts.

III. SCOPE OF THE LGC REVIEW

The focus of the present LGC review is limited to its fiscal provisions primarily because said

provisions are deemed to be critical to the LGUs’ ability to deliver basic services, strengthening

local governance and, consequently, improving the welfare of local communities. More

specifically, the scope of the LGC review includes the following topics: (i) functional/

expenditure assignment, (ii) revenue assignment and LGU revenue raising powers; (iii)

intergovernmental transfers, (iv) LGU borrowing, (v) creation of LGUs, (vi) inter-local

alliances and cooperation, and (vii) local fiscal administration.

IV. PROPOSED AMENDMENTS TO THE 1991 LGC

Table 1 presents the various amendments related to the aforementioned topics that were

considered during the consultations for the LGC review. It summarizes the issues that

motivated each of the proposed amendments and maps support of various stakeholders to each

of the proposed amendments. This section highlights the proposed amendments that generated

the greatest support among the various stakeholders and which are most likely to pass muster

in Congress.

1. Revenue Assignment

The low local tax-to-GDP ratio and low OSR1-to-GDP ratio of all LGUs in the aggregate as

well as their heavy reliance on fiscal transfers, particularly the internal revenue allotment

(IRA), is indicative of the low degree of revenue autonomy of the LGU sector in the country

in the post-LGC period. As a

result, accountability at the local level is likely to continue to be rather weak.2

Tax assignment under the LGC scores low in terms of the revenue autonomy criterion

(Manasan 2005, Diokno 2012, ADB 2012). On the one hand, the LGC seriously limits their

power to set local tax rates. On the other hand, although the 1991 LGC authorizes LGUs to

levy local taxes on a good number of tax bases including some which were not allowed during

1 OSR refers to own-source revenues.

2 The efficiency gains of decentralization are best realized when the local taxes (and/ or user charges) that citizen/

voters pay and the benefits of that they receive as a result of local spending are linked as closely as possible such

that citizens/ voters essentially “pay” for the public services they receive from their local governments (Bird 2000).

When this happens, then citizens demand good quality local services from their elected officials in exchange for

the taxes they pay. Thus, the demand for local accountability is created. Note that the link between local services

and taxes is broken when local governments are largely funded from out of transfers from the central government.

However, it is not expected that subnational government will be fully self-reliant. Nonetheless, many experts

agree that some degree of revenue autonomy is a necessary condition for fiscal decentralization to function in an

efficient manner. In other words, “subnational governments need to control their own revenues in order to

facilitate effective decentralized control of spending” and “control in this sense requires that they can affect the

volume of own revenues significantly at the margin through their own policy choices” for which they are publicly

responsible (Bird 1999).2 In this manner, greater reliance on own source revenues provides local governments

the incentive to spend in a more fiscally responsible manner and be more accountable to their constituents.

3

the pre-LGC period (like banks and other financial institutions, and printing/publication), the

size of the base of local taxes outside of the real property tax and the local business tax

continues to be insignificant as the bulk of the productive tax bases still rest with the central

government. The inadequacy of the tax bases assigned to LGUs is most pronounced in the case

of provinces and municipalities.

At the same time, LGUs have not fully maximized the local taxing powers that have been

assigned to them under LGC for a number of reasons (Manasan 200x, 2007; Talierco 2003).

One, the capacity of tax administration systems in many LGUs is weak not only in terms of the

technical capability of assigned personnel but also in terms of use of ICT. Two, the LGC

prescribes different tax rate schedule for different categories of firms. This situation tends to

increase administrative and compliance costs and further strains the capacity of an already

weak local tax administration (Taliercio 2003). Three, many LGU officials tend not to fully

utilize the tax powers assigned to them. For instance, many provinces and cities do not update

their schedule of market values of real property once every three years as prescribed by the

LGC.3 Also, few LGUs have revised their local tax codes since 1992 despite the fact that rate

of some of the taxes are not indexed to inflation. This development is reportedly due to the

resistance on the part of either the local chief executive or the local Sanggunian (or both) to

increase local tax rates in general for fear of a backlash from their constituents during election

time. It may also be due to the disincentive effect of the IRA distribution formula on local tax

effort (Manasan 2007).

Given this perspective, the direction of the review of revenue assignment under the LGC is

focused on the enhancement of LGUs’ revenue performance to promote autonomy and to

reduce their dependence on intergovernmental fiscal transfers. In this way, LGUs will have the

incentive to allocate public funds and deliver services in an effective and efficient manner. A

secondary objective of the reform relates to the use of tax policy to enhance local economic

development via promoting the ease and cost of doing business at the local level. The latter

objective has been espoused by the business sector, particularly the National Competitiveness

Council as well as local and foreign chambers of commerce. Many amendments related to

LGU taxing powers were taken up during the consultations. Two of the more important

proposals which have garnered significant support from various stakeholders are highlighted

below.4

Authority to Approve the Schedule of Market Value of Real Properties. Various amendments

to the LGC provisions related to the revenue raising powers of LGU were raised and considered

during the consultations (Table 1). Among these proposals, the one that received the most

support from various stakeholders and the one that has the greatest probability of passing

muster in Congress is the one related to the schedule of market value of real properties for tax

purposes. The proposal aims not only to help ensure that the schedule of market values will be

updated regularly in a timely fashion but also help promote the integrity and fairness of the real

property tax by strengthening the real property valuation standards. In specific terms, the

proposal will amend Section 212 and Section 214 of the Code so as to transfer the authority to

approve the schedule of market value (SMV) of real properties (which is used as the basis of

real property taxation) from the local Sanggunians to the Department of Finance while still

retaining the autonomy of provinces and cities to set tax rates and assessment levels. If the

3 The Code mandates that LGUs to conduct a general revision of market values once every three years with the

first one taking effect in 1994.

4 The other proposals are presented in Table 1 and are discussed in greater detail in Manasan and Avila (2014).

4

SMVs of all provinces and cities were to be fully updated, potential RPT revenues for all

provinces in the aggregate is estimated to increase by 97% (or PhP 9.6 billion) while RPT

revenues for all cities as group will increase by 138% (or PhP 40.8 billion) for a total of PhP

50.3 billion, other things being equal. Several bills supporting this proposal have already been

filed in Congress (e.g., House Bills 84 [Sarmiento], 490 [Biazon], 1060 [Gonzalez] and 1797

[Mercado], among others) and have advanced through the legislative mill having already been

approved by the House of Representatives (HOR) in plenary. The HOR version, in particular,

is supported by the DOF which has included it in its list of priority bills. On the other hand,

the proposed amendment was strongly supported by Local Chief Executives during the Luzon,

Visayas and Mindanao LGC consultations, many of whom see the proposal as an effective way

of helping divert the political flak from the updating of the schedule of market values. In

particular, the League of Cities passed a resolution during its November 2014 General

Assembly supporting this proposal. The proposal also got the general support of the business

sector. At the same time, this proposal has received the support of the business sector including

the Joint Foreign Chambers of Commerce.

Reform of local business tax. The other proposal that also received broad-based support is the

one that proposes to amend Section 143 of the LGC by simplifying the differentiated and

graduated local business tax structure that currently applies to different types of business

enterprises to a single flat tax rate not exceeding 1.5% of their gross receipts/ sales. This move

is justified on the grounds that the different graduated local business tax rate schedule for

different types of businesses complicates local tax administration. First, the present graduated

rate structure is regressive because it imposes higher effective tax rates on smaller businesses

relative to larger ones. Second, the disparities in effective tax rates with respect to the size and

the type of business tend to provide a venue for tax evasion. A study conducted under the

USAID INVEST Project in 2012 indicates that the effective tax rates in 66 cities that were

sampled was equal to 0.8% on the average, varying from 0.2% to 1.6%. The revenue impact

of the proposal is PhP 36 billion for cities and PhP 5 billion for municipalities. This proposal

was well-received during the LGU consultations in Luzon, Visayas and Mindanao. House Bill

3538 (Abu), which is consistent with the proposed amendment, has been filed in Congress.

However, while the business sector supports the shift to a uniform flat local business tax rate,

they indicated that the proposed maximum rate of 1.5% is on the high side.

2. Functional/ Expenditure Assignment

Lack of clarity in functional assignment. At present, NG-LG relations is weighed down by the

overlapping, and at times, unclear assignment of functions across various levels of government

(i.e., among the national government and the different levels of LGUs) and results in the waste

of resources. At the same time, numerous unfunded mandates results in relevant services either

not being delivered at all or not delivered in sufficient quantities. In either case, the welfare of

local communities is adversely affected.

To achieve greater clarity in functional assignment, it is proposed that Section 17 (a) of the

1991 LGC be amended by inserting a proviso that will differentiate between fully devolved

functions and delegated functions. Fully devolved functions are those for which LGUs are

tasked with the exclusive responsibility for service provision while delegated functions are

those for which the national government has primary responsibility for provision but which are

implemented by LGUs. Delegated functions are typically associated with services that support

national objective and/ or those that involve externalities. As such, delegated functions are best

financed through conditional transfers to ensure that they are not under-provided.

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LGUs officials exhibited strong support for the abovementioned proposal during the Luzon,

Visayas and Mindanao island-wide LGU consultations. The DBM likewise expressed its

support for the said proposal given its consistency with the department’s public financial

management reform initiatives. A detailed delineation of functions in key sectors (e.g., health,

environment and natural resources, and agriculture) is currently being undertaken at the behest

of League officials and DBM officials in order to operationalize the proposal in specific sectors.

Provision of LGU budget support to offices of national government agencies stationed in the

LGU. Still another proposal that received the strong support of LGU officials is one that will

rectify the current practice among LGUs of providing budget support/ “subsidy” to personnel

and offices of national government agencies that are stationed in the LGU. This practice puts

undue pressure on LGU finances. Such support typically takes the form of honoraria to national

government personnel in field offices of national government agencies and/ or MOOE support

in the form of travel/ transportation and supply expenses. The cost of said LGU subsidy to

national government agencies amounts to about 0.5%-2.0% of their budgets in 2012. During

the consultations, LGU officials were one in proposing to amend the Section 447, Section 458

and Section 468 by explicitly prohibiting LGUs from granting additional allowances and other

benefits to judges and other national government officials who are stationed in or assigned to

the municipality, city and province, respectively, given that these national government agencies

are supposed to get their budgets from under the General Appropriations Act.

3. Intergovernmental Transfers

Increase in the IRA. The perception that the IRA does not provide sufficient resources needed

by LGUs to deliver fully devolved services is very strong among LGU officials. Thus, it is not

surprising that the top-of-the-mind proposal of LGU officials with regards to amending the

LGC relates to amending Section 284 of the 1991 LGC so as to increase the IRA from the

current 40% share in national internal revenue taxes to any one of the following alternatives:

(i) 40% of national internal revenue taxes including those collected by the Bureau of Customs,

(ii) 40% of all national taxes, (iii) 50% of national internal revenue taxes, or (iv) 50% of all

national taxes. The incremental revenue impact (based on actual NG tax collections in 2012)

ranges from: (i) PhP 97 billion if the IRA is increased to 50% of national internal revenue taxes

collected by the BIR, (ii) PhP 98 billion with the inclusion of the exclusion of VAT/ excise

taxes collected by the BOC in computing the 40% share of LGUs in national internal revenue

taxes (i.e., Mandanas SC petition), (iii) PhP 115 billion if the IRA is increased to 40% of all

national taxes, (iv) PhP 220 billion if the IRA is increased to 50% of national internal revenue

taxes including VAT/ excise taxes collected by the BOC, and (v) PhP 240 billion if the IRA is

increased to 50% of all national taxes. There many bills filed at both Houses of Congress in

support of these proposals. In addition, Congressman Mandanas has petitioned the Supreme

Court to rule for the inclusion of the VAT and excise tax collections of the BOC in the

computation of the IRA. Given the significant implications on macroeconomic and fiscal

flexibility of the part of the national government, the Department of Finance is strongly

opposed to any increase in the IRA, making these proposals very contentious between the

national government and LGUs.

Improving the equalization feature of intergovernmental transfers. Intergovernmental transfers

in the Philippines are dominated by the IRA. The IRA has consistently been faulted by various

experts in that it tries to do many things at the same time – closing the vertical gap, equalizing

across LGUs, etc. – but it does none of them well. One of the more important criticisms of the

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IRA relates to its inability to sufficiently equalize across different levels of LGUs and across

LGUs within each level in the sense of providing more resources to LGUs with lower revenue

capacity relative to their needs and less to LGUs with greater revenue capacity relative to their

needs. The IRA has also been criticized because of its disincentive effects on local revenue

generation. To address these concerns, it is proposed that Section 3 (d) of the 1991 LGC be

amended to specifically introduce the principle that the share of LGUs in national taxes shall

take into account the disparities in the revenue raising capacity or revenue potential of LGUs

in line with their expenditure needs (i.e., for intergovernmental transfers to also have

equalization as an objective). The proposal received the strong support of Local Chief

Executives during the Luzon, Visayas and Mindanao consultations. Some officials of the

League of Cities and League of Provinces, however, wanted to be better clarified on the

measure that will be used to operationalize the concept of equalization. On the other hand,

while the fiscal oversight agencies of the national government are not averse to the idea of

increasing equalization, they expressed some concern regarding where to source the

equalization transfer, if it should imply an additional transfer.

4. LGU Borrowing

Subnational borrowing is an important source of local development finance if LGUs are to be

able to finance lumpy investments on local infrastructure. At present, the overall level of

subnational borrowing is low relative to international standards. It is also low relative to the

financing requirement for local infrastructure for much needed service delivery.

Certain provisions of the 1991 LGC also constrain LGU access to the credit and capital market.

Specifically, the preferential treatment given to government financial institutions (GFIs) as

LGU depository bank has been found to discourage the entry of private financial institutions

(PFIs) in the LGU credit market5 and, as a result, reduce competition and its potential to bring

down LGU borrowing cost. In line with this, LGU officials who attended the Luzon, Visayas

and Mindanao consultations have signified their strong support to the proposal to amend

Section 311 of the 1991 LGC so as to explicitly allow LGUs who will be borrowing from PFIs

to open depository accounts with said PFIs without any need for prior government approval.

This proposal has likewise garnered some support from the business sector. However, the DOF

has expressed some caution in pursuing this proposal because of perceived governance

concerns regarding certain PFI lending practices.

Central government procedural controls also appear to effectively limit LGU borrowing in the

Philippines. A number of studies have proposed modifications to the administrative regulations

on LGU borrowing to facilitate LGU access to credit finance.

However, given the twin goals of a good LGU debt regulatory framework (namely, (i) to

facilitate LGU borrowing, and (ii) to mitigate fiscal risks associated with LGU borrowing), two

proposals related to the risk mitigation aspects of the LGU debt regulatory framework have

been put on the table: (i) to amend Section 296 and Section 297 of the 1991 LGC so as to

explicitly limit the use of the proceeds of LGU borrowing to capital investments only; and (ii)

to amend Section 324 (b) of the Code so as to define the debt service ratio in relation to the net

operating surplus before interest payments and capital expenditures and not in relation to

regular income as provided for at present. The first proposal would align current practice with

the best practice in other countries. It has found some support from LGU officials in the Luzon

5 Banks generally prefer to lend to clients which maintain some deposits with them.

7

consultation. On the other hand, the second proposal addresses concerns (as articulated in the

a COA special audit report and a number of technical studies) that the present way of measuring

the debt service ratio does not adequately take into account the true capacity of LGUs to service

their debt given the preponderance of mandatory expenditures in the LGUs’ budgets.

5. Creation of LGUs

A growing trend in favor of the conversion of municipalities into cities and the breaking up of

existing provinces/ municipalities/ barangays into two or more new provinces/ municipalities/

barangays is evident since the passage of the 1991 LGC. This trend may be explained by: (i)

pressure from municipalities to become cities in order to obtain a larger IRA share, and (ii)

splitting of provinces, municipalities and barangays to create political space for local leaders.

However, such a trend tends to result in inefficiently sized jurisdictions.

At present, the requirements for the creation of new provinces, cities and municipalities are

governed by the 1991 LGC and are based on three criteria: (i) LGU income, (ii) population and

(iii) land area. The income requirement for the creation of new LGUs under the 1991 LGC is

based on total General Fund income in 1991 prices and is set equal to PhP 2.5 million in the

case of municipalities, PhP 20 million in the case of provinces and cities and PhP 50 million in

the case of highly urbanized cities.

In 2001, the income requirements for the creation of new cities was amended by Republic Act

9009 such it is now equal to PhP 100 million of total locally generated income in 2000 prices.

However, the income requirement for municipalities, highly urbanized cities and provinces set

out in the 1991 LGC has remained unchanged to date. Thus, LGU officials in the Luzon,

Visayas and Mindanao consultation signified their support to a proposal to align the income

requirement for the creation of municipalities, highly urbanized cities and provinces with that

of cities as per RA 9009. Related to this, House Bill 5021 (which proposes to increase the

income requirement for the creation of new municipalities to PhP 12.5 million in 2013 prices,

the income requirement for the creation of highly urbanized cities to PhP 250 million of total

locally generated income in 2000 prices and the income requirement for the creation of

provinces to PhP 200 million of total locally generated revenue in 2000 prices) was approved

by the House of Representatives and transmitted to the Senate in November 2014.

6. Interlocal Alliances and Cooperation

Inter-LGU cooperation is deemed necessary and critical when the delivery of devolved services

involves economies of scale (e.g., solid waste management and water supply) and/ or

externalities or spillover effects (e.g., coastal resource management and environmental

management). In the past, many attempts at inter-LGU cooperation have been hamstrung by

questions related to the financial management of the interlocal cooperation (e.g., how they will

manage funds they have contributed to the alliance, how they can access financing from the

credit markets). To address this constraint, it is proposed that Section 33 of the 1991 LGC be

amended so as to establish a regulatory framework governing the creation and operation of

inter-local cooperations (ILCs) including the registration of ILCs in a National Registry to be

administered a national government agency (e.g., DILG) which will vest ILCs thus registered

with a legal personality.

7. Fiscal Administration and Financial Management

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Sound public financial management (PFM) at the local level ensures accountability and

efficiency in the management of public resources, which is critical to improving the delivery

of local services. The approach to strengthening public financial management systems involves

improving the institutional arrangements and management practices in all the key elements of

the PFM system (i.e., revenue generation, budgeting, accounting, auditing, cash management,

debt management and public sector reporting on its financial operations) so as to create

incentives for better resource allocation, resource utilization and financial management.

A recent rapid appraisal of the LGU PFM system indicates that overall the system is weakest

in terms of (i) internal and external audit, (ii) policy-based budgeting, and (iii) accounting,

recording and reporting. To help address these weaknesses of the LGU PFM system, several

proposals that involve amendments to the 1991 LGC have been put forward.

One, it is proposed that the full disclosure policy which was first introduced by former DILG

Secretary Jesse Robredo and which requires LGUs to post on their websites and in conspicuous

places all statements/ documents relating to their revenues, expenditures, procurement, loans,

etc. be legislated to ensure that this practice becomes a permanent feature of the LGU PFM

system. This proposal will help promote increased accountability at the local level by ensuring

greater transparency in LGU operations. LGU officials who attended the LGU consultations

in Luzon, Visayas and Mindanao signified their strong support to this proposal. On the other

hand, a bill embodying this proposal has been filed at the House of Representatives.

Two, the DBM as part of its PFM reform initiative at the local level has propose the amendment

of Section 47 (b) of the 1991 LGC to exclude “internal audit” from the functions of the Local

Accountant and to insert a new section on the creation of an Internal Audit Service as a

mandatory unit in the LGU. This move is intended to strengthen internal control at the LGU.

During the LGU consultations, this proposal received some support from LGU officials.

Three, a trend favoring the creation of local economic enterprises (LEEs) is evident in recent

years. However, many local economic enterprises are found to be operating at a loss. In view

of this problem, the DBM is proposing to amend Section 22 (d) of the LGC such that the setting

up and operation LEEs shall be the subject of regulation to be issued by the national

government.

Fourth, many Local Sanggunians fail to pass the Appropriations Ordinance in a timely manner,

thereby reducing the predictability of local budgets and weakening the PFM at the local level.

To counter this problem, the DBM proposes to amend the 1991 LGC by imposing sanctions

(in the form of nonpayment of salaries and allowances of members of Local Sanggunians that

fail to enact the Appropriation Ordinance in time before the start of the Budget Year).

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Table 1. Proposed Amendments to the Fiscal Provisions of the Local Government Code of 1991, by Topic/ Issue and by Stakeholder Support

Issues

Proposed Amendment

Stakeholder’s Support/Opposition

Functional and Expenditure Assignments

Overlapping and, at times, unclear assignment of functions across various levels of government (NG and different levels of LGUs)

Unfunded mandates

Amend Section 17 (a) of the 1991 LGC by inserting a proviso that will differentiate between fully devolved functions and delegated functions o Fully devolved functions are those for

which LGUs are given the exclusive responsibility for service provision.

o Delegated functions are those for which the national government has primary responsibility for provision but which are implemented by LGUs. Delegated functions are typically associated with national objectives and/ or externalities

Delegated functions are best financed through conditional transfers

Consistent with PFM reform of NG Supported by DBM Strong support in principle from LGUs in

Luzon, Visayas and Mindanao consultations League officials want to see details of

delineation

LGU “subsidy” to national government agencies strain LGU finances

Amend Sections 447 (1) (xi), 458 (1) (xi), and 468 (1) (xi) of the 1991 LGC so as to explicitly prohibit LGUs from granting additional allowances and other benefits to judges, prosecutors, and other national government officials stationed in or assigned to the municipality, city and province, respectively.

Strong support from LGUs in Luzon, Visayas and Mindanao consultations

2

Issues

Proposed Amendment


Own-Source Revenue and Revenue Assignment

Outdated schedule of fair market value of real property in many provinces and cities

Need to strengthen real property valuation standards to promote integrity and fairness of RPT system

Amend Sections 212 and Section 214 so as to assign the approval of the schedule of market values of real properties situated in each province/ city/ MM municipality to the Department of Finance instead of requiring that schedule of market value be enacted into an ordinance by the local Sanggunians

Retain LGUs’ autonomy in setting assessment levels for RPT purposes (Section 218) and setting real property tax rates (Sections 232, 233, 235 and 236)

Revenue impact estimated to be equal to

PhP 50 billion per year, ceteris paribus

DOF priority bill Strong support from LGUs in Visayas and

Mindanao consultations o LCP National Assembly passed resolution

support this proposal Broad support from business sector

(including Joint Foreign Chambers of Commerce)

Consolidated version of various bills filed in Congress have been approved by the House of Representatives and transmitted to Congress

Different graduated local business tax rate schedule for different types of business complicates local tax administration

Structure is regressive, imposing higher effective tax rates on smaller businesses relative to larger ones

Disparities in effective tax rates with respect

to size and type of business tend to provide a venue for tax evasion

Amend Section 143 by simplifying the graduated business tax applicable to various types of businesses to a single tax rate not exceeding 1.5% of the gross sales/receipts of the preceding year for both cities and municipalities


PhP 41 billion per year

LGU support in Luzon, Visayas and Mindanao consultations

Some support from business sector (including European Chamber of Commerce [ECCP]) for flat LBT rate but thinks 1.5% is too high

House bill along this line filed in Congress (Cong. Abu)

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Issues

Proposed Amendment


Revenue from local taxes with peso-denominated tax rate (set at a maximum of PhP 300 for professional tax and PhP 500 for delivery vans in 1991) eroded by inflation over time

Insert paragraph in Sec. 191 of LGC: “In case of fixed taxes prescribed in this Code, the maximum allowable rate may be adjusted not more than once every 3 years based on the average annual inflation rate based on CPI as certified by the Philippine Statistics Authority


PhP 440 million

Some support from LGU Luzon consultation Business sector agree with indexation in

principle but argue that tax on delivery vans increase cost of doing business

LGU host of plantations of business enterprises with integrated production systems not able to receive share in local business tax

Impose local business tax on plantations and sugar centrals of business enterprises operating integrated production systems based on the value of production.


Business sector argue this will result in double taxation

Lack of administrative recourse for taxpayers in cases of disputes on local taxes ►current situation expensive for taxpayers because they have to go to court immediately

Amend Sec. 195 of the LGC on protest of assessment and Sec. 196 on claim for refund of tax credit to provide an administrative mechanism for appeal of the assessment of taxes decided by the local treasurer to the Department of Finance/Bureau of Local Government Finance.

Some support from business sector (e.g. PCCI and ECCP)

Some support from BLGF but point out that this will require strengthening of BLGF

4

Issues

Proposed Amendment


LGUs (particularly provinces) need more revenue productive taxes

Proposed amendment to community tax becomes more relevant if/ when proposals to reduce personal income tax rate succeeds to offset resulting reduction in IRA

Community tax – low but not insignificant

revenue yield

Amend Sec. 157 of the LGC to: o increase the community tax (to be

renamed residence tax) from P1 to P10 for every P1000 income for individuals

o remove the cap of P5,000 on tax due o and transfer the collection of the same

to the BIR

Delete Sec. 158 which imposes community tax on juridical persons


PhP 13 billion a year

LGUs not supportive of earlier proposals to abolish Community tax and would rather strengthen said tax

Some groups in the business sector prefer piggyback on marginal income tax rate; some think 1% is too high

Complaints of “exorbitant” local fees and charges

Complaints regarding too many fees and charges

Insert paragraph at the end of Sec. 147. “The Department of Interior and Local Government (DILG) and the Department of Finance (DOF) shall jointly issue guidelines to determine the amount of reasonable fees LGUs can impose (based on the cost of regulation, inspection and licensing using cost accounting framework)

Some support from business sector (including ECCP)

Support from BLGF

5

Issues

Proposed Amendment


The power to LGUs to levy other taxes, fees and charges on any base or subject not otherwise specifically enumerated or taxed under the provisions of the National Internal Revenue Code or other applicable laws (Section 129 and Section 186 of 1991 LGC) effectively results in an “open list” approach to local taxation creating problems to the business sector because of attempts of some LGUs to impose nuisance taxes with high compliance cost but little revenue yield in the aggregate

Amend Section 186 by specifying a closed positive list of local taxes with well-defined bases that LGUs can levy

ECCP supports clear taxation rules between national and local governments

Inconsistency between Sec. 192 of LGC and Article 282 of IRR

Need to clarify LGU power to grant tax incentives so as to prevent unnecessary loss of revenue

Amend Sec. 193 to read: Authority to local tax exemption privileges - Local governments units may, through ordinances duly approved, grant tax exemptions, incentives, or reliefs FOR THE PURPOSE OF PROMOTING OR ENCOURAGING INVESTMENTS IN THEIR JURISDICTIONS, under such terms and conditions as they may deem necessary, PROVIDED THAT THE DURATION OF SUCH INCENTIVES SHALL NOT EXCEED 5 YEARS FROM THE DATE OF REGISTRATION; PROVIDED FURTHER THAT SUCH INCENTIVE SHALL BE AVAILED ONLY ONCE.

Some support from business sector (particularly PCCI)

6

Issues

Proposed Amendment


Varying share of LGUs in gross income tax on locators

While LGUs did concur with establishment of ecozones, LGUs belatedly realize that their share from gross income is not enough given losses in LBT and/or RPT

Set share of LGUs in gross income tax equal to 3% (out of the 5% gross income tax on locators) uniformly for PEZA, other ecozones and TIEZA

Support from LGUs in Luzon and Visayas consultations

ECCP calls for an amendment that will set out a clear framework of the mechanism, structure and procedures that will ensure that revenues from the PEZAs mutually benefit PEZA and LGUs

Exemptions from LBT and RPT currently provided under the LGC erodes local tax revenue

Amend Sec. 193 by withdrawing exemptions or incentives granted to, or presently enjoyed by all persons, whether natural or juridical, including government-owned or controlled corporations and other similar government agencies IN THE PERFORMANCE OF THEIR PROPRIETARY FUNCTIONS, water districts, and electric cooperative (except those registered CDA)

Support from LGUs in Mindanao consultation

Intergovernmental Fiscal Transfers

Perception on part of LGUs that IRA does not provide sufficient resources needed for LGUs to deliver fully devolved services

Amend Sec. 284 of LGC such that the IRA shall be set equal to 40%-50% of all national taxes (i.e., including collections of both BIR and BOC in the base)

Incremental IRA will range from PhP 97 billion

to PhP 240 billion

Very strong support from LGUs ULAP supports that Sec. 284 be amended to

reflect that IRA be set equal to 50% of all national taxes

Many bills in House and Senate Mandanas petition pending at SC Opposition from DOF

7

Issues

Proposed Amendment


IRA does not assist fiscal equalization in the sense of providing more resources to LGUs with lower revenue capacity relative to their needs and less to LGUs with greater revenue capacity relative to their needs

Amend Section 3 (d) to specifically introduce principle that share of LGUs in national taxes shall take into account disparities in revenue raising capacity of LGUs in line with their expenditure needs (i.e., have equalization as an objective)

Support from LGUs in Luzon, Visayas and Mindanao consultations

Supported by ULAP

Many ad hoc grants implemented by NGAs allegedly in support of national objectives

Some debate on appropriateness of said

grants

Introduce provision in LGC to establish system of conditional transfers with well-defined cost-sharing provisions and performance indicators in support to delegated functions


Supported by ULAP DBM supports incentivized “block grants”

Limitations on utilization of share in national wealth esp. that related to share from energy related undertakings

Liberalize the utilization of the LGU share in national wealth by removing the fix share (80%) prescribed in Section 294 of the LGC to be devoted to lowering the cost of electricity in the LGU

Strong support from LGUs in Visayas and Mindanao consultations

LGU Borrowing and Credit Finance

Need to better manage fiscal risks arising from LGU borrowing

Delete Section 296 (b) of 1991 LGC which allows LGUs to borrow “for the purpose of stabilizing finances.” Also, amend Section 297 of 1991 LGC to explicitly prohibit LGU borrowing for non-capital expenditures (Golden Rule)

LGU support in Luzon consultation

8

Issues

Proposed Amendment


Need to better manage fiscal risks arising from LGU borrowing by aligning measurement of debt service ratio to LGUs’ true capacity to service their debt

Amend Section 324 (b) so as to define the debt service ratio not in relation to regular LGU income ratio as provided in LGC at present but in relation to the net operating surplus before interest payments and capital expenditures (i.e., current revenues less current expenditures net of interest payments) instead

Preference for gov’t financial institutions as LGU depository bank (Section 311 of LGC) ► discourages entry of private institutions in LGU credit market

Amend Sec. 311 so as to explicitly allow LGUs to open depository account in PFIs if LGUs will be borrowing from PFIs without any need for prior government approval


Some support from business sector (e.g., PCCI)

DOF does not support this

Some last termer LCEs tend to max out LGU borrowing capacity leaving incoming LCEs little leeway to undertake own development initiatives

Amend Sec. 297 providing for the mandatory public hearing and publication of proposed loan amount and purpose prior to Sanggunian authorization to secure loan

Some support from LGUs in Luzon, Visayas and Mindanao consultations for limits on borrowing of last termer LCEs

Some opposition from business sector (e.g., PCCI)

9

Issues

Proposed Amendment


Inter-local Cooperation

Inter-LGU cooperation deemed necessary and critical when delivery of devolved service involves: o economies of scale (e.g., solid waste

management, water supply) o externalities or spillover effects (e.g.,

coastal resource management, environmental management)

Attempts at inter-LGU cooperation to date have been hamstrung by questions related legal personality and how they will manage funds they have contributed to the alliance, how they can access financing from both credit and capital markets, etc.

Amend Sec. 33 of the LGC to establish regulatory framework for inter-local cooperation and alliances; register ILCs in a National Registry to vest ILC with legal personality

Some support from LGUs in Luzon an Mindanao consultations

Creation of LGUs

Growing trend in favor of… o conversion of municipalities to cities o Breaking up of existing provinces/

municipalities/ barangays into two or more new provinces/ municipalities/ barangays

Such a trend tends to result in inefficiently sized jurisdictions

Amend Secs. 442, 452, 461 to align the income requirements for the creation/conversion of a municipality, highly urbanized city, and province with that in RA 9009 which provides new income criteria for the creation of cities


House Bill 5021 has been approved by the House of Representatives and transmitted to the Senate in November 2014.

10

Issues

Proposed Amendment


Local Fiscal Administration

Need to ensure transparency in LGU operations for greater accountability

Legislate full disclosure policy for LGUs requiring them to post documents relating to income, expenditures, procurement, loans, etc. in conspicuous places for transparency


House bill file in Congress

Need to promote PFM by strengthening internal control

Amend Sec. 474 (b) to remove “internal audit service” as one of the functions of the Accountant

Insert an Article in Title V, Book III of the LGC on the creation of Internal Auditor as a mandatory position

Supported by DBM Some support from LGUs

Many Local Sanggunians fail to pass Appropriation Ordinance on or before the end of the fiscal year as mandated in Sec. 319 of the LGC

Amend Sec. 323 to mandate the holding of daily sessions, exclusive of Saturdays, Sundays and holidays, without additional remuneration for the sanggunian members, until the appropriation ordinance is approved, and no other business may be taken up during such sessions.

Supported by DBM

Many local economic enterprises are operating at a loss

Amend Section 22 (d), Book I to mandate that the setting up and operation of local economic enterprises (LEEs) shall be subject to regulation to be issued by the national government

Supported by DBM

RESULTS OF CONSULTATIONS ON AMENDING

THE FISCAL PROVISIONS OF THE 1991 LOCAL

GOVERNMENT CODE: POWER POINT

PRESENTATION

JANUARY 2015

THE REVIEW OF THE 1991 LOCAL GOVERNMENT CODE

Improving Lives Through Local Governance Reform: Transparency, Accountability and Better Services

PRESENTATION TO THE COORDINATING COMMITTEE ON DECENTRALIZATION

Results of Nationwide Consultations on

the Review of the Local Government

Code of 1991


Result of Consultations

Island-wide consultations in Luzon, Visayas and Mindanao

attended by close to 400 LGU chief executives, council

members, and officers

Smaller meetings with selected officials of Leagues of

Provinces, Cities, Municipalities, Vice Governors,

Councilors, Vice Mayors, ULAP, Provincial Board Members

Meetings with technical staff of ULAP, League of Provinces,

League of Cities and League of Municipalities

Consultations with business sector (PCCI, TMAP, BAP,

BPO sector, ECCP, JFCC, etc.)

Consultations with national government agencies

Scope of LGC Review

1. Expenditure assignment

2. Revenue assignment and taxing powers

3. Intergovernmental fiscal transfers

4. LGU borrowing and credit finance

5. Creation of LGUs

6. Inter-local cooperation/alliances

7. Fiscal administration


1. Expenditure Assignment

Expenditure Assignment – who does what?

Issue:

Overlapping and, at times, unclear assignment of functions across various levels of government (NG and different levels of LGUs) Results in waste of resources

Unfunded mandates Results in relevant services not being delivered at all or not

delivered in sufficient quantities

In either case, the welfare of local communities

is adversely affected.

Expenditure Assignment – who does what?

Proposed amendment Amend Section 17 (a) of the 1991 LGC by inserting a proviso that will

differentiate between fully devolved functions and delegated functions o Fully devolved functions are those for which exclusive responsibility for

service provision is assigned to LGUs. o Delegated functions are those for which the national government has

primary responsibility for provision but which are implemented by LGUs; delegated functions typically associated with national objectives and/ or externalities


Stakeholder support

Consistent with PFM reform of NG; Strong support in principle from LGUs in Luzon, Visayas and Mindanao consultations; League officials want to see details of delineation

* Studies now on-going with respect to functional assignment in health, environment and natural resources; study on agriculture to follow.


2. Own-Source Revenues

and Revenue Assignment

Own-source revenues and revenue assignment

Overarching issues

Lack of productive source of local revenues ► high LGU dependence on transfers ► weak revenue autonomy ► perverse incentives and weak accountability

Wide flexibility in taxes/ fees that LGUs are allowed to impose ► discourages prospective investors in local economy

Revenue assignment - Schedule of market value (SMV)

of real property

Specific issue Outdated schedule of fair market value of real property in

many provinces and cities o SMV at least 2 cycles behind in 59% of provinces & 72% of cities in

2014


Revenue assignment - SMV

Proposed Amendment



Revenue assignment - SMV

Impact If SMVs of all provinces and cities were to be fully updated,

potential RPT revenues for all provinces in the aggregate will increase by 97% (or PhP 9.6 billion) while RPT revenues for all cities as group will increase by 138% (or PhP 40.8 billion) for a total of PhP 50.3 billion, other things being equal

Stakeholder support DOF priority bill strong support from LGUs in Visayas and Mindanao

consultations o LCP National Assembly passed resolution support this proposal

General support from business sector Number of bills filed in Congress (e.g., Sarmiento bill)


3. Intergovernmental

Fiscal Transfers

Issue Perception on part of LGUs that IRA does not provide

sufficient resources needed for LGUs to deliver fully devolved services

Proposed amendment (from LGU consultations) Amend Sec. 284 of LGC such that the IRA shall be set equal to

40%-50% of all national taxes (i.e., including collections of both BIR and BOC in the base)

Intergovernmental Fiscal Transfers – IRA increase

Impact Incremental revenue impact (based on actual NG tax collections in

2012) o PhP 97 billion if the IRA is increased to 50% of national internal revenue taxes

collected by BIR o PhP 98 billion with the inclusion of VAT/ excise taxes collected by BOC in

computing 40% IRA share in national internal revenue taxes (i.e., Mandanas petition at the SC)

o PhP 115 billion if the IRA is increased to 40% of all national taxes o PhP 220 billion if the IRA is increased to 50% of national internal revenue taxes

including VAT/ excise tax collections of BOC o PhP 240 billion if the IRA is increased to 50% of all national taxes

Significant implications on macroeconomic flexibility Demand for increase may be mitigated by increase in LGU taxing

powers

Stakeholder support Very strong support from LGUs Many bills in House and Senate Mandanas petition pending at SC Opposition from DOF

Intergovernmental Fiscal Transfers – IRA increase

Issue IRA does not assist fiscal equalization in the sense of providing

more resources to LGUs with lower revenue capacity relative to their needs and less to LGUs with greater revenue capacity relative to their needs

Proposed amendment Amend Section 3 (d) to specifically introduce principle that

share of LGUs in national taxes shall take into account disparities in revenue raising capacity of LGUs in line with their expenditure needs (i.e., have equalization as an objective)

Intergovernmental Fiscal Transfers – Equalization grant

Impact can be designed and implemented in a marginal and

sequential manner so as not to harm any LGU in the process and without impacting negatively on NG flexibility

If distribution is calibrated relative to revenue capacity as measured by potential revenue, it will incentivize own-revenue generation

Stakeholder support Support from LGUs in Luzon, Visayas and Mindanao

consultation

Intergovernmental Fiscal Transfers – Equalization grant


4. LGU Borrowing

and Credit Finance

Overarching issues

Subnational borrowing important if LGUs are to be enabled to finance lumpy investments on local infrastructure

At present, subnational borrowing is low relative to LGU financing for local infrastructure

oNeed to streamline procedures governing LGU access to credit market


Issue Preference for gov’t financial institutions as LGU depository

bank (Section 311 of LGC) ► discourages entry of private institutions in LGU credit market o Greater competition has potential to reduce LGU borrowing cost

Proposed amendment Amend Sec. 311 so as to explicitly allow LGUs to open

depository account in PFIs if LGUs will be borrowing from PFIs without any need for prior government approval

Stakeholder support Strong support from LGUs in Luzon, Visayas and Mindanao Some support from business sector DOF does not support this

LGU Credit Finance – LGU deposits in PFIs

Issues

Inter-LGU cooperation deemed necessary and critical when delivery of devolved service involves: o economies of scale (e.g., solid waste management, water supply)

o externalities or spillover effects (e.g., coastal resource management, environmental management)

Attempts at inter-LGU cooperation to date have been hamstrung by questions related to how they will manage funds they have contributed to the alliance, how they can access financing from both credit and capital markets, etc.

Inter-LGU Alliances /Cooperation

Proposed amendment Establish regulatory framework for inter-local cooperation

and alliances; register ILCs in a National Registry to vest ILC with legal personality

Stakeholder support

Some support from LGUs in Luzon and Mindanao consultation

Inter-LGU Alliances /Cooperation


6. Creation of LGUs

Issues Growing trend in favor of…

o conversion of municipalities to cities o Breaking up of existing provinces/ municipalities/ barangays into

two or more new provinces/ municipalities/ barangays


Proposed amendment Align income requirements for the creation/conversion of

highly urbanized city, province and municipality with that in RA 9009 which provides new income criteria for the creation of cities

Stakeholder support Support from LGUs in Luzon, Visayas and Mindanao

Creation of LGUs


7. Local Fiscal

Administration

Issue Need to ensure transparency in LGU operations for greater

accountability

Proposed Amendment Legislate full disclosure policy for LGUs requiring them to

post documents relating to income, expenditures, procurement, loans, etc. in conspicuous places for transparency

Stakeholder support Strong support from LGUs in Luzon, Visayas and Mindanao

consultation House bill file in Congress

Local Fiscal Administration (1)

Issues Need to promote PFM by strengthening internal control

Proposed Amendment Amend Sec. 47 (b) to exclude “internal audit” from functions of

Accountant;

Insert Section on the creation of Internal Audit Service as a mandatory position

Stakeholder support Supported by DBM Some support from LGUs

Local Fiscal Administration (2)

Thank you very much!

MATRIX OF PROPOSED AMENDMENTS TO THE

FISCAL PROVISIONS OF THE 1991 LOCAL

GOVERNMENT CODE, BY TOPIC AND BY

STAKEHOLDER SUPPORT

1

Matrix of Proposed Amendments to the Fiscal Provisions of the Local Government Code of 1991, by Topic/Issue and by Stakeholder Support

Issues

Proposed Amendment


Functional and Expenditure Assignments

Overlapping and, at times, unclear assignment of functions across various levels of government (NG and different levels of LGUs)

Unfunded mandates

Amend Section 17 (a) of the 1991 LGC by inserting a proviso that will differentiate between fully devolved functions and delegated functions o Fully devolved functions are those for

which LGUs are given the exclusive responsibility for service provision.

o Delegated functions are those for which the national government has primary responsibility for provision but which are implemented by LGUs. Delegated functions are typically associated with national objectives and/ or externalities


Consistent with PFM reform of NG Supported by DBM Strong support in principle from LGUs in

Luzon, Visayas and Mindanao consultations League officials want to see details of

delineation

LGU “subsidy” to national government agencies strain LGU finances

Amend Sections 447 (1) (xi), 458 (1) (xi), and 468 (1) (xi) of the 1991 LGC so as to explicitly prohibit LGUs from granting additional allowances and other benefits to judges, prosecutors, and other national government officials stationed in or assigned to the municipality, city and province, respectively.


2

Issues

Proposed Amendment


Own-Source Revenue and Revenue Assignment

Outdated schedule of fair market value of real property in many provinces and cities





₱50 billion per year, ceteris paribus

DOF priority bill Strong support from LGUs in Visayas and

Mindanao consultations o LCP National Assembly passed resolution

support this proposal Broad support from business sector

(including Joint Foreign Chambers of Commerce)

Consolidated version of various bills filed in Congress have been approved by the House of Representatives and transmitted to Congress

Different graduated local business tax rate schedule for different types of business complicates local tax administration

Structure is regressive, imposing higher effective tax rates on smaller businesses relative to larger ones

Disparities in effective tax rates with respect

to size and type of business tend to provide a venue for tax evasion

Amend Section 143 by simplifying the graduated business tax applicable to various types of businesses to a single tax rate not exceeding 1.5% of the gross sales/receipts of the preceding year for both cities and municipalities


₱41 billion per year


Some support from business sector (including European Chamber of Commerce [ECCP]) for flat LBT rate but thinks 1.5% is too high

House bill along this line filed in Congress (Cong. Abu)

3

Issues

Proposed Amendment


Revenue from local taxes with peso-denominated tax rate (set at a maximum of ₱300 for professional tax and ₱500 for delivery vans in 1991) eroded by inflation over time

Insert paragraph in Sec. 191 of LGC: “In case of fixed taxes prescribed in this Code, the maximum allowable rate may be adjusted not more than once every 3 years based on the average annual inflation rate based on CPI as certified by the Philippine Statistics Authority


₱440 million

Some support from LGU Luzon consultation Business sector agree with indexation in

principle but argue that tax on delivery vans increase cost of doing business

LGU host of plantations of business enterprises with integrated production systems not able to receive share in local business tax

Impose local business tax on plantations and sugar centrals of business enterprises operating integrated production systems based on the value of production.


Business sector argue this will result in double taxation

Lack of administrative recourse for taxpayers in cases of disputes on local taxes ►current situation expensive for taxpayers because they have to go to court immediately

Amend Sec. 195 of the LGC on protest of assessment and Sec. 196 on claim for refund of tax credit to provide an administrative mechanism for appeal of the assessment of taxes decided by the local treasurer to the Department of Finance/Bureau of Local Government Finance.

Some support from business sector (e.g. PCCI and ECCP)

Some support from BLGF but point out that this will require strengthening of BLGF

4

Issues

Proposed Amendment


LGUs (particularly provinces) need more revenue productive taxes

Proposed amendment to community tax becomes more relevant if/ when proposals to reduce personal income tax rate succeeds to offset resulting reduction in IRA

Community tax – low but not insignificant

revenue yield

Amend Sec. 157 of the LGC to: o increase the community tax (to be

renamed residence tax) from P1 to P10 for every P1000 income for individuals

o remove the cap of P5,000 on tax due o and transfer the collection of the same

to the BIR



₱13 billion

LGUs not supportive of earlier proposals to abolish Community tax and would rather strengthen said tax

Some groups in the business sector prefer piggyback on marginal income tax rate; some think 1% is too high

Complaints of “exorbitant” local fees and charges

Complaints regarding too many fees and charges

Insert paragraph at the end of Sec. 147. “The Department of Interior and Local Government (DILG) and the Department of Finance (DOF) shall jointly issue guidelines to determine the amount of reasonable fees LGUs can impose (based on the cost of regulation, inspection and licensing using cost accounting framework)

Some support from business sector (including ECCP)

Support from BLGF

5

Issues

Proposed Amendment


The power to LGUs to levy other taxes, fees and charges on any base or subject not otherwise specifically enumerated or taxed under the provisions of the National Internal Revenue Code or other applicable laws (Section 129 and Section 186 of 1991 LGC) effectively results in an “open list” approach to local taxation creating problems to the business sector because of attempts of some LGUs to impose nuisance taxes with high compliance cost but little revenue yield in the aggregate

Amend Section 186 by specifying a closed positive list of local taxes with well-defined bases that LGUs can levy

ECCP supports clear taxation rules between national and local governments

Inconsistency between Sec. 192 of LGC and Article 282 of IRR

Need to clarify LGU power to grant tax incentives so as to prevent unnecessary loss of revenue

Amend Sec. 193 to read: Authority to local tax exemption privileges - Local governments units may, through ordinances duly approved, grant tax exemptions, incentives, or reliefs FOR THE PURPOSE OF PROMOTING OR ENCOURAGING INVESTMENTS IN THEIR JURISDICTIONS, under such terms and conditions as they may deem necessary, PROVIDED THAT THE DURATION OF SUCH INCENTIVES SHALL NOT EXCEED 5 YEARS FROM THE DATE OF REGISTRATION; PROVIDED FURTHER THAT SUCH INCENTIVE SHALL BE AVAILED ONLY ONCE.

Some support from business sector (particularly PCCI)

6

Issues

Proposed Amendment


Varying share of LGUs in gross income tax on locators

While LGUs did concur with establishment of ecozones, LGUs belatedly realize that their share from gross income is not enough given losses in LBT and/or RPT

Set share of LGUs in gross income tax equal to 3% (out of the 5% gross income tax on locators) uniformly for PEZA, other ecozones and TIEZA

Support from LGUs in Luzon and Visayas consultations

ECCP calls for an amendment that will set out a clear framework of the mechanism, structure and procedures that will ensure that revenues from the PEZAs mutually benefit PEZA and LGUs

Exemptions from LBT and RPT currently provided under the LGC erodes local tax revenue

Amend Sec. 193 by withdrawing exemptions or incentives granted to, or presently enjoyed by all persons, whether natural or juridical, including government-owned or controlled corporations and other similar government agencies IN THE PERFORMANCE OF THEIR PROPRIETARY FUNCTIONS, water districts, and electric cooperative (except those registered CDA)

Support from LGUs in Mindanao consultation

Intergovernmental Fiscal Transfers

Perception on part of LGUs that IRA does not provide sufficient resources needed for LGUs to deliver fully devolved services

Amend Sec. 284 of LGC such that the IRA shall be set equal to 40%-50% of all national taxes (i.e., including collections of both BIR and BOC in the base)

Incremental IRA will range from ₱97 billion to

₱240 billion

Very strong support from LGUs ULAP supports that Sec. 284 be amended to

reflect that IRA be set equal to 50% of all national taxes

Many bills in House and Senate Mandanas petition pending at SC Opposition from DOF

7

Issues

Proposed Amendment


IRA does not assist fiscal equalization in the sense of providing more resources to LGUs with lower revenue capacity relative to their needs and less to LGUs with greater revenue capacity relative to their needs

Amend Section 3 (d) to specifically introduce principle that share of LGUs in national taxes shall take into account disparities in revenue raising capacity of LGUs in line with their expenditure needs (i.e., have equalization as an objective)


Supported by ULAP

Many ad hoc grants implemented by NGAs allegedly in support of national objectives

Some debate on appropriateness of said

grants

Introduce provision in LGC to establish system of conditional transfers with well-defined cost-sharing provisions and performance indicators in support to delegated functions


Supported by ULAP DBM supports incentivized “block grants”

Limitations on utilization of share in national wealth esp. that related to share from energy related undertakings

Liberalize the utilization of the LGU share in national wealth by removing the fix share (80%) prescribed in Section 294 of the LGC to be devoted to lowering the cost of electricity in the LGU

Strong support from LGUs in Visayas and Mindanao consultations


Need to better manage fiscal risks arising from LGU borrowing

Delete Section 296 (b) of 1991 LGC which allows LGUs to borrow “for the purpose of stabilizing finances.” Also, amend Section 297 of 1991 LGC to explicitly prohibit LGU borrowing for non-capital expenditures (Golden Rule)

LGU support in Luzon consultation

8

Issues

Proposed Amendment


Need to better manage fiscal risks arising from LGU borrowing by aligning measurement of debt service ratio to LGUs’ true capacity to service their debt

Amend Section 324 (b) so as to define the debt service ratio not in relation to regular LGU income ratio as provided in LGC at present but in relation to the net operating surplus before interest payments and capital expenditures (i.e., current revenues less current expenditures net of interest payments) instead

Preference for gov’t financial institutions as LGU depository bank (Section 311 of LGC) ► discourages entry of private institutions in LGU credit market

Amend Sec. 311 so as to explicitly allow LGUs to open depository account in PFIs if LGUs will be borrowing from PFIs without any need for prior government approval


Some support from business sector (e.g., PCCI)

DOF does not support this

Some last termer LCEs tend to max out LGU borrowing capacity leaving incoming LCEs little leeway to undertake own development initiatives

Amend Sec. 297 providing for the mandatory public hearing and publication of proposed loan amount and purpose prior to Sanggunian authorization to secure loan

Some support from LGUs in Luzon, Visayas and Mindanao consultations for limits on borrowing of last termer LCEs

Some opposition from business sector (e.g., PCCI)

9

Issues

Proposed Amendment


Inter-local Cooperation

Inter-LGU cooperation deemed necessary and critical when delivery of devolved service involves: o economies of scale (e.g., solid waste

management, water supply) o externalities or spillover effects (e.g.,

coastal resource management, environmental management)

Attempts at inter-LGU cooperation to date have been hamstrung by questions related legal personality and how they will manage funds they have contributed to the alliance, how they can access financing from both credit and capital markets, etc.

Amend Sec. 33 of the LGC to establish regulatory framework for inter-local cooperation and alliances; register ILCs in a National Registry to vest ILC with legal personality

Some support from LGUs in Luzon an Mindanao consultations

Creation of LGUs

Growing trend in favor of… o conversion of municipalities to cities o Breaking up of existing provinces/

municipalities/ barangays into two or more new provinces/ municipalities/ barangays


Amend Secs. 442, 452, 461 to align the income requirements for the creation/conversion of a municipality, highly urbanized city, and province with that in RA 9009 which provides new income criteria for the creation of cities


House Bill 5021 has been approved by the House of Representatives and transmitted to the Senate in November 2014.

10

Issues

Proposed Amendment


Local Fiscal Administration

Need to ensure transparency in LGU operations for greater accountability

Legislate full disclosure policy for LGUs requiring them to post documents relating to income, expenditures, procurement, loans, etc. in conspicuous places for transparency


House bill file in Congress

Need to promote PFM by strengthening internal control

Amend Sec. 474 (b) to remove “internal audit service” as one of the functions of the Accountant

Insert an Article in Title V, Book III of the LGC on the creation of Internal Auditor as a mandatory position

Supported by DBM Some support from LGUs

Many Local Sanggunians fail to pass Appropriation Ordinance on or before the end of the fiscal year as mandated in Sec. 319 of the LGC

Amend Sec. 323 to mandate the holding of daily sessions, exclusive of Saturdays, Sundays and holidays, without additional remuneration for the sanggunian members, until the appropriation ordinance is approved, and no other business may be taken up during such sessions.

Supported by DBM

Many local economic enterprises are operating at a loss

Amend Section 22 (d), Book I to mandate that the setting up and operation of local economic enterprises (LEEs) shall be subject to regulation to be issued by the national government

Supported by DBM

REFORM OF LOCAL TAXING POWERS UNDER

THE 1991 LOCAL GOVERNMENT CODE

Rosario G. Manasan and Antonio A. Avila Jr. ADB Consultants

NOVEMBER 2014

i

TABLE OF CONTENTS

Page

LIST OF FIGURES ............................................................................................................... iii

LIST OF TABLES……………….………………………………………………………….iii

EXECUTIVE SUMMARY………………………………………………………………….iv

I. INTRODUCTION ............................................................................................................ 1

1. Revenue Autonomy and Efficiency Gains from Decentralization ........................ 1

2. Weak Revenue Autonomy in Philippine Decentralization .................................... 1

3. Reasons for weak revenue autonomy ...................................................................... 4

4. Objectives of the Review of Revenue Assignment under the LGC ...................... 8

II. REAL PROPERTY TAXATION ................................................................................ 8

1. Current Features of Real Property Taxation ......................................................... 8

1.1 Tax rates, assessment levels ................................................................................ 8

1.2 Preparation of schedule of market values, conduct of general revision, approval

thereof and collection of real property tax .......................................................... 9

1.3 Distribution of proceeds of RPT ....................................................................... 11

2. Assessment of Real Property Taxation ................................................................. 12

2.1 Trend in RPT revenues ...................................................................................... 12

2.2 Outdated and understated schedule of fair market value of real properties ...... 13

3. Direction of Reform in Real Property Taxation .................................................. 14

3.1 Increase in maximum allowable basic RPT rate ............................................... 14

3.2 Transfer of the authority to approve the SMVs of real properties .................... 14

3.3 Advantages of the House Bills on SMV ........................................................... 16

3.4 Revenue Impact ................................................................................................. 16

3.5 Stakeholder Support .......................................................................................... 17

III. LOCAL BUSINESS TAXATION ............................................................................. 17

1. Current Features of Local Business Taxes ........................................................... 17

1.1. Different graduated rate structures for the various types of businesses like

manufacturers, contractors, etc .......................................................................... 18

1.2 Preferential tax treatment of exporters and sale of essential commodities ....... 18

1.3 On the situs of the local business tax ................................................................ 19

2. Assessment of Local Business Taxation ................................................................ 19

ii

2.1 Trend in local business tax revenues ................................................................. 19

2.3 Effective tax rates of the graduated rates on various types of businesses ......... 21

2.4 On the Situs of the Business Tax ....................................................................... 22

2.5 Tax on peddlers ................................................................................................. 23

3. Direction of Reform in Local Business Taxation: Some Options towards

Simplification........................................................................................................... 23

3.1 Option 1: different single rate for each category of business ............................ 23

3.2 Uniform single Rate for all types of businesses ................................................ 23

3.3 Revenue effect of proposed reforms ................................................................. 24

IV. OTHER LOCAL TAXES, FEES AND CHARGES ................................................ 24

1. Local Taxes Levied at Peso-Denominated Tax Rates .......................................... 24

2. The Community Tax ............................................................................................... 25

2.1 Current features of the community tax on individuals ...................................... 25

2.2 Issues/ Problems in the Collection of the Community Tax ............................... 26

2.3 Proposed amendments to the community tax .................................................... 27

3. LGU Power to Levy Fees and Charges ................................................................. 27

3.1 Current provision on the power of LGUs to impose fees and charges .............. 27

3.2 Issues on the imposition of fees and charges .................................................... 28

3.3 Recommended Reforms on Fees and Charges .................................................. 29

4. Administrative Remedies on Protest of Assessment and Claim for Refund ..... 29

4.1. Current situation on taxpayer’s remedies .......................................................... 29

4.2 Issues/ problems on the taxpayer’s remedies .................................................... 29

4.3 Proposed amendment regarding taxpayer’s remedies ....................................... 30

5. Local Tax Exemptions and Tax Incentives ........................................................... 30

5.1 Current situation regarding LGUs’ Power to grant tax exemptions/incentives 30

5.2 Proposed Amendments to Sec. 192 of the LGC ................................................ 31

6. Withdrawal of Tax Exemptions/ Tax Incentives of GOCCs ............................... 31

6.1 Current situation and attendant issues ............................................................... 31

6.2 Proposed amendments related to the withdrawal of tax exemptions from

GOCCs in the LGC ........................................................................................... 32

V. CONCLUSIONS ......................................................................................................... 32

iii

List of Figures

Figure 1. Components of LGU Income as % of GDP, for All LGUs Combined, 1991-2013 .. 2

Figure 2. Composition of Total LGU Income for All LGUs Combined, 1991-2013 ............... 3

Figure 3. Components of LGU Income as % of GDP, by Level of Local Government, 1991-

2013............................................................................................................................................ 3

Figure 4. Composition of LGU Income, by Level of Local Government, 1991-2013 .............. 3

Figure 5. NG and LGU Tax Revenues as % of GDP, 1991-2013 ............................................ 5

Figure 6. Composition of Local Tax Revenue By Type of Tax, 1991-2013 ............................ 6

Figure 7. Local Tax Revenue of Provinces, Cities and Municipalities as % of GDP, 1991-

2013............................................................................................................................................ 7

Figure 8. Composition of Local Taxes, By Level of Local Government, 1991-2013 .............. 7

Figure 9. RPT Revenues of Provinces, Cities and Municipalities as % of GDP, 1991-2013 . 12

Figure 10. Local Business Tax Revenues, as % of GDP, 1991-2013 ..................................... 20

Figure 11. Revenues From Fees Relative to Cost of Issuing The Permit/ License .............. 288

List of Tables

Table 1. Taxes Assigned to Provinces, Cities And Municipalities and Barangays Under The

LGC............................................................................................................................................ 5

Table 2. Schedule of Assessment Levels for Real Properties for Purposes of The RPT ...... 101

Table 3. RPT Collection Efficiency, 1989-2013 .................................................................... 13

Table 4. Distribution of Provinces and Cities by Age of Real Property Values, as June 2014

.................................................................................................................................................. 13

Table 5. Cities with Basic RPT Rates Set At 2% ................................................................... 15

Table 6. Local Business Tax on Hypothetical Business Establishment with Annual Gross

Receipts of ₱500,000 ............................................................................................................... 18

Table 7. Effective Rate of Business Tax in Cities, by Business Type and Size ..................... 21

Table 8. Comparison of The Actual and Proposed Effective Tax Rate ................................ 244

Table 9. Net Community Tax Collection .............................................................................. 277

iv

EXECUTIVE SUMMARY

The subnational governments need to control their own revenues to facilitate effective

decentralized control of spending, in which they can affect the volume of own revenues

significantly through their own policy choices, for which they are publicly responsible (Bird

1999). Greater reliance on own-source revenues (OSR) provides local government units

(LGUs) the incentive to spend in a more fiscally responsible manner and be more accountable

to their constituents. The low local tax-to-GDP and OSR-to-GDP ratios of all LGUs and their

heavy reliance on fiscal transfers, particularly on the internal revenue allotment (IRA), is

indicative of the low degree of revenue autonomy of the LGUs in the country in the post-Local

Government Code (LGC) period.

The OSR of LGUs have started to show signs of stagnation after the initial up swell in

the early years of LGC implementation. Weak local revenue autonomy and high IRA

dependency is manifested by all levels of local governments because the LGC limits the power

of the LGUs to set local tax rates and the revenue productivity of assigned local tax bases is

also limited. The LGC fixes the tax rate of some of the taxes that are assigned to LGUs (e.g.,

special education fund, real property tax [RPT] and the community tax). Likewise, the size of

the base of taxes outside of the real property tax and the local business tax continues to be not

significant as the bulk of the productive tax bases still rest with the central government.

Given this perspective, the direction of the review of revenue assignment under the

LGC is focused on the enhancement of LGUs’ revenue performance to promote autonomy

rather than dependence on intergovernmental fiscal transfers. A secondary objective of the

reform relates to the use of tax policy to enhance local economic development via promoting

ease of doing business at the local level.

This paper aims to review and assess real property taxation in the Philippines as defined

in the LGC with the end in view of transforming RPT in a manner that will promote its

contribution to revenue autonomy of LGUs. In particular, the reforms on RPT include: (i)

increasing the maximum allowable basic RPT rate for provinces; and (ii) shifting the authority

to approve the schedule of market values of real properties as the basis of real property taxation

from the local Sanggunians to the national government (either the Department of Finance or

the proposed National Valuation Authority) in order to depoliticize the updating of said

schedule. The revenue yield of the latter amendment is estimated at ₱50 billion per year, ceteris

paribus. This was also well received by local chief executives who attended consultations with

LGU officials conducted in Luzon, Visayas and Mindanao in September 2014. Similarly,

House Bill 490, promoting fiscal autonomy of local governments to provide basic services by

enhancing their capacity to generate local revenues from the RPT, is considered a priority bill

by the DOF.

This paper also evaluates the local tax policy, local administration related to local taxes

and the setting of local fees and charges. In line with this, the following amendments to the

LGC are proposed with the aim of improving the revenue autonomy of LGUs: (i) imposition

of an ad valorem rate of a maximum 1.5% on the gross receipts/sales of the preceding year on

all types of business establishments, with estimated revenue yield of ₱41 billion per year; (ii)

adjustment of peso-denominated tax rates (e.g. professional tax and tax on delivery trucks and

vans) once every three (3) years based on the average annual inflation rate as certified by the

Philippines Statistical Authority, with estimated revenue yield of ₱440 million per year; and

v

(iii) transforming the community tax to be more productive by increasing the rate, removing

the cap on the tax per individual and transferring collection to the BIR, with estimated revenue

yield of ₱13 billion per year. Furthermore, this paper recommends a number of other

amendments aimed at improving tax administration and improving the overall business

environment and competitiveness of LGUs from the perspective of local economic

development. This concluding set of proposals, however, is generally neutral in terms of their

revenue impact.

1

REFORM OF LOCAL TAXING POWERS UNDER THE 1991 LOCAL

GOVERNMENT CODE

Rosario G. Manasan and Antonio A. Avila Jr.

I. INTRODUCTION

1. Revenue Autonomy and Efficiency Gains from Decentralization

The efficiency gains of decentralization are best realized when the local taxes (and/ or

user charges) that citizen/ voters pay and the benefits of that they receive as a result of local

spending are linked as closely as possible such that citizens/ voters essentially “pay” for the

public services they receive from their local governments (Bird 2000). When this happens,

then citizens demand good quality local services from their elected officials in exchange for

the taxes they pay. Thus, the demand for local accountability is created.

However, the link between local services and taxes is broken when local governments

are largely funded from out of transfers from the central government. It is not expected that

subnational government will be fully self-reliant. As such, transfers from the national

government remains as one of the building blocks on which decentralization is built. However,

many experts agree that some degree of revenue autonomy is a necessary condition for fiscal

decentralization to function in an efficient manner. In other words, “subnational governments

need to control their own revenues in order to facilitate effective decentralized control of

spending” and “control in this sense requires that they can affect the volume of own revenues

significantly at the margin through their own policy choices” for which they are publicly

responsible (Bird 1999).1 In this manner, greater reliance on own source revenues provides

local governments the incentive to spend in a more fiscally responsible manner and be more

accountable to their constituents.

2. Weak Revenue Autonomy in Philippine Decentralization

The low local tax-to-GDP ratio and OSR-to-GDP ratio of all LGUs in the aggregate as

well as their heavy reliance on fiscal transfers, particularly the IRA, is indicative of the low

degree of revenue autonomy of the LGU sector in the country in the post-LGC period. As

result, accountability at the local level is likely to continue to be rather weak. Given this, it is

not surprising that the Philippine Development Plan 2016-2020 has reiterated the call for the

strengthening of local accountability. Philippine fiscal decentralization is characterized by

weak revenue autonomy.

LGU own-source revenues (OSR), in general, and local taxes, in particular, have started

to show signs of stagnation if not deterioration after the initial up swell in the early years of

LGC implementation. Thus, after increasing from 0.8% of GDP in 1991 to an average of 1.2%

1 It may be noted that while revenue sharing with the central government (e.g., through block grants) may provide

LGUs with adequate own-source revenues, this scheme does not provide fiscal autonomy because subnational

governments do not have the power to affect the amount of shared revenues they receive. Central government

transfers may actually be perceived as having zero marginal costs to the local recipients, thereby resulting in less

efficient spending.

2

of GDP in 1997-2005, OSR of all provinces, cities and municipalities combined2 slipped to an

average of 1.1% of GDP in 2006-2013 (Figure 1). In like manner, after expanding significantly

from 0.5% of GDP in 1991 to an average of 0.9% of GDP in 1997-2005, local tax revenues of

all LGUs as a group contracted to an average of 0.8% of GDP in 2006-2013.

Figure 1. Components of LGU income as % of GDP, for all LGUs combined, 1991-

2013

Although a similar decline in the IRA-to-GDP ratio is evident in 2004-2013, LGUs

continue to be more dependent on the IRA relative to the period before the implementation of

the Local Government Code or LGC (Figure 1). After surging from 0.7% of GDP in 1991 to

an average of 2.2% of GDP in 1994-2011, the IRA of all LGUs in the aggregate declined to an

average of 2.0% of GDP in 2012-2013.3 As a corollary, the contribution of the IRA in total

LGU income of all LGUs as group rose from 40% in 1991 to 65% in 1994-2011 but waned

somewhat to 61% in 2012-2013. Thus, while IRA was almost equal to OSR for all LGUs as a

group in 1991, it has grown to about twice the size of OSR in 1999-2011 (Figure 2).

Weak local revenue autonomy and high IRA dependency is manifested by all levels of

local governments but is more muted in the case of cities. In particular, after increasing almost

imperceptibly from 0.14% of GDP in 1991 to 0.15% of GDP in 1993-2000, the OSR of all

provinces in the aggregate deteriorated to an average of 0.14% of GDP in 2001-2013, back to

pre-LGC level (Figure 3). This is a trend that is mirrored by similar movements in their local

tax revenues. But with their IRA growing at a faster pace, the share of OSR in total LGU

income of all provinces combined contracted from 33% in 1991 to 16% in 2001-2013 while

the share of their IRA rose from 45% to 81% (Figure 4). In like manner, the OSR of all

municipalities in the aggregate increased from 0.33% of GDP in 1991 to an average of 0.38%

in 1993-2000 but dipped to an average of 0.24% in 2001-2013, a level even lower than the pre-

LGC level (Figure 3). As is the case with provinces, the movement of municipal OSR appears

to be associated with similar movements in local tax revenues and increased dependence on

the IRA (Figure 4). In contrast, the increase in the OSR of all cities as a group is not only

more significant but also sustained. To wit, it went up from 0.33% of GDP in 1991 to a peak

of 0.82% of GDP in 2003 and subsequently stagnated at around 0.77% of GDP in 2001-2013.

Again, the movement in their OSR is associated with corresponding movements in their local

2 Barangays are not included in this analysis because of lack of consolidated barangay data either at BLGF or the

COA. Subsequently, this paper will use the term “all LGUs” when referring to financial data to mean “all

provinces, cities and municipalities,” the term “all LGUs.” 3 The decline in the IRA in 2012-2013 may be attributed to the deterioration in BIR collections in 2009-2010.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

% of GDP

IRA LGU OSR other Y, incl grants LGU tax

3

tax revenues, also, while dependence of all cities in the aggregate on IRA rose from 36% in

1991 to 45% in 2001-2013, it was less pronounced compared to that of provinces and

municipalities.

Figure 2. Composition of total LGU income for all LGUs combined, 1991-

2013

Figure 3. Components of LGU income as % of GDP, by level of local government,

1991-2013

Figure 4. Composition of LGU income, by level of local government, 1991-2013

IRA40%

OSR45%

Other, incl. grants

15%

1991

IRA65%

OSR33%

Other, incl. grants

2%

1994-2011

IRA61%

OSR36%

Other, incl. grants

3%

2012-2013

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

total OSR IRA LGU tax

% of GDP

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

IRA LGU tax total OSR

% of GDP All municipalities combinedAll provinces combined

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

IRA LGU tax total OSR

% of GDP All cities combined

4

3. Reasons for weak revenue autonomy

Limited taxing authority with respect to rate setting

The Local Government Code (LGC or the Code) explicitly enumerates 11 taxes that

LGUs may impose (Table 1). In addition to these 11 taxes, Section 186 of the Code also gives

LGUs to levy other taxes, fees or charges “on any base or subject not otherwise specifically

enumerated herein or taxed under the provisions of the National Internal Revenue Code.” In

contrast, Section 133 of the LGC contains the common limitations on the taxing powers of the

LGUs, i.e., the taxes, fees and charges that all LGUs are specifically not allowed to levy.

Many analysts have pointed out that the reasons why the tax assignment under the Local

Government Code scores low in terms of the revenue autonomy criterion (Manasan 2005,

Diokno 2012, ADB 2012). The LGC seriously limits their power to set local tax rates. One,

the Code fixes the tax rate of some of the taxes that are assigned to LGUs (like the SEF real

property tax and the community tax). Two, while LGUs do have some discretion in setting tax

rates in the case of other local taxes, the Code sets limits (i.e., floors and ceilings) on the tax

rates that LGUs may impose. Moreover, the maximum allowable rates appear to be low. For

instance, although the Local Government Code raised the ceiling rate for real property taxation

at the provincial level from 0.5% to1%, it withdrew the power of municipalities4 to impose

4 Municipalities in Metro Manila are still allowed to impose real property taxes.

IRA45%

OSR33%

Other, incl.

grants

22%

Provinces, 1991

IRA81%

OSR16%

Other, incl. grants

3%

Provinces, 2001-2013

IRA41%

OSR46%

Other, incl.

grants

13%

Munis, 1991

IRA77%OSR

20%

Other, incl.

grants

3%

Munis, 2001-2013

IRA36%

OSR58%

Other, incl.

grants

6%

Cities, 1991

IRA45%

OSR54%

Other, incl.

grants

1%

Cities, 2001-2013

5

such tax, thus maintaining the effective real property tax rate in provincial municipalities at the

pre-Local Government Code level (Manasan, 1992). In terms of real property assessment

levels, the LGC set maximum assessment rates for different classes of property whereas the

levels themselves were fixed in the pre-LGC period. The maximum assessment rates set under

the LGC are no higher and often significantly lower than the fixed assessment rates in the pre-

LGC period5, thereby resulting in the reduction in the effective assessment levels of residential

land, all types of buildings and all types of machinery, leading to a potentially substantial

reduction in real property tax revenues. Three, the Code mandates that tax rates can only be

adjusted once in 5 years and by no more than 10%. This provision is particularly restrictive

in the case of taxes (like the professional tax and the tax on delivery vans and trucks) whose

rates are specified in nominal peso terms. Clearly, the resulting adjustments will not allow

LGUs to maintain the real value of their revenues.

Table 1. Taxes assigned to provinces, cities and municipalities and barangays under the

LGC

Limited revenue productivity of assigned local tax bases

The Local Government Code authorizes LGUs to levy local taxes on a good number of

tax bases (including some which were not allowed under the Presidential Decree (PD) 231 and

Presidential Decree 464 during the pre-LGC period like banks and other financial institutions,

and printing/publication). However, despite these changes, the size of the base of taxes outside

of the real property tax and the local business tax continues to be not significant as the bulk of

the productive tax bases still rest with the central government. This point is illustrated starkly

in Figure 5 which shows how small LGU tax revenues (which never breached 1% of GDP in

1991-2013) are relative to national government tax revenues (which ranged from 12%-15% of

GDP during the same period) when measured in terms of GDP. Thus, the increase in the share

of LGUs in total tax revenues of the general government between the pre-LGC and the post

LGC period is small, from 3.7% in 1991 to an average of 6.2% in 1999-2013.

Figure 5. NG and LGU tax revenues as % of GDP, 1991-2013

5 The LGC also provided for the exemption of residential buildings with market value below P175,000 from real

property taxation.

Cities Provinces Municipalities Barangays

On Business x x x

On Real Property x x a/ a/

On Idle Lands x x

On Real Property Transfers x x

On Business of Printing and

Publication x x

On Franchise x x

On Sand, Gravel and

Other Quarry Resources x x a/ a/

On Amusement Places x x a/

On Professionals x x

On Delivery Vans and Trucks x x

On Community Tax x x b/

a/ Shares in proceeds of levy of province.

b/ Shares in proceeds of levy of municipalities

6

Although the LGC allows LGUs to impose 11 types of local taxes, only two of these

taxes are actually important in terms of revenue yield. In 1991, prior to the implementation of

the LGC, the RPT contributed the bulk (62%) of total local tax revenues, the local business tax

(37%) while other taxes account for the remainder (16%). In 2009-2013, the local business tax

gained more importance with the share of local business tax and RPT in total local tax revenues

about equal at 44% each while the share of other taxes went down to 12%.

The inadequacy of the tax bases assigned to LGUs is most pronounced in the case of

provinces and municipalities. The local tax-to-GDP ratio of provinces is not only the lowest

among that of provinces, cities and municipalities, it has also shown a declining trend in more

recent years. To wit, after increasing from 0.07% of GDP in 1991 to an average of 0.10% of

GDP in 1993-2000, local tax revenue of all provinces in the aggregate gradually dipped to

0.06% of GDP in 2013, a level that is even slightly lower than its 1991 level (Figure 7). In

like manner, after increasing sharply from 0.21% of GDP in 1991 to 0.41% of GDP in 1993,

local tax revenue of all municipalities combined persistently declined to 0.09% of GDP in 2013.

On the other hand, local tax revenue of cities as a group peaked at 0.69% of GDP in 2003 from

a low of 0.23% of GDP in 1991 but stagnated at around 0.61% of GDP thereafter. Moreover,

it appears that the LGC has redistributed local tax bases away from provinces and

municipalities in favor of cities (Figure 8). Thus, the share of cities in local tax revenues of all

LGUs combined increased from 46% in 1991 to an average of 76% in 2009-2013 while that of

provinces in local tax revenues of all LGUs combined decreased from 13% in 1991 to an

average of 9% in 2009-2013 and that of municipalities contracted from 41% to 15%.

Figure 6. Composition of local tax revenue by type of tax, 1991-2013

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

% of GDP

NG tax LGU tax

RPT, 61.5

Business tax, 37.1

Other taxes, 15.6

1991

RPT

Business tax

Other taxes

RPT, 43.9

Business tax, 44.4

Other taxes, 11.6

2009-2013

RPT

Business tax

Other taxes

7

Figure 7. Local tax revenue of provinces, cities and municipalities as % of GDP, 1991-

2013

Figure 8. Composition of local taxes, by level of local government, 1991-2013

The differences in the revenue performance of provinces, cities and municipalities may

partly be explained by differences in their tax bases as well as differences in their taxing

powers. Being more urbanized and having economies that are more market-based, the tax base

of cities tends to be more buoyant when compared to those of municipalities and provinces.

However, the changes in the own-source revenue effort of cities may also be explained by the

reclassification (i.e., the conversion) of a significant number of municipalities into cities in

more recent years. Manasan (2007) compared the revenue effort of the original 60 cities at the

time the Local Government Code was enacted with the revenue effort of all cities (including

those that have been converted from municipalities into cities following the implementation of

the Code) and found that almost all of improvement in the revenue effort of all cities in the

aggregate in the last half of the 1990s and early 2000s is due to the latter factor.

Less than optimal utilization of local taxing powers

Earlier studies have pointed out that LGUs have not fully maximized the utilization of

the local taxing powers that have been assigned to them under LGC (Manasan 200x, 2007;

Talierco 2003). First, many of the personnel assigned to the tax division are not well-equipped

technically for their tasks. Very few of these units have certified public accountants in their

rolls, thereby impairing their audit capability. Also, not many LGUs have computerized their

assessment and collection functions of their Local Treasurers Office. Two, the LGC prescribes

different tax rate schedule for different categories of firms. This situation tends to increase

administrative and compliance costs and further strains the capacity of an already weak local

-

0.100

0.200

0.300

0.400

0.500

0.600

0.700

0.800

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

% of GDP

Prov Cities Munis

Prov, 13.3

Cities, 46.0

Munis, 40.7

1991

Prov

Cities

Munis

Prov, 8.8

Cities, 75.9

Munis, 15.3

2009-2013

Prov

Cities

Munis

8

tax administration (Taliercio 2003). Three, many LGU officials tend not to fully utilize the tax

powers assigned to them. For instance, many provinces and cities do not update their schedule

of market values of real property once every three years as prescribed by the LGC.6 Also, few

LGUs have revised their local tax codes since 1992 despite the fact that rate of some of the

taxes are not indexed to inflation. This development is reportedly due to the resistance on the

part of either the local chief executive or the local Sanggunian (or both) to increase the tax rates

in general for fear of a backlash from their constituents during election. It may also be due to

the disincentive effect of the IRA distribution formula on local tax effort (Manasan 2007).

4. Objectives of the Review of Revenue Assignment under the LGC

Given this perspective, the direction of the review of revenue assignment under the

LGC is focused on the enhancement of LGUs’ revenue performance to promote autonomy

rather than dependence on intergovernmental fiscal transfers. In this way, LGUs will have the

incentive to allocate public funds and deliver services in an effective and efficient manner. A

secondary objective of the reform relates to the use of tax policy to enhance local economic

development via promoting ease of doing business at the local level. The latter objective has

been espoused by the business sector, particularly the National Competitiveness Council and

local chambers of commerce.

In this regard, this paper aims to review and assess real property taxation in the

Philippines as defined in the LGC with the end in view of transforming RPT in a manner that

will promote its contribution to revenue autonomy of LGUs. In particular, the reforms may

include: (i) increasing the maximum allowable basic RPT rate for provinces, and (ii) shifting

the authority to approve the schedule of market value of real properties as the basis of real

property taxation from the local Sanggunians to the national government (either the

Department of Finance (DOF) or the proposed National Valuation Authority).

The paper also evaluates the tax policy and local administration related to local business

taxes and other local taxes. In addition, it also considers problems related to the setting of local

fees and charges.

II. REAL PROPERTY TAXATION

1. Current Features of Real Property Taxation

1.1 Tax rates, assessment levels

Under the Local Government Code, the power to impose the real property tax belongs

to the provinces, cities and municipalities in the Metro Manila area. Thus, the LGC provides

that a province or city or a municipality within the Metropolitan Manila Area may levy an

annual ad valorem tax on real property such as land, building, machinery, and other

improvement at a rate not exceeding 1% of the assessed value of the real property in the case

of provinces or 2% in the case of cities or municipalities within the Metropolitan Manila Area.

In addition to the foregoing levy which is referred to as the basic real property tax, a province

or city, or a municipality within the Metropolitan Manila Area, may levy and collect an annual

6 The Code mandates that LGUs to conduct a general revision of market values once every three years with the

first one taking effect in 1994.

9

tax of 1% of the assessed value of real property, the proceeds of which shall accrue exclusively

to the Special Education Fund (SEF).

As indicated above, the tax base of the RPT is the “assessed value" or the taxable value

of a real property is the fair market value of the real property multiplied by the assessment

level. In turn, “assessment level” is the percentage that is applied to the fair market value to

determine the taxable value of the property. Real property is classified for assessment purposes

on the basis of its actual use and on the basis of a uniform classification within each local

government unit. The assessment levels to be applied to the fair market value of real property

to determine its assessed value shall be fixed by ordinances of the Sangguniang Panlalawigan,

Sangguniang Panlungsod or Sangguniang Bayan of a municipality within the Metropolitan

Manila Area, at the rates not exceeding the schedule provided in Table 2.

1.2 Preparation of schedule of market values, conduct of general revision, approval thereof

and collection of real property tax

The LGC provides that all real property, whether taxable or exempt, shall be appraised

at the current and fair market value7 prevailing in the locality where the property is situated. In

every province and city, including the municipalities within the Metropolitan Manila Area, the

provincial, city or municipal assessor are duty-bound to prepare and maintain an assessment

roll which shall list all real property, whether taxable or exempt, located within the territorial

jurisdiction of the local government unit concerned. Real property shall be listed, valued and

assessed in the name of the owner or administrator, or anyone having legal interest in the

property. When real property is assessed for the first time or when an existing assessment is

increased or decreased, the provincial, city or municipal assessor shall within thirty (30) days

give written notice of such new or revised assessment to the person in whose name the property

is declared.

The LGC also provides that the provincial, city or municipal assessor shall undertake a

general revision of real property assessments within two years after the effectivity of the LGC

Code (i.e., 1994) and every three years thereafter. Before any general revision of property

assessment is made as mandated under the LGC, the provincial, city and municipal assessor of

the municipalities within the Metropolitan Manila Area shall prepare a schedule of fair market

values for the different classes of real property situated in their respective local government

units and such schedule shall be enacted into an ordinance by the Sanggunian concerned.

Under the LGC, the real property tax for any year shall accrue on the first day of

January. The collection of the real property tax and the enforcement of the remedies provided

under the LGC is the responsibility of the city or municipal treasurer concerned. At the same

time, the provincial, city or municipal assessor is mandated to prepare and submit to the

treasurer of the local government unit, on or before the thirty-first (31st) day of December each

year, an assessment roll containing a list of all persons whose real properties have been newly

assessed or reassessed and the values of such properties.

7 Fair market value is defined as the price at which a property may be sold by a seller who is not compelled to

sell and bought by a buyer who is not compelled to buy.

10

Table 2. Schedule of assessment levels for real properties for purposes of the RPT

11

1.3 Distribution of proceeds of RPT

A. LAND

Class Assessment level

Residential 20%

Agricultural 40%

Commercial 50%

Industrial 50%

Mineral 50%

Timberland 20%

B. BUILDINGS AND OTHER STRUCTURES

Over Not Over

P175,000.00 0%

P175,000.00 300,000.00 10%

300,000.00 500,000.00 20%

500,000.00 750,000.00 25%

750,000.00 1,000,000.00 30%

1,000,000.00 2,000,000.00 35%

2,000,000.00 5,000,000.00 40%

5,000,000.00 10,000,000.00 50%

10,000,000.00 60%

Over Not Over

P300,000.00 25%

P300,000.00 500,000.00 30%

500,000.00 750,000.00 35%

750,000.00 1,000,000.00 40%

1,000,000.00 2,000,000.00 45%

2,000,000.00 50%

Over Not Over

P300,000.00 30%

P300,000.00 500,000.00 35%

500,000.00 750,000.00 40%

750,000.00 1,000,000.00 50%

1,000,000.00 2,000,000.00 60%

2,000,000.00 5,000,000.00 70%

5,000,000.00 10,000,000.00 75%

10,000,000.00 80%

Over Not Over

P300,000.00 45%

P300,000.00 500,000.00 50%

500,000.00 750,000.00 55%

750,000.00 1,000,000.00 60%

5,000,000.00 2,000,000.00 65%

2,000,000.00 70%

C. MACHINERIES

Class Assessment

Agricultural 40%

Residential 50%

Commercial 80%

Industrial 80%

D. SPECIAL CLASSES

Actual UseAssessment

Level

Cultural 15%

Scientific 15%

Hospital 15%

10%

10%

Local water districts

Government-owned or controlled

corporations engaged in the supply and

distribution of water and/or generation

and transmission of electric power

Assessment Levels

Assessment Levels

Assessment Levels

Assessment Levels

(4) Timberland

Fair market Value

Fair Market Value

Fair Market Value

Fair Market Value

(1) Residential

(2) Agricultural

(3) Commercial / Industrial

12

Thirty five percent of the proceeds of the basic real property tax imposed by the

province goes to general fund of the province, 40% to the general fund of the municipality and

25% to the barangay where the property is located hand while 70% the proceeds of the basic

real property tax imposed by the city goes to the general fund of the city, 15% to the barangay

where the property is located and 15% divided equally among all the barangays in the city. On

the other hand, 35% of the proceeds of the basic real property tax imposed by a municipality

within the Metropolitan Manila Area shall accrue to the Metropolitan Manila Development

Authority, 35% to the general fund of the municipality, 15% to the barangay where the property

is located and 15% is divided equally among all the barangay in the municipalities.

On the other hand, the entire proceeds from the additional one percent (1%) tax on real

property accruing to the Special Education Fund (SEF) imposed by the city is automatically

released to the city school boards. On the other hand, the proceeds from the additional 1% SEF

imposition of the province is divided equally between the provincial school board and the

municipal school board.

2. Assessment of Real Property Taxation

2.1 Trend in RPT revenues

Total RPT revenues of provinces, cities and municipalities combined grew 0.31% of

GDP in 1991 to 0.48% of GDP in 2003 but started to decline from thereon and stagnated at an

average of 0.35% of GDP in 2008-2013 (Figure 9). This trend is largely driven by a similar

movement in the case of all cities in the aggregate. In comparison, after increasing from 0.16%

of GDP in 1991 to 0.19% of GDP in 1992, RPT revenues of provinces and municipalities

combined declined persistently to a low of 0.09% of GDP in 2013.

Figure 9. RPT revenues of provinces, cities and municipalities as % of GDP, 1991-2013

The deteriorating trend in RPT revenues occurred despite some improvement in RPT

collection efficiency for both provinces (including municipalities) and cities alike (Table 3).

While a declining trend in RPT collection efficiency of both provinces and cities was seen in

0.000

0.100

0.200

0.300

0.400

0.500

0.600

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

% of GDP

all LGUs Cities Prov+Munis

13

1992-2000, some improvement is evident in 2007-2012 due perhaps to numerous initiatives

aimed at improving real property tax administration that were launched by the Bureau of Local

Government Finance (BLGF) and development partners.

Table 3. RPT collection efficiency a/, 1989-2013

2.2 Outdated and understated schedule of fair market value of real properties

The contraction in the RPT revenues in since 2003 when measure relative to GDP may

be attributed for the most part to the outdated and understated schedule of fair market value of

real properties that LGUs use as the basis of computing the tax due from the tax. As of June

2014, 24% of all provinces had schedules that are based on values that are at least 10 years old

while the comparable figure for cities is 40% (Table 4). As of the end of 2008, some 8% of

total number of provinces and cities for which there is data have approved their updated

schedule of fair market value of real properties for purposes of the RPT only once since the

implementation of the LGC. Although 23 provinces and 37 cities have approved updated

schedule of fair market value of real properties in 2010-2012, the number of LGUs which have

updated their schedule of fair market value only once has remained unchanged.

Moreover, many local assessors in 1992 pointed out that the ratio of the “true market

value” of real properties and the “fair market value” as enacted by ordinance lies between 3

and 5 (Manasan 1992). In like manner, a more recent study found that the value of land

obtained from records of sales transactions at the Register of Deeds is about 3.5 times as large

as the LGU approved schedule of fair market value in 2004 (LAMP 2004).

Table 4. Distribution of provinces and cities by age of real property values, as June

2014

All LGUs Prov Cities

1989-1991 b/ 58.2 54.4 63.1

1992-2000 b/ 55.4 49 59.7

2007 c/73.1 52.8 95.1

2008 c/71.5 58.9 78.3

2009 c/70.2 68.9 70.5

2010 c/76.4 64.8 82.4

2011 c/ 77.6 74.3 79.2

2012 c/ 83.3 77.9 85.9

c/ Author's estimates; considers total actual

collections (both the tax due for current year and

the tax due for prior years in case of delinquent

accounts)

a/ RPT collection efficiency defined as actual

collections as percentage of potential revenue.

b/ from Manasan 2007; estimate considers

actual collections of tax due for current year

only.

14

In turn, the rampant undervaluation of the LGU schedule of fair market value of real

property has been ascribed to the politicization of the process of updating the schedule of fair

market values by requiring that the same be legislated by local Sanggunians. This is so because

many elected local officials tend to veer away from appearing to impose higher taxes for fear

of losing in the elections. Moreover, Gonzalez8 argue that political influence in the updating

of the schedule of market value “is manifested in local officials in allowing minimal, selective

and subjective increases in valuations and frequent deferment of the general revision of

property assessments contrary to the provision of the LGC requiring revisions every three

years. Given this, it is unlikely the revision of the schedule of fair market values will be based

on purely technical considerations.

3. Direction of Reform in Real Property Taxation

The main thrusts of the reform of real property taxation main include (i) an increase in

the maximum allowable basic RPT rate that provinces may levy from 1% to 2% and (ii) the

transfer of the authority to approve the schedule of fair market value of real properties for

purposes of real property taxation from the local Sanggunians to the Department of Finance as

proposed in a number of bills [e.g., House Bills 84 (Sarmiento), 490 (Biazon), 1060 (Gonzalez)

and 1797 (Mercado), among others] that are currently filed in Congress.

3.1 Increase in maximum allowable basic RPT rate

An increase in the maximum allowable RPT rate for provinces may be justified on the

grounds that at present all provinces have already set their basic RPT rate at the maximum

allowable rate of 1%. In contrast, 20 out of 144 cities (or 19%) have set their RPT rates at the

maximum allowable rate of 2% (Table 5). On the other hand, the basic RPT rates of the rest

of the cities are either equal to or greater than 1% but less than 2% with the exception of one

city (General Santos City) which has a basic RPT rate of 0.38%.

3.2 Transfer of the authority to approve the SMVs of real properties

House Bills 84, 490, 1060 and 1797 bills seek to promote fiscal autonomy of local

governments to provide basic services by enhancing their capacity to generate local revenues

from the real property tax and by minimizing the politicization of real property taxation.

Specifically, these bills intend to achieve this by:

(a) separating the function of valuing or appraising of real properties from the functions of

tax policy and administration; and

(b) transferring the authority to approve the Schedule of Market Values (SMVs) of real

property which serve as the basis of the real property tax of provinces, cities and the

municipality within Metro Manila from the Sanggunian concerned to the Secretary of

Finance while still retaining with the local Sanggunians the authority to enact an

8 Explanatory Note of House Bill 1060.

Number % Number %

over 10 years 19 23.8 58 40.3

6 - 10 years 28 35.0 46 31.9

5 years or less 33 41.3 40 27.8

TOTAL 80 100.0 144 100.0

Provinces CitiesAge of real property

values

15

ordinance setting the appropriate assessment levels and tax rates in the province, city

or Metro Manila municipality.

Table 5. Cities with basic RPT rates set at 2%

In particular, House Bills 84 and 1060 propose to establish the Real Property Valuation

Service (RPVS) under the Bureau of Local Government Finance of the Department of Finance

(BLGF-DOF) which will be tasked with the following functions, among others:

(a) to develop, adopt, and maintain valuation standards consistent with generally accepted

valuation standards, regulations and specification for real property appraisal used for

tax and other purposes, and ensure compliance therewith by national government

agencies (NGAs), local government units (LGUs), and other concerned parties;

(b) to review for compliance with the real property valuation policies and standards and

recommend for approval of the Secretary of Finance the SMVs as prepared by the

provincial assessor together with municipal assessors, and city assessors, including the

municipal assessor of Metro Manila, for both local and national tax purposes;

(c) to maintain a roster of government appraisers and assessors; and

(d) to develop and maintain a comprehensive and up-to-date electronic database of real

property transactions and prices of materials for buildings, machinery, and other

structures.

Provincial assessors together with municipal assessors, and city assessors, including

the municipal assessor in Metro Manila, shall prepare the SMVs for the different classes of

real property situated within their respective local government units, pursuant to the valuation

standards, rules, regulations and other specifications set by the BLGF-DOF. The said SMVs

shall be submitted by the assessor concerned, copy furnished the provincial governor or the

city mayor, as the case may be, and the concerned Sanggunian, to the BLGF Regional Office

for review and compliance with other requirements not later than the thirty first (31st) day of

October of the immediately preceding calendar year the general revision of real property

assessments shall be undertaken. The said SMVs shall be reviewed by the BLGF Regional

Office within thirty 30) days upon receipt thereof, and shall then be submitted by the same to

the BLGF Central Office. Upon the recommendation of the BLGF Executive Director, the

Secretary of Finance shall approve the SMV within sixty (60) days from receipt of the same;

otherwise, said schedule shall be deemed approved.

NCR Region III

Makati a/ Angeles

Mandaluyong a/ Olongapo

Manila a/ Region IV-B

Muntinlupa a/ Puerto Princesa

Navotas a/ Region VI

Pasay a/ Bago

Pasig a/ La Carlota

Quezon City a/ Region VII

CAR Cebu

Baguio Toledo

Region I Region VIII

Dagupan Calbayog b/

Laoag

San Fernando, La Union

a/ for real properties classified as commercial or industrial

a/ for real properties classified as commercial, industrial or special

16

The SMV as approved by the Secretary of Finance shall be transmitted to the concerned

assessor who shall confer with the local chief executive regarding the said approved SMV.

Likewise, the concerned assessor shall submit to the local chief executive a tax impact report

of the new SMV as against the existing assessment levels and tax rates, and shall provide the

Sanggunian, through the Chairman of the Committee on Ways and Means, a copy of such

report. The local chief executive shall transmit the approved SMV together with the tax impact

report within fifteen (15) days from receipt of the same to the Sanggunian for the enactment

of an Ordinance setting the appropriate assessment levels and tax rates. The concerned

Sanggunian shall enact such Ordinance, upon conduct of public hearings and proper

consultation, within sixty (60) days from receipt thereof; otherwise, the existing Ordinance on

assessment levels and tax rates shall remain in force and effect.

3.3 Advantages of the House Bills on SMV

First, the establishment and maintenance of valuation standards that would govern real

property valuation in the Philippines will promote integrity and fairness in the valuation and

appraisal practices in the country. Second, the adoption of the SMV as the single valuation base

for all national and local real property-related taxes will not only make taxation more equitable

but it will also minimize confusion in the minds of taxpayers. At present, there are two systems

of valuing real properties for taxation purposes. For property-related taxes collected by the

Bureau of Internal Revenue like the Capital Gains Tax, Estate Tax, Donor's Tax and

Documentary Stamp Tax, the Schedule of Zonal Values prepared by the Bureau of Internal

Revenue (BIR) or the SMVs of the LGUs, whichever is higher, is applied. LGUs, on the other

hand, prepare, legislate and implement their own SMVs on which the assessment of real

properties for local tax purposes is based. However, differences in the valuation methodologies

and procedures adopted by the BIR and the LGUs as well as differences in the dates of revision

or adjustment of values, have resulted to differences in the values used for taxation purposes.

Also, local assessors tend to operate independently of one another partly because of inadequate

technical supervision on valuation matters. As a result, large disparities between the SMVs

used by LGUs and BIR Zonal Values tend to reduce the credibility of the tax system especially

when different values are attributed to the same property. At the same time, the SMVs of

different LGUs are not consistent with one another, thereby making the system inequitable.

Also, an apparent duplication of effort is evident in the preparation of the LGU SMVs, on the

one hand, and the BIR’s Zonal Values, on the other hand, along parallel tracks.

Institutional arrangements. As indicated above, House Bills 84 and 1060 call for the

establishment of the RPVS under the BLGF-DOF to essentially lead, manage, review and

recommend the SMVs that are prepared by provincial/ municipal/ city assessors. In contrast,

House Bills 490 and 1797 propose the creation of the National Valuation Authority to

undertake the same functions that HB 84 and HB 1797 assigns to the RPVS. In this respect,

HB 84 and HB 1060 have an edge over the other two house bills because the BLGF-DOF do

possess some well-established expertise on real property valuation.

3.4 Revenue Impact

Closer scrutiny of the increases in the SMVs of the various provinces and cities which

conducted general revisions of their SMVs in 1993-2012 suggests that on the average the SMVs

of said provinces and cities rose by 7.0%-7.5% yearly in 1993-2012. If the SMVs of all

17

provinces and cities were to be fully updated, potential RPT revenues for all provinces in the

aggregate would have increased by 97% (or ₱9.6 billion) in 2012 while that of all cities as a

group will expand by 138% (or ₱40.8 billion) for a total of ₱50.3 billion, ceteris paribus. If

one takes into account the undervaluation of the LGUs’ SMVs relative to real property sales

data as reflected in deed of sales submitted to the Register of Deeds, RPT revenues may

increase by almost 8-fold as a result of the HBs 84 and 1060.

3.5 Stakeholder Support

The proposal to separate the function of valuing or appraising of real properties from

the functions of tax policy and tax administration and to transfer the authority to approve the

Schedule of Market Values (SMVs) of real property (which is used as the basis for the

assessment of the real property tax of provinces, cities and Metro Manila municipalities from

the Sanggunian concerned to the Secretary of Finance appears to have the support of many

sectors. The proposal was well received by Local Chief Executives who attended consultations

with LGU officials conducted in Luzon, Visayas and Mindanao in September 2014. On the

other hand, HB 490 is considered a priority bill by the Department of Finance.

III. LOCAL BUSINESS TAXATION

1. Current Features of Local Business Taxes

Prior to the passage of the LGC, various laws were authorized municipal councils,

municipal district councils and cities councils to impose the municipal license taxes or what is

now known as the local business tax. The latest of those laws was PD 231, as amended by PD

426 otherwise known as the Local Tax Code (LTC) of 1973 that provided a detailed

enumeration of the tax bases which LGUs could tap.

The LGC of 1991 (RA 7160), the law currently governing business taxation introduced

significant changes in the tax, among which are:

(i) The lifting of some limitations on the taxing powers of LGUs allowing them to impose

business tux on forest concessionaires, operators of motorized tricycles, etc.;

(ii) Withdrawal of some exemptions or incentives enjoyed by persons and corporations

including government-owned and controlled corporation (GOCCs);

(iii) Increase in the graduated tax rates based on the amount of gross receipts/sales during

the preceding year for manufacturers wholesalers and contractors;

(iv) Allowing the imposition of the business tax at a maximum rate of 2% for municipalities

and 2.5% for cities on a base or subject not otherwise specifically enumerated in the

LGC or taxed under the provisions of the National Internal Revenue Code (NIRC), as

amended, or other applicable laws; and

(v) The number of categories used to classify business enterprises for local business tax

purposes was reduced from 23 to only 8 under the LGC as a result of the merging of

some types of businesses under a single category and the reclassification of others under

more general categories or under the catch-all category. Businesses now merged with

other groups include rice and corn, tobacco dealers, amusement places, hotels and

motels, etc. Retailers were formerly part of the wholesalers group but are now treated

separately. Exporters are merged with businesses dealing in essential commodities and

boarding houses, hotels and motels are now grouped under a more general category of

contractors.

18

1.1. Different graduated rate structures for the various types of businesses like

manufacturers, contractors, etc.

In terms of structure, the local business tax under the LGC takes various forms

depending on the type of business. The local business tax that the LGC allows cities and

municipalities to impose on the majority of local businesses (specifically, manufacturers,

wholesalers, exporters and those engaged in essential commodities and contractors) applies (i)

a graduated specific rate structure on annual gross receipts/ gross sales of business

establishments provided said gross receipts/ gross sales do not exceed a given amount and (ii)

an ad valorem rate on gross receipts/ gross sales of business establishments whose gross

receipts/ sales exceed the said given amount. On the other hand, the LGC mandates that a

two-tiered ad valorem tax be imposed on retailers and a single ad valorem rate be levied on

banks and other financial institutions. Lastly, the LGC calls on cities and municipalities to

impose a specific (or per unit) tax of ₱50 on peddlers. However, the LGC does not provide for

a well-defined tax rate structure for businesses that are not currently specified in therein.

The graduated tax rate schedule for manufacturers has 20 brackets, that for wholesalers

has 24 and that for contractors has 19. The initial gross receipts brackets also differ, viz.: less

than ₱10,000 for manufacturers, less than ₱l,000 for wholesalers and less than ₱5,000 for

contractors.

The tax rates applicable to various business groups with the same gross sales/receipts

also differ. For example, for a gross receipts of P500,000, the maximum rates applicable is

highest for contractors whose tax due is ₱9,250, followed by retailers with tax due of ₱9,000,

and manufacturers ₱8,000, etc. (Table 6).

Table 6. Local Business Tax on Hypothetical Business Establishment with Annual

Gross Receipts of ₱500,000

Manufacturers ₱8,000

Wholesalers 6,600

Retailers 9,000

Exporters and those engaged in

essential commodities as;

- Manufacturers P4,000

- Wholesalers 3,300

- Retailers 4,500

Contractors 9,250

Banks 2,500

1.2 Preferential tax treatment of exporters and sale of essential commodities

The LGC provides preferential treatment (in the sense of taxing them at reduced rates

relative to other businesses) to exporters and businesses dealing in essential commodities.

Thus, the LGC sets the applicable local business tax on exporters and businesses dealing in

essential commodities to be equal to one-half (1/2) of the rates prescribed for manufacturers,

19

wholesalers or retailers, as the case may be. The LGC adds rice and corn to the list of essential

commodities in PD 231 while it excluded locally manufactured fabrics and firewood from the

same list. Moreover, the preferential tax treatment on exporters applies only to their export

sales.

1.3 On the situs of the local business tax

Sec. 150 of the LGC provides the following situs of the business tax.

(i) Businesses maintaining or operating branch or sales outlet elsewhere shall record the

sale in the branch or sales outlet making the sale or transaction, and the tax thereon shall

accrue and shall be paid to the municipality where such branch or sales outlet is located.

(ii) In cases where there is no such branch or sales outlet in the city or municipality where

the sale or transaction is made, the sale shall be duly recorded in the principal office

and the taxes due shall accrue and shall be paid to such city or municipality.

(iii) The following sales allocation shall apply to manufacturers, assemblers, contractors,

producers, and exporters with factories, project offices, plants, and plantations in the

pursuit of their business:

(a) Thirty percent (30%) of all sales recorded in the principal office shall be

taxable by the city or municipality where the principal office is located; and

(b) Seventy percent (70%) of all sales recorded in the principal office shall be

taxable by the city or municipality where the factory, project office, plant, or

plantation is located.

(c) In case of a plantation located at a place other than the place where the factory

is located, said seventy percent (70%) mentioned above shall be divided as

follows:

(1) Sixty percent (60%) to the city or municipality where the factory is

located; and

(2) Forty percent (40%) to the city or municipality where the plantation is

located.

(d) In case where a manufacturer, assembler, producer, exporter or contractor has

two (2) or more factories, project offices, plants, or plantations located in

different localities, the seventy percent (70%) mentioned above shall be

prorated among the localities where the factories, project offices, plants, and

plantations are located in proportion to their respective volume or production

during the period for which the tax is due.

2. Assessment of Local Business Taxation

2.1 Trend in local business tax revenues

Total revenues from the local business tax of all cities and municipalities combined

grew sharply from 0.14% of GDP in 1991 to 0.33% of GDP in 1997 but stagnated at around

that level until 2009 before showing increased buoyancy in 2010-2013 (Figure 10). Said

movement appears to be largely driven by the movement of local business tax revenues in

cities. In contrast, after improving from 0.07% of GDP in 1991 to 0.09% of GDP in 1996,

local business tax revenues of municipalities exhibited a well-defined downtrend starting in

1997 to a low of 0.03% of GDP in 2013. The increase in local business tax revenues of all

cities as a group may be attributed to the conversion of municipalities to cities and partly, by

the faster rate of growth of the market economy in cities relative to that in municipalities. This

20

trend has resulted in the contraction in the share of municipalities in total local business taxes

from a peak of 54% in 1993 to a low of 8% in 2013.

Figure 10. Local business tax revenues, as % of GDP, 1991-2013

2.2 Graduated tax schedule and business grouping complicates tax administration

The LGC marked a shift in government policy with regards to the local business tax.

Thus, while formerly, the municipal license tax was used as an instrument to regulate economic

activities, the LGC transformed the tax to a turnover tax. It reduced the number of categories

used to classify different types of business enterprises for local business tax purposes from 23

to 8 by grouping together business enterprises in similar activities so as to simplify and make

the local business tax more uniform.

A NTRC study9 conducted in 1991 pointed out that the weaknesses brought about by

the imposition of differentiated tax rates on different types of business First, differentiated tax

rates makes for a complicated tax structure and increases administrative as well as compliance

costs and further strains the capacity of an already weak local tax administration. Second, the

structure tends to be regressive, i.e. firms with higher levels of gross receipts are taxed at lower

effective rates. Third, the significant differences in tax burden among taxpayers with the same

gross receipts across different business groups tend to promote inequity. Said disparities also

tend to provide a venue for tax evasion as it provides businesses the incentive to be classified

under categories that subjected to lower-tax rates.

Because of the differentiated rate structure for different types of businesses, the

assessment and collection of the local business tax became more complicated for

establishments engaged in multiple types of businesses. For instance, a diversified business

like a supermarket engaged in wholesaling, retailing and operating cafeteria must declare the

gross receipts for each category of business and separate the sales of essential commodities. In

addition, the said business establishment will have to secure a Mayor’s permit for each type of

business i.e. as wholesaler, retailer and cafeteria. Adding to the complication of tax

administration is the various requirements for securing Mayor’s permit like barangay

clearance, zoning/locational clearance, fire safety inspection permit, sanitary permit, health

clearance/certificate, environmental clearance certificate, among others. Then, the owner will

pay the Mayor’s permit fee for each of type of business.

9 National Tax Research Center, “An Analysis of the Local Business Tax Structures Under the Local Government

Code of 1991”, an unpublished study conducted in 2001.

0.000

0.050

0.100

0.150

0.200

0.250

0.300

0.350

0.400

0.450

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

% of

GDP

All LGUs cities muni

21

2.3 Effective tax rates of the graduated rates on various types of businesses

Based on the graduated business tax schedule prescribed in the LGC, the statutory

effective tax rates vary according to annual gross receipts of various business establishments.10

In the case of manufacturers, the statutory effective rates range from 0.375% for firms whose

annual gross receipts are such that they belong to the top gross receipts bracket to 3.3% for

firms whose annual gross receipts are such that they belong to the bottom gross receipts bracket.

On the other hand, in the case of wholesalers, the effective tax rate varies from 0.5% to 3.6%

while in the case of contractors, it varies from 0.5% to 1.8%. It is emphasized that the statutory

effective rates are regressive because the effective rates generally decline as the gross receipts

of the business establishment increases (Annex A).

A study conducted by the National Tax Research Center in 2001 revealed that the

overall average ETRs of municipalities and cities were only 0.531% and 0.517% based on the

1999 collections. The proportion of the base that is captured as tax by LGUs is, therefore, less

than half of the average effective rates set by the Code. The NTRC study explained that this

was partly due to the fact that some LGUs were imposing rates lower than the maximum

prescribed by the Code. Moreover, tax evasion in the form of under declaration of sales is still

the foremost problem on business tax administration as pointed out by the respondent

treasurers.

It can also be observed using the NTRC survey data that the over-all effective tax rate

in municipalities is slightly higher at 0.531% compared to that cities’ ETR of 0.517% in spite

of the fact the cities can impose tax rates that are 50% higher than the rate allowed for

municipalities. The NTRC study acknowledges the possibility that the rates adopted are lower

than the maximum prescribed in the LGC. However, this is true only if the gross receipts/sales

of the business is already in the highest bracket where the LGC prescribes the maximum rate.

Thus, it can be surmised, therefore, that the higher effective rate in municipalities compared to

cities is better explained by the fact that businesses in municipalities are small or micro

enterprises which are subject to the higher statutory effective rate. Conversely, this also implies

that most of the big businesses are located in cities.

A more recent study conducted by the USAID INVEST Project11 indicated that the

effective tax rates in 66 sample cities nationwide vary by type and size of the business ranging

from 0.18% to 1.6%. Consistent with the results of the 2001 NTRC study, it shows that the

effective tax rates tend to be regressive because the tax burden of micro enterprises are

generally higher compared to the medium and large enterprises (Table 7).

Table 7. Effective Rate of Business Tax in Cities, by Business Type and Size a/

Business Type Industry Business

Size

Gross

Receipt

Business Tax

(Average)

Effective

Rate

(%)

1. Packaging

Plant

Manuf’ring Large P1 B ₱1,788,507.67 0.1789

10 The effective tax rate (ETR) as used in this study is the amount of tax over gross receipts/sales. Generally, it

is indicative of the tax burden of a business since it measures the proportion of the amount of local business tax

paid to total gross receipts/sales. 11 USAID INVEST Project, “Study on the Business Permit Licensing Service Fees and Charges”, an unpublished

study conducted in 2012.

22

2. Bank Finance Medium P35 M ₱110,272.17 0.3151

3. Construction

Supply

Trading

Trading Small P200 M ₱507,237.39 0.2536

4. Supermarket Retail Small P50 M ₱185,142.67 0.3703

5. Restaurant

(fine dining)

Service Micro P5 M ₱32,225.50 1.6113

6. Medical

Clinic

Service Micro P1 M ₱6,019.45 0.6019

7. Internet Shop Service Micro P150k ₱2,483.25 1.6555

8. Bakery Retail Micro P80k ₱1,125.25 1.4066

Average

Effective Tax

Rate

0.7991

a/ 66 sample cities nationwide

Source of basic data: PART I: Survey of Business Tax and Fees, Study on Business Permit Licensing

Service Fee and Charges, USAID INVEST Project, 2012

A surprising finding in the INVEST study was that first and second class cities tended

to charge lower business taxes and fees than did third and fourth class cities. One might think

that the opposite would be true, given that the cost of living in the more progressive first- and

second-income class cities would be higher. Moreover, these cities rank high among cities in

terms of the absolute size their local business tax collections. Lower business tax rates and

higher business tax revenues in first and second income class cities indicate that there are more

business establishments in the said cities and/ or that business establishments in these cities

have higher gross receipts. This may be due to a number of factors: (i) tax administration in

first/ second income class cities are more efficient, (ii) more and bigger businesses tend to

agglomerate in said cities of the size of the larger market in these cities, and (iii) the lower

effective tax rates in these cities make them a more competitive business location and enables

these cities to attract more and bigger business establishments.

2.4 On the Situs of the Business Tax

The situs of the business tax is one of the contentious that were raised during the

regional consultations. In particular, city and municipal mayors in Mindanao complained of

the difficulty of collecting business taxes from branches and plantations located in their

respective localities. For instance, tax collections from branches of banks are small because

they do not declare interest income since the loans are booked in the head office and the interest

income is recorded therein. Big cities where the head office of the banks and other financial

institutions are the ones benefitting from the situs of taxation.

In another case, Mindanao mayors cited the problems of collecting the business tax

from the plantation located in their area because of the complicated procedure in determining

the tax that accrues to the LGU where the plantation is located. Owners of plantations with

head offices in Metro Manila or Cebu usually declare small amount of gross receipts/sales. But

the accuracy of the declared amount is difficult to verify because of non-cooperation with local

tax authorities citing the confidentiality of information.

23

City and Municipal Mayors also cited similar problems regarding the operation of sugar

centrals in their areas. The bulk of the business tax is being collected by LGUs, usually big

cities, where the head office of the sugar mills.

2.5 Tax on peddlers

Sec. 143 (g), Chapter 2, Title One, Book II of the LGC authorizes LGUs to impose a

tax on peddlers engaged in the sale of any merchandise or article or commerce, at a rate not

exceeding Fifty pesos (P50.00) per peddler annually. Data from BLGF and COA, however, do

not indicate any collection from the peddlers tax. It can be surmised although the peddler’s tax

is part of the revenue code of many LGUs, the revenue tax from the said tax is not big enough

for COA or BLGF to report it separately.

It terms of administration, it would be costly on the part of the city or municipality to

collect such tax considering that peddlers are mobile. It is, however, justified that peddlers

should be regulated not by the city or municipality but barangays. A barangay permit maybe

required from peddlers before they can sell their merchandise within the territory of the

barangays.

3. Direction of Reform in Local Business Taxation: Some Options towards

Simplification

3.1 Option 1: different single rate for each category of business

Some participants in the regional consultations proposed to replace the graduated local

business tax rate schedule with a single ad valorem tax rate that may vary for each of the major

groups/ types of businesses. Some of the options offered are as follows:

(i) On manufacturers, producers of agricultural products including plantations and

commercial fishing, assemblers, repackers, processors, brewers, distillers, rectifiers,

and compounders of liquors, distilled spirits, and wines or manufacturers of any article

of commerce of whatever kind of nature ---- 1%

(ii) On wholesalers, distributors, or dealers in any article of commerce of whatever kind or

nature ---- 1.5%

(iii) On exporters, and on manufacturers, millers, producers, wholesalers, distributors,

dealers or retailers of essential commodities ---- ½ of 1%

(iv) On retailers ---- 2%

(v) On contractors and other independent contractors ---- 1.5%

(vi) On banks and other financial institutions ----- 1%

(vii) On peddlers engaged in the sale of any merchandise or article or commerce – to be

abolished

(viii) On other businesses including those any business engaged in the production,

manufacture, refining, distribution or sale of oil, gasoline, and other petroleum products

Engaged in petroleum products etc.

3.2 Uniform single Rate for all types of businesses

House Bill (HB) 3538 of Batangas Rep. Raneo F. Abu proposed several amendments

to the various provisions on local taxation. One of the major proposals in HB 3538 is to

simplify the business tax structure by abolishing the graduated business tax rates and changing

24

the tax rate to not more than 2.5% of the gross sales or receipts of the preceding calendar year.

There is no corresponding bill filed in the Senate.

As shown in Table 7, the effective tax rates ranged from 0.1789% for manufacturers,

etc. to 1.655% for internet cafe with the overall average effective rate at 0.7991%. It is

therefore proposed that the single ad valorem rate will be a maximum 1.5% on the gross

receipts/sales of the preceding year to all businesses. A simplified system will ease the

administration of the business tax.

A comparison of the effective rates and the proposed 1.5% uniform rate for all businesses is

shown Table 8. The average increase is 88% while the manufacturing sector will experience

the highest increase of 738% followed by construction with 492%. Restaurants and internet

shop will shoulder lower tax burden.

Table 8. Comparison of the Actual and Proposed Effective Tax Rate

Business Type Industry Business

Size

Effective

Rate

(%)

Proposed

Uniform

Single

Rate

Inc/Dec

in

effective

tax rate

1. Packaging Plant Manuf’ring Large 0.1789 1.5% 738.5%

2. Bank Finance Medium 0.3151 1.5% 376.0%

3. Construction

Supply Trading

Trading Small 0.2536 1.5% 491.5%

4. Supermarket Retail Small 0.3703 1.5% 305.1%

5. Restaurant (fine

dining)

Service Micro 1.6113 1.5% -6.9%

6. Medical Clinic Service Micro 0.6019 1.5% 149.2%

7. Internet Shop Service Micro 1.6555 1.5% -9.4%

8. Bakery Retail Micro 1.4066 1.5% 6.6%

Average Effective

Tax Rate

0.7991

1.5% 87.7%

3.3 Revenue effect of proposed reforms

In 2013, total collections from business taxes of all cities amounted ₱41.1 billion. If

the 0.80 % (or 80% of 1%) current effective rate of business taxes in cities will be increased to

1.5%, then the incremental revenue would amount to P36 billion.

In the case of municipalities, it is possible that the effective tax rate is higher by 3%

compared to cities based on the results of the NTRC survey cited earlier in spite of the fact that

cities can impose a rate 50% higher than municipalities. If this effective rate is increased to

1%, then the incremental revenue from business taxes in municipalities would amount to ₱4.6

billion. Thus, the total additional revenue for cities and municipalities combined with the

simplification of the local business tax therefore would amount to ₱40.6 billion.

IV. OTHER LOCAL TAXES, FEES AND CHARGES

1. Local Taxes Levied at Peso-Denominated Tax Rates

25

At present, two local taxes in the LGC are levied at peso-denominated rates – the ₱300

professional tax and the ₱500 tax on delivery trucks and vans. With the fixed peso rates,

collections from these taxes are inelastic i.e. collections do not change even when there is

increase in prices. To make these taxes more productive, it is suggested that the rates be

adjusted once every three (3) years based on the average annual inflation rate as certified by

the Philippines Statistical Authority.

If the peso-denominated rates are adjusted on the basis of the Consumer Price Index

from 1992 to 2014, then the professional tax should be P960 (300 x 3.20) and the tax on

delivery trucks and vans should be P1,600 (500 x 3.20). With these adjusted rates, collections

from the professional will increase from ₱18.3 million in 2012 to ₱58.6 million and from the

tax on delivery trucks and vans from ₱178.4 million in 2012 to ₱571 million.

The following is the proposed amendment:

“Sec. 191 Authority of Local Government Units to Adjust Rates of Tax

Ordinances. - Local government units shall have the authority to adjust tax rates as

prescribed herein not oftener than once every five (5) years, but in no case shall such

adjustment exceed ten percent (10%) of the rates fixed under this Code. IN THE CASE

OF FIXED TAXES PRESCRIBED IN THIS CODE, THE MAXIMUM

ALLOWABLE RATE MAY BE ADJUSTED NOT MORE THAN ONCE EVERY

THREE (3) YEARS BASED ON THE AVERAGE ANNUAL INFLATION RATE

AS CERTIFIED BY THE PHILIPPINE STATISTICAL AUTHORITY.”12

2. The Community Tax

The community tax (or residence tax) was introduced by the Spaniards in 1884.

Originally known as the cedula during the Spanish colonial rule, the community tax (or

residence tax) was imposed on all residents above 18 years of age regardless of nationality.

Upon payment of said tax, a cedula or residence certificate was issued to the taxpayer for

identification and other purposes.

In 1939, the cedula tax was renamed as the residence tax via Commonwealth Act No.

465. The Act introduced some innovations on the features such as, but not limited to, (i) an

additional residence tax on individuals based on the worth of their real properties, and/or gross

receipts or earnings derived from the exercise of their profession or occupation, and (ii)

inclusion of a residence tax on corporations. The said law was later incorporated under Section

38 of Presidential Decree No. 231. Under PD 231, the residence tax was a national imposition

that was collected by the city and municipal treasurers in their capacity as deputies of the

Bureau of Internal Revenue (BIR).

With the enactment of the LGC, the residence tax, renamed as community tax, became

a local government tax with cities and municipalities being given the authority to levy the said

tax. Basically, the community tax individuals and corporations is similar to the former

residence tax as to tax base and purpose, differing only to a certain extent with respect to the

tax rates.

2.1 Current features of the community tax on individuals

12 Proposed insertions are in upper case letters.

26

Under Sec. 157, Art. 6, Chapter 2, Book II of the LGC, an annual community tax is

levied on every inhabitant of the country, 18 years of age, or over who has been regularly

employed on a wage or salary basis for at least one month during any calendar year or who is

engaged in any business or occupation, or who owns real property with total assessed value of

at least ₱l,000 or who is required by law to file an income tax return. The basic rate of the

community on individuals is Five pesos (₱5) and an annual additional tax of One peso (₱1) for

every One thousand pesos (₱1,000) of income regardless of whether from business, exercise

of profession or from property which in no case shall exceed Five thousand pesos (₱5,000).

2.2 Issues/ Problems in the Collection of the Community Tax

As indicated earlier, the 1991 LGC transformed the community tax from a national tax

into a local imposition to buoy up local revenues and enhance the financial capacity of local

government units (LGUs). However, decades later, the community tax remains as one of the

poorly administered local taxes. As pointed out by the National Tax Research Center (NTRC)

and the DOF, the various issues confronting the administration of the tax has slowed down its

growth and prevented it from becoming an important local revenue source.

The importance of the Community Tax Certificate (CTC) as an identification document

has progressively diminished through the years. Save for the purpose of authenticating certain

legal documents, the CTC is no longer the main document to identify the affiants in the

notarization of a legal document. Moreover, there were claims that a syndicate has been

producing fake certificates and selling it nationwide. This means that collections from the tax

accrue to the LGU coffers. This may be attributed, among others, to the failure of most LGUs

to strictly enforce sanctions against falsification, altering or counterfeiting of the CTC.

Payment of the tax is mostly done on a voluntary basis. The practice among treasurers

of accepting information supplied by the taxpayers without verifying or cross-checking, is quite

prevalent. The present system does not provide for a way to check whether the taxpayer is

paying the true amount of community tax due. Although there are available documents to verify

the amount of the said tax, these are rarely used by LGUs to improve tax collection. The non-

payment of the true amount of the community tax due has effectively deprived the local

government with much needed revenues.

Another weakness in the administration of the community tax is the indiscriminate

issuance of the CTC. This has placed doubt on its credibility as a proof for identification. Most

LGUs accept payment of the said tax even if the taxpayer is not a resident for the purpose of

generating more revenues. However, this is in violation of the pertinent provision in the Code

that the community tax shall be paid in the place of residence of the individual.

Despite its weaknesses, the revenue importance of the community tax cannot be

ignored. It is considered as one of the sources of tax revenue of local governments. As noted

earlier, the nationwide collection from the tax averaged ₱l.37 billion, which is almost 2% of

the total tax revenues of LGUs for CYs 2008 to 2012. If the cost of community tax certificate

printed by BIR is deducted the net CTC collection will be reduced from an average of ₱1.37

billion to ₱0.91 billion. The cost of community tax certificate is roughly equivalent to 1/3 of

the total revenue (Table 9).

27

Table 9. Net Community Tax Collection

Year

Community

Tax

Collection

Cost of

CTC

Certificate

Net CTC

Collection

2008 1,069 462.78 606.22

2009 1,064 406.56 657.44

2010 1,313 445.35 867.65

2011 1,879 522.94 1,356.06

2012 1,545 501.60 1,043.40

Average 1,374 467.84 906.16

Source of data: COA and NTRC

In the 16th Congress, HB 2033 of Rep. Evelina G. Escudero, HB 2196 of Rep. Anthony

M. Bravo and Rep. Cresente C. Paez and SB 1082 of Sen. Francis G. Escudero propose to

abolish the community tax including the use of community tax certificate. The proponents

contend that the CTC has lost its significance and value, since other proofs of identification are

already available. Hence, it has become an unnecessary burden imposed on the people who are

required to present it when doing public transactions.

The intent and purpose of the proposal is recognized, however, this may generate

resistance on the part of LGUs unless it will be replaced by an alternative revenue source.

During the regional consultations, Municipal and City Mayors were unanimous in resisting the

proposal to abolish the community tax. Instead, the participants suggested the strengthening

of the administration of the tax.

2.3 Proposed amendments to the community tax

To make the community tax more productive, the following are the proposed

amendments:

(i) Rename the community tax to residence tax;

(ii) In lieu of the basic P 5.00 and additional community tax, impose a residence tax on all

individuals at the rate of P10 for every P1000 income;

(iii) The P5,000 cap will be repealed which means that there is no limit as the amount of

the tax; and

(iv) To ensure collection, the proposed residence tax will be collected by BIR based on the

income tax return of the individual to be remitted to the city or municipality where the

residence of the taxpayer is located.

The 2013 BIR collections from individual income tax amounted to ₱246 billion. With

effective rate of 18%, this means that the total taxable income is ₱1,366 billion. If the 1%

residence tax is imposed on the total individual taxable income, then the estimated revenue of

the proposed residence tax is ₱13.66 billion.

3. LGU Power to Levy Fees and Charges

3.1 Current provision on the power of LGUs to impose fees and charges

Sec. 147 of the LGC and Article 233 of its Implementing Rules and Regulations (IRR)

may impose and collect such reasonable fees and charges on businesses and occupations on the

28

practice of any profession or calling before any person may engage in such business or

occupation, or practice such profession or calling provided that such fees or charges shall only

be commensurate to the cost of issuing the license or permit and the expenses incurred in the

conduct of the necessary inspection or surveillance (emphasis supplied). Moreover, it provides

that no such fee or charge shall be based on capital investment or gross sales or receipts of the

person or business.

3.2 Issues on the imposition of fees and charges

A 2012 study conducted by the USAID INVEST Project in cooperation with the

Department of Interior and Local Government (DILG) and the Bureau of Local Government

Finance (BLGF) of Department of Finance concluded that there a clear indication that some

fees charged by cities were, in fact, higher than the cost associated with the processing/ issuance

of the permits, while other fees were currently priced lower than the cost associated with the

processing/ issuance of the permits. The study determined the misalignment by first adjusting

the current resources to the total volume of businesses that needed to be served, followed by a

calculation of the costs of providing the services and comparing these costs with the fees

collected for the services. To illustrate, in one of the cities where the study was conducted, the

total fees collected in a year for the sanitary permit fee was P4 million, while the corresponding

costs of regulation, licensing and inspection amounted to P1.9 million only. This disparity

indicated that the current sanitary permit rates for this city should be lowered by 50% for it to

be compliant with the Local Government Code. Conversely, if the collection for another fee

turned out to be lower than the cost related to the issuance of the permit, the fee should be

increased to recover the said cost.

Figure 11. Revenues from Fees relative to cost of issuing the permit/ license

The said study recommended that cities should align fees whose rates are decided upon

by the local government, with the effective cost related to the issuance of the permits to the

businesses so as to recover these cost in their entirety and/or avoid the overcharging of

businesses. One of the insights from the study of fees is that both the local government and

businesses will benefit from the upgrading of the efficiency of the cities’ service operations in

connection with regulation, licensing and inspections. Efficiency can be improved by

reallocating the people’s time across department to maximize available human resources.

Indeed, a simulation conducted by the study showed that this procedure would lead to the

29

lowering of the cost of issuing the permit by more than 40%, in some cases. Given this, the

reduction in cost should translate to lower fees charged businesses.

3.3 Recommended Reforms on Fees and Charges

In view of the above, it is recommended that the DILG and BLGF/DOF issue guidelines

in the setting of reasonable fees that will be commensurate to the cost of issuing the license or

permit and the expenses incurred in the conduct of the necessary inspection or surveillance. In

this regard, it is proposed that Sec. 147 of the LGC be amended as follows:

“SEC. 147. Fees and Charges. - The municipality may impose and collect such

reasonable fees and charges on business and occupation and, except as reserved to the

province in Section 139 of this Code, on the practice of any profession or calling,

commensurate with the cost of regulation, inspection and licensing before any person

may engage in such business or occupation, or practice such profession or calling. THE

DEPARTMENT OF INTERIOR AND LOCAL GOVERNMENT (DILG) AND

THE BUREAU OF LOCAL GOVERNMENT FINANCE (BLGF) OF THE

DEPARTMENT OF FINANCE (DOF) SHALL JOINTLY ISSUE GUIDELINES

TO DETERMINE THE AMOUNT OF REASONABLE FEE BY COMPUTING

THE COST OF REGULATION, INSPECTION AND LICENSING BASED ON

COST ACCOUNTING FRAMEWORK.”13

4. Administrative Remedies on Protest of Assessment and Claim for Refund

4.1. Current situation on taxpayer’s remedies

Under Sec. 195, Art. 6, Chapter 6, Book II of the LGC, the taxpayer may file a written

protest with the local treasurer contesting the assessment; otherwise, the assessment shall

become final and executory. The local treasurer shall decide the protest within sixty (60) days

from the time of its filing. If the local treasurer finds the protest to be wholly or partly

meritorious, he shall issue a notice canceling wholly or partially the assessment. However, if

the local treasurer finds the assessment to be wholly or partly correct, he shall deny the protest

wholly or partly with notice to the taxpayer. The taxpayer shall have thirty (30) days from the

receipt of the denial of the protest or from the lapse of the sixty (60) day period prescribed

herein within which to appeal with the court of competent jurisdiction otherwise the assessment

becomes conclusive and unappealable.

Under Sec. 196, Art. 6, Chapter 6, Book II of the LGC, no case or proceeding shall be

maintained in any court for the recovery of any tax, fee, or charge erroneously or illegally

collected until a written claim for refund or credit has been filed with the local treasurer. No

case or proceeding shall be entertained in any court after the expiration of two (2) years from

the date of the payment of such tax, fee, or charge, or from the date the taxpayer is entitled to

a refund or credit.

4.2 Issues/ problems on the taxpayer’s remedies

Under Sec. 195 of the LGC, if local treasurer has denied the protest of the taxpayer on

the assessment of his tax liability, the only recourse available to the taxpayer is to go to court.

This available recourse of the taxpayer is very expensive. Hence, the business sector has

13 Proposed insertion is in upper case letters.

30

pointed out the importance of making available an administrative mechanism to the taxpayer

in cases of adverse decision made by the local treasurer. An option to address this issue is via

an administrative mechanism whereby taxpayers may appeal the decision of the local treasurer

to the Department of Finance. If the appeal is denied by the Department of Finance, then the

taxpayer can go to court.

Similarly, a taxpayer may claim a tax refund/ tax credit by filing a written request for

such with the local treasurer. Should such a claim be denied, the taxpayer may appeal to the

Secretary of Finance. He has a final recourse to the courts should the latter appeal fail.

4.3 Proposed amendment regarding taxpayer’s remedies

In view of the foregoing discussion, it is proposed that Sec. 195, Art. 6, Chapter 6, Book

II of the LGC be amended by inserting the following phrase:

“The taxpayer shall have thirty (30) days from the receipt of the denial of the protest or

from the lapse of the sixty (60) day period prescribed herein within which to appeal

with the [court of competent jurisdiction] with the Secretary of Finance. He has a final

recourse to the courts should the latter appeal fail.”

Likewise, Sec. 196, Art. 6, Chapter 6, Book II of the LGC shall be amended by inserting

the following phrase:

“Should such a claim be denied, the taxpayer may appeal to the Secretary of Finance.

He has a final recourse to the courts should the latter appeal fail.”

5. Local Tax Exemptions and Tax Incentives

5.1 Current situation regarding LGUs’ Power to grant tax exemptions/incentives

Under Sec. 192, Chapter 5, Title I, Book II of the LGC, local government units may,

through ordinances duly approved, grant tax exemptions, incentives or reliefs under such terms

and conditions, as they may deem necessary. However, Article 282 of the Implementing Rules

and Regulations (IRR) of the LGC provided certain limitations that are not explicitly stated in

Sec. 192 of the LGC. For instance, Article 282 (b) (1) (iv) states that exemption or relief

granted shall take effect only during the next calendar year for a period not exceeding twelve

(12) months as may be provided in the ordinance. In addition, Art. 282 (b) (2) (ii) provides

that the grant of the tax incentive shall be for a definite period not exceeding one (1) calendar

year.

Sec. 192 of the LGC clearly provides that the LGUs themselves shall prescribe the

terms and conditions under which they desire to grant exemptions, incentives, or reliefs because

the grant of authority was complete and unconditional. However, under Article 282 of the IRR

of the LGC, limitations were placed on such authority, which appear inconsistent with the letter

and spirit of the law.

Given LGU officials concern for securing more revenues to be able to defray the cost

of delivering basic and other services, many of them are not inclined to grant tax exemptions,

incentives or reliefs. Further, except for few enlightened local executives, mostly in the large

LGUs, most do not realize the potential for economic development if they know how to use

this authority.

31

Hence, there is a need to clarify the power of LGUs to grant tax exemption privileges

by stating the purpose (to promote or encourage investments) and limiting the duration of such

tax exemption to 5 years. This is to guide LGUs in the grant of tax incentives and prevent

possible abuses in this area.

5.2 Proposed Amendments to Sec. 192 of the LGC

The proposed amendment limits exemption privileges and tax reliefs to those critical to

the economic development of the LGUs.

“Sec. 192 Authority to grant LOCAL Tax Exemption Privileges - Local

government units may, through ordinances duly approved, grant tax exemptions,

incentives or reliefs FOR THE PURPOSE OF PROMOTING OR

ENCOURAGING INVESTMENTS IN THEIR JURISDICTIONS, under such

terms and conditions as they may deem necessary; PROVIDED THAT THE

DURATION OF SUCH INCENTIVES SHALL NOT EXCEED FIVE (5) YEARS

FROM THE EFFECTIVE DATE OF THE ORDINANCE GRANTING THE

INCENTIVE: PROVIDED, FURTHER THAT SUCH INCENTIVE SHALL BE

AVAILED ONLY ONCE.”14

6. Withdrawal of Tax Exemptions/ Tax Incentives of GOCCs

6.1 Current situation and attendant issues

Sec. 193 of the LGC provides for the withdrawal of tax exemptions or incentives

granted to, or presently enjoyed by, among others, government-owned or controlled

corporations except local water districts, cooperatives duly registered under R.A. 6398, non-

stock and non-profit hospitals and educational institutions. Supreme Court decisions in various

cases involving GOCCs also affirmed the withdrawal of their tax exemptions. Some GOCCs,

however, claim that they are considered as government agencies not GOCCs. Hence, there is a

need to clarify the withdrawal of tax exemptions/incentives of GOCCs.

It is recommended that the removal of the tax exemption privileges of government

agencies or entities that generate revenues like Philippine Ports Authority, Manila International

Airport Authority, Philippine Reclamation Authority, Philippine Retirement Authority should

be explicitly stated.

It is further recommended that no law providing tax exemption from local government

taxes, fees and charges shall be enacted without prior consultation with the League of Cities,

League of Provinces, League of Mayors and Liga ng mga Barangay and prior recommendation

of the Department of Finance.” This addresses another source of concern, that is, how quickly

the legislators negate the provisions of the LGC, only months after it was passed. For example,

in the case of Section 193, on withdrawal of tax-exempt privileges with effect from the passing

of the Code in 1991 (effective 1 Jan 1992), the Senate again granted exemptions on a telephone

franchise to Bayantel on 20 July 1992 (RA No. 7633). Since the latter was passed after that of

the LGC, it was decided by the Supreme Court that it should override Section 193. It is

recommend that the effect of Section 193 be reinstated in the proposed amendments to the LGC

and that the Section be amended to ensure that, before any exemption is given, the opinions of

14 Proposed insertion is in upper case letters.

32

the Department of Finance and leagues of LGUs must be sought. This would help stop lobbying

for certain sectors, e.g. telecoms franchise.

6.2 Proposed amendments related to the withdrawal of tax exemptions from GOCCs in the

LGC

In view of the above, it is recommended that Sec. 193 of the LGC be amended as

follows:

“Sec. 193 Withdrawal of Tax Exemption Privileges. - Unless otherwise provided in this

Code, tax exemptions or incentives granted to, or presently enjoyed by all persons, whether

natural or juridical, including government-owned or controlled corporations, AND

OTHER SIMILAR GOVERNMENT AGENCIES OR ENTITIES GENERATING

REVENUES AS DETERMINED BY THE DEPARTMENT OF FINANCE SUCH

AS, BUT NOT LIMITED PHILIPPINE PORTS AUTHORITY, MANILA

INTERNATIONAL AIRPORT AUTHORITY, PHILIPPINE RECLAMATION

AUTHO-RITY, PHILIPPINE RETIREMENT AUTHORITY [, except local water

districts, cooperatives duly registered under R.A. 6398, non-stock and non-profit hospitals

and educational institutions,] are hereby withdrawn effective January 1, 2007.

EXCEPT AS PROVIDED HEREIN, NO LAW PROVIDING TAX EXEMPTION

FROM LOCAL GOVERNMENT TAXES, FEES AND CHARGES SHALL BE

ENACTED WITHOUT PRIOR CONSULTATION WITH THE LEAGUE OF

CITIES, LEAGUE OF PROVINCES, LEAGUE OF MAYORS AND LIGA NG MGA

BARANGAY AND PRIOR RECOMMENDATION OF THE DEPARTMENT OF

FINANCE.” 15

V. CONCLUSIONS

This study shows proposes the following amendments to the LGC with the end in view

of improving the revenue autonomy of local government units:

(i) Shift of authority to approve schedule of market value of real property to Department

of Finance from local Sanggunians in order to depoliticize the updating the said

schedule. Revenue yield of this amendment is estimated at ₱50 billion per year,

ceteris paribus.

(ii) Imposition of an ad valorem rate of a maximum 1.5% on the gross receipts/sales of

the preceding year on all types of business establishments. Estimated revenue yield

of this amendment is ₱36 billion per year.

(iii) The peso-denominated tax rates e.g. professional tax and tax on delivery trucks and

vans, will be adjusted once every three (3) years based on the average annual inflation

rate as certified by the Philippines Statistical Authority. Estimated revenue yield is

₱440 million per year.

(iv) To make the community tax more productive, it is proposed that (a) the community

tax be renamed the residence tax, (b) that the community tax rate be increased from

₱1 to ₱10 per ₱1,000 income, (c) remove the ₱5,000 cap on the tax per individual,

and (d) the BIR shall collect the residence tax on remit the proceeds based on

derivation. Estimated revenue yield is ₱13 billion per year.

15 Proposed insertion to the section is in upper case letters while parts that are proposed to be deleted are in

shown in parenthesis.

33

Thus, the estimated total revenue take from these amendments reaches ₱99.4 billion per year

or almost a third of total IRA share in 2013.

In addition to the above amendments aimed at enhancing the taxing authority of LGUs in order

to generate more revenue, this paper also proposes a number of other amendments aimed at

improving tax administration and improving the overall business environment and

competitiveness of LGUs from the perspective of local economic development. The latter set

of proposals, however, is generally neutral in terms of their revenue impact. These include:

(i) Amending Sec. 147 of the LGC mandating the DILG and BLGF/DOF to issue

guidelines in setting the reasonable fees that will only be commensurate to the cost

of issuing the license or permit and the expenses incurred in the conduct of the

necessary inspection or surveillance;

(ii) Amending Sec. 195 and Sec. 196, Art. 6, Chapter 6, Book II of the LGC for the

purpose of providing administrative recourse in cases of dispute between a taxpayer

and the local treasurer;

(iii) Amending Sec. 193 of the LGC for the purpose of clarifying the withdrawal of tax

exemptions from GOCCs; and

(iv) Amending Sec. 192 of LGC for the purpose of clarifying LGUs powers related to

the grant of tax incentives and tax exemptions promoting local economic

development.

PHILIPPINES DECENTRALIZATION:

THE CHANCE FOR A LOCAL PERSONAL INCOME

TAX

Santiago Díaz de Sarralde Miguez1

ADB Consultant

DECEMBER 2014

1 I would like to thank the help and useful advices of all the ADB team and the participants in the meetings,

as well as Fatima del Prado for her technical assistance.

i

TABLE OF CONTENTS

LIST OF FIGURES ........................................................................................................ ii

LIST OF TABLES .......................................................................................................... ii

LIST OF BOX ................................................................................................................. ii

EXECUTIVE SUMMARY ........................................................................................... iii

I. INTRODUCTION ................................................................................................ 1

II. THEORETICAL BACKGROUND: DECENTRALIZATION, FISCAL

FEDERALISM, AND THE REVENUE ASSIGNMENT PROBLEM. .......... 2

1. Decentralization Guidelines. .......................................................................................... 3

2. Tax Policy Options ......................................................................................................... 5

2.1. The traditional candidates .............................................................................. 6

2.2. Broad-base options: consumption; corporate income; personal income ........ 7

III. FISCAL DECENTRALIZATION AND LOCAL FINANCE: THE

PHILIPPINE AND INTERNATIONAL EXPERIENCE ................................ 9

1. Tax and revenue assignments in the Local Government Code ............................... 10

2. Local Government Units in figures ............................................................................ 15

IV. OPENING UP NEW TAX BASES: PERSONAL INCOME TAXATION AS

A POTENTIAL TOOL FOR LOCAL AUTONOMY .................................... 20

1. Personal Income Tax as a Local Tax: technical options and international

experience. ..................................................................................................................... 23

1.1. Local PIT: Tax Base options ........................................................................ 23

1.2. Local PIT: Tax Administration Options ....................................................... 25

1.3. Personal Income Tax Decentralization: international experience ................ 26

2. Evaluating a Local Personal Income Tax for the Philippines. ................................ 28

2.1. Local-PIT Revenue Potential ....................................................................... 29

2.2. Territorial distribution of the Local-PIT ...................................................... 31

2.3. Central PIT´s reform and the role of a Local-PIT ........................................ 34

V. FINAL REMARKS ............................................................................................ 37

BIBLIOGRAPHY ......................................................................................................... 37

ANNEX 1 ....................................................................................................................... 39

ii

LIST OF FIGURES

Figure 1. Tax Decentralization Guidelines ....................................................................... 6

Figure 2. Tax Decentralization Menu ............................................................................... 9

Figure 3. Administrative Regions (17) Local Government Units .................................. 10

Figure 4. National Government Tax Revenue. 2013 ...................................................... 21

LIST OF TABLES

Table 1: Tax assignments ............................................................................................... 11

Table 2. Local Government Units Revenue ................................................................... 15

Table 3. The Philippines and LGUs revenue and expenditures assignments in figures . 15

Table 4. LGUs Sources of Income, (% of Total) ............................................................ 17

Table 5. LGUs Taxes. 2013 ............................................................................................ 18

Table 6. LGUs Per capita Income .................................................................................. 18

Table 7. NATIONAL GOVERNMENT TAX REVENUES, 2013 (% of Total) ........... 21

Table 8. Public Sector, (%GDP) ..................................................................................... 22

Table 9. Maximum Standard Tax Rates (%) .................................................................. 23

Table 10. Personal Income Tax Decentralization Tax Base Options ............................. 24

Table 11. Personal Income Tax Decentralization Tax Administration Options ............. 25

Table 12. PIT decentralization in the OECD .................................................................. 26

Table 13. Philippines´ PIT schedule ............................................................................... 29

Table 14. PIT: FIES Microsimulation and BIR Collection Billion PHP ........................ 29

Table 15. Local-PIT ........................................................................................................ 30

Table 16. Territorial distribution of the Local-PIT ......................................................... 31

Table 17. Territorial distribution of the Local-PIT ......................................................... 32

Table 18. Local-PIT Baseline Scenario .......................................................................... 33

Table 19. PIT Reform´s Bills ......................................................................................... 34

Table 20. PIT Reform Options ....................................................................................... 35

LIST OF BOX

BOX 1. PIT Decentralization in particular countries ..................................................... 27

iii

EXECUTIVE SUMMARY

Fiscal Decentralization Theory

1. The basic message of fiscal federalism basic message is clear and appealing: certain

public activities could be more efficiently performed by subnational governments, getting

closer to the preferences of the voters and allowing them to control democratically

governmental behavior.

2. Without a strong link between expenditure and revenue competences the whole

mechanism gets weak in terms of autonomy and accountability of the different levels of

government creating malfunctions in terms of efficient provision and democratic control.

3. Even if there is no unified theory to the distribution of revenue sources in a

decentralized context, a set of tax decentralization guidelines can be useful: a) Tax

assignment should follow expenditure responsibilities; b) The benefit principle should

be the primary guidance; c) Evenly distributed tax bases are preferred; d) Immobile tax

bases present advantages; e) Visibility of tax choices is fundamental to reinforce

accountability; f) The efficiency of tax administration should be considered; g) Fiscal

responsibility at the margin is the key to make local governments responsible for the full

marginal tax price of their spending decisions; h) Tax revenues should be stable,

predictable and sustainable; i) A global approach should be adopted, considering taxes,

transfers and borrowing; j) A hard budget constraint must exist.

4. A flexible (but theoretically consistent) point of view on the application of these

guidelines and the emphasis on the relevance of the marginal tax decisions, expand the

potential toolbox for tax decentralization: user charges, special assessments, betterment

levies or fees; property taxes; motor vehicle taxes; consumption taxes (e.g., excise taxes,

general sales taxes); business (indirect estimation of the firm´s ability to pay through

some form of corporate income tax); personal income (e.g, personal income tax; pay-roll

taxes).

5. Personal income should be considered a clear candidate for decentralization. Based on

the tax subject’s residence, the tax shows a benefit link, it is also quite immobile, more

evenly distributed and more elastic than other possible tax bases, potentially visible and

positive in terms of accountability, and its revenue potential is clearly relevant. The

problems arise when considering complexity, administrative and compliance costs and

central government’s reluctance to share this central piece of its tax system. Nevertheless

some alternatives exist to try to overcome, or at least minimize, these disadvantages.

Fiscal Decentralization and Local Finance: the Philippines and International

Experience

6. On the expenditure side, devolution in Philippines fits academic prescriptions and is

aligned with best international experiences, even if the legal framework is complicated

due to the different levels of government and somewhat overlapping functions. The

degree of internal decentralization in the expenditure side is quite high and close to

international average, showing the importance of the devolution process (even if global

figures in terms of public sector´s role in the economy are low)

iv

7. The revenue side tells us a different story when it comes to accomplished autonomy

and accountability goals. The share of local taxes in total revenues in the Philippines is

low, especially for provinces and municipalities. The vertical gap is met with transfers,

weakening the link between expenditure and revenue responsibilities.

8. LGUs´ tax assignment can be considered complex, inefficient and rigid: embodies too

many different tax items –weakening visibility-; requires an extremely decentralized tax

administration; most taxes are relatively unproductive in terms of revenue; the burden

falls specially on businesses with a design that taxes indirect signs of real ability to pay;

most important –and elastic- tax bases –income, consumption- are excluded; tax rates

level and changes are limited; and tax liabilities are often expressed in nominal terms and

tax base actualization restricted.

9. The transfer system, the IRA especially, meets the vertical gap but its design presents

important flaws: its amount is linked to central government’s internal tax revenues with

a three years lag; the shares of the different LGUs are fixed and independent of any

objective needs´ index; the distribution inside each LGU lacks of any short or medium

term dynamic adjustment factor and there is no reference to fiscal capacity in order to

equalize horizontal differences.

Opening up new tax bases: Personal Income Taxation as a potential tool for Local

Autonomy

10. Central Government reserves for itself the bulk of the potential tax bases and the tax

structure that emerges is quite classical in the context of developing countries: nearly 60%

of the revenue comes from indirect taxation and even in the direct taxation field the role

of progressive personal taxation is weak. Even in the Asian context, the use that the

Philippines is giving to these tax bases is limited. Revenue to GDP ratio is below the

Philippines level in only four countries (Bangladesh, Pakistan, Sri Lanka and Taipei). The

nominal level of tax rates does not seem to be the problem -in general above the Asian

average- but the large tax incentives, exemptions and tax administration deficits.

11. On the basis of the theoretical framework and taking into account the tax bases

nowadays closed to LGUs, personal income should be considered as a serious option to

assign additional fiscal space to local government units. Technical options for the use of

personal income as a local tax base, and possible tax administration arrangements on the

basis of international experience should be analyzed.

12. Beginning with the Tax Base, we can distinguish three basic options: the first two

correspond to a classic piggyback tax, surcharge or surtax on central PIT (the first one

would introduce local taxation on central PIT taxable income, using a single tax rate or

opening the chance to surtax differently every tax bracket of central tax schedule; the

second would use central PIT tax liability as the base for local taxation); the third option,

a Decentralized Personal Income Tax, implies the creation of a totally autonomous

decentralized tax with no connection with the central one, implying different tax bases

and rates.

13. Considering all dimensions (design flexibility; progressivity; fiscal autonomy;

simplicity; tax administration; potential use) the surtax on central PIT taxable income

v

would seem to be the best design option on the basis of the desired characteristics, with

the one or multiple tax rates´ choice depending on the design priorities: simplicity and

minimum administrative costs or flexibility.

14. The two tax administration´s options available when considering the implementation

of a local PIT-based tax are to use central or local tax administration systems. The other

critical decisions to consider are whether to focus on an employer or employee residence

basis.

15. Taking into account all dimensions (administrative and compliance costs; tax

autonomy visibility; resolution of conflicts; tax fraud fight), central tax administration on

employee residence basis seems to be the best design option for the tax administrative

arrangements, especially in a local context, if administrative and compliance costs are not

excessive and a one-tax rate on central PIT taxable base is considered.

16. International experience shows 13 OECD countries using decentralized PITs, 11 of

them at the local level. Most of them use central PIT taxable income as their tax base,

even if some experiences exist adjusting it to create their own tax base or charging local

or state tax on central tax liability. Tax rates are, usually, not progressive, especially at

the local level, and central (or coordinated) tax administration is the dominant pattern. In

most of these countries decentralized PIT accounts for a relevant share of local and/or

state tax revenue.

Evaluating a Local Personal Income Tax for the Philippines

17. 1% surtax on central taxable income would yield 10 billion pesos, 4.65% of simulated

PIT tax in 2012. To reach the same revenue outcome through a surcharge on central tax

liability we would need a nominal tax rate nearly 5 times higher as long as it would fall

on a smaller tax base.

18. Administrative and compliance costs of this Local-PIT would be also minimized with

this design, even if, being realistic, some challenges will arise that would require

improvements in the withholding process. From the juridical point of view this reform

would require amendments to PIT legislation and to the LGC.

19. Revenue potential must be analyzed taking into account the territorial distribution of

the Local-PIT and pointing out some possible links with the transfer system. The results

reflect the differences in the territorial distribution of personal income. As a whole, the

Cities will collect 53% of the revenue while accounting for 36% of the population, while

Provinces and Municipalities, as a whole, would benefit from the 47% of the revenue,

representing 64% of the Philippines inhabitants.

20. At the first stage of the process it would be advisable to limit tax rate decentralization

to Cities and Provinces. This option would limit overlapping to Provinces and Cities,

relatively easy to solve by tax administration, while Municipalities (and Barangays)

participation should be determined in a way similar to the Property Tax, establishing the

distribution of proceeds in the LGC.

21. The range of tax rate autonomy and its ceilings or floors could evolve in time

according to experience, but arguably the departing scenario should set a uniform 1%

vi

minimum tax rate for all LGUs across the country, leaving them the autonomy to modify

it by, for instance, a 20% up or down after three years. Departing from a uniform tax

scenario across the country, LGUs and BIR would have the time to evaluate the

mechanism, to solve its administrative challenges and to know better their taxable basis

in order to evolve to higher steps in the decentralization process.

22. Differences in per capita taxable income could be offset in the first steps of the reform

adjusting the Cities share in IRA. The revenue that they would get in the baseline scenario

(homogeneous 1% Local-PIT) in excess to their population share could be balanced

reducing their IRA share. This liberated space in the transfer formula could be used to

finance Provinces and Municipalities and, even, to consider the introduction of Fiscal

Capacity variables in the formula, equalizing differences in per capita income.

23. Finally, it has to be taken into account that nowadays there is a strong pressure in the

Philippines to reform PIT at the central level based on different arguments (excessive

number of tax brackets; too high tax rates, especially the top one; no indexation of tax

brackets since 1997, giving place to bracket creep; excessive burden falling on middle

class salaries; etc.)

24. Simulations show the feasibility of a parallel reform on central PIT and LGUs tax

revenues, creating a Local-PIT:

- Local-PIT (based on central PIT taxable income, administered by BIR and

assigned to LGUs) could be used to minimize global tax revenue´s costs –

something essential given Philippines´ tax revenue to GDP figures-. A tax rate

between 1 and 2% yields enough revenue to recover LGUs losses in most of the

central PIT´s reform scenarios.

- Local-PIT would create some room to mitigate PIT structural deficiencies. As

long as it increases average tax rate it allow to face tax schedule and marginal tax

rates alleged flaws while preserving, at least partially, PIT redistributive potential.

- Local-PIT would increase LGUs´ autonomy and accountability as long as they

are given the possibility to change to some extent the baseline tax rate.

1

I. INTRODUCTION

As requested by the Terms of Reference and in the framework of the Local Government

Finance and Fiscal Decentralization Reform Program for the Philippines, this consultancy

aims to address one of the factors limiting Local Governments Units’ (LGUs’) ability and

willingness to generate own-source revenues, by exploring the possibility of opening up

some of the tax bases now assigned to the central government to subnational

governments, incorporating best international practices to the country’s context.

The report will review the provisions of the 1991 Local Government Code (LGC) related

to local taxation, inter-LGU revenue sharing arrangements and evaluate the gaps on LGU

taxing powers. Alternative options for expanding LGU taxing powers, including piggy

back taxes on central government, and tax administration arrangements vis-à-vis the

central government will be analyzed.

The first section of the report summarizes the theoretical background, reviewing the

arguments for decentralization, fiscal federalism and the revenue assignment problem. As

a result, a set of tax decentralization guidelines and a menu of tax decentralization options

will be offered as an analytical framework for the following sections.

The second section of the report analyzes fiscal decentralization and local finance in the

Philippines, including LGC expenditure and revenue provisions, LGUs´ tax assignment,

and presenting a statistical analysis of the sources of revenue of LGUs in the Philippines,

autonomy and accountability in the context of international experience. This section

concludes by critically evaluating the devolution process and identifying possible

reforms.

In its third section, the report discusses options for the creation of new fiscal space for

LGUs, in order to increase local governments’ autonomy and accountability, in particular

by exploring Personal Income Taxation (PIT) as a potential tool. After analyzing the

limits of the LGC on LGUs’ fiscal bases and their relative dimension, the report

benchmarks the Philippines’ local fiscal indicators with regional neighbors in order to

contextualize the policy options. Following this comparative analysis, and focusing on

personal income, different technical options for the design and administration of a local

piggy-back tax on the PIT will be assessed, taking into account international experience

in this field. Lastly, we evaluate the feasibility of creating a local-PIT surtax on central

taxable income, administered by the BIR and based on tax payers residence. To do that,

we use 2012-2103 FIES (Family Income and Expenditure Survey) to microsimulate PIT

results and decentralization options.

Results show the feasibility of this kind of “triple-dividend” reform. A local-PIT (based

on central PIT taxable income, administered by BIR -minimizing administrative and

compliance costs- and assigned to LGUs): 1) creates opportunities to mitigate PIT

structural deficiencies; 2) minimizes global tax revenue´s costs and 3) increases LGUs´

autonomy and accountability.

2

II. THEORETICAL BACKGROUND: DECENTRALIZATION, FISCAL

FEDERALISM, AND THE REVENUE ASSIGNMNT PROBLEM

Decentralization is such a rich and complex concept that deserves monographic studies

on its meaning and definitions. One example can be found in the context of the United

Nations Development Programme (UNDP), the working paper “Decentralization: A

Sampling of Definitions”2 is introduced as one of the tasks associated with the thematic

evaluation of UNDP supported decentralization and local governance initiatives. This

paper underlines at the outset that “decentralization is not so much a theory as it is a

common and variable practice in most countries to achieve primarily a diverse array of

governance and public sector management reform objectives. In fact, a quick review of

the literature shows that there is no common definition or understanding of

decentralization, although much work has gone into exploring its differing applications”.

Nevertheless, the intuition behind the concept is quite clear and tries to give an answer to

the question of how we should organize the process of social choice and administration

of public affairs, particularly in the context of a democratic society. In the early 19th

century Alexis de Tocqueville's classic study, “Democracy in America”, we already find

the dimensions associated to the concept of decentralization. In his own words:

"Decentralization has, not only an administrative value, but also a civic dimension, since

it increases the opportunities for citizens to take interest in public affairs; it makes them

get accustomed to using freedom. And from the accumulation of these local, active,

persnickety freedoms, is born the most efficient counterweight against the claims of the

central government, even if it were supported by an impersonal, collective will".

As a guide to the collective decision-making organization, decentralization is closely

connected with the “subsidiarity principle”, that, following the Oxford English

Dictionary, can be defined as the idea that a central authority should have a subsidiary

(that is, a supporting, rather than a subordinate) function, performing only those tasks

which cannot be performed effectively at a more immediate or local level3.

More specifically, in the field of Public Finance, the seminal contribution to the theory of

the intergovernmental assignment of functions provided by Richard Musgrave in his

“Theory of Public Finance” (1959) identifies three functions of the public sector:

macroeconomic stabilization; income redistribution; and efficient allocation of resources,

and, broadly speaking, concludes that the first two should be carried out by the central

government, meanwhile there is certain scope for the subnational governments to

contribute to the efficient allocation of resources.

In his classic work, “Fiscal Federalism,” Wallace Oates (1972) offers some criteria to

decide on the functions of the different levels of government when providing goods and

services, summarized in the so-called decentralization theorem: each public service

2 UNDP (1999). 3 Subsidiarity is perhaps presently best known as a general principle of European Union law. According to

this principle, the EU may only act (i.e. make laws) where action of individual countries is insufficient.

3

should be provided by the jurisdiction having control over the minimum geographical

area that would internalize benefits and costs of such provision, taking into account

economies of scale, externalities, the heterogeneity of preferences and the potential

benefits from competition among them. Previously, Tiebout (1956) analyzed the

democratic process that backs up decentralization in the context of the provision of local

public goods, allowing the citizens to “vote with their feet”, changing their residence

according to the expenditure-revenue mix that better accommodates their preferences.

During the second half of the past century, this theoretical body gets enriched by multiple

contributions stressing the political consequences of decentralization as a tool to control

governmental power - Brennan and Buchanan (1980, 1982) - and its role improving

democratic decision making due to its proximity to voters and local preferences - Oates

(1999)-.

Summing up, the basic message is clear and appealing: certain public activities could be

more efficiently performed by subnational governments, getting closer to the preferences

of the voters and allowing them to control democratically governmental behavior. But,

how do we translate this theoretical guideline into the practical design of expenditure and

revenue functions across levels of government?

1. Decentralization Guidelines.

The expenditure side of the equation seems to follow in practice quite closely the

theoretical recommendations, preserving macroeconomic stabilization, income

redistribution and the provision of global public goods as central level functions, while

local public goods are decentralized to subnational governments4.

On the other hand, the revenue assignment process, also has developed recommendations

to design the distribution of revenue sources in a decentralized context, well aware that

without a strong link between expenditure and revenue competences the whole

mechanism gets weak in terms of autonomy and accountability of the different levels of

government creating malfunctions in terms of efficient provision and democratic control.

Nevertheless, while guidelines to local taxation can also be found in the theory of

federalism, their impact on actual arrangements is considered too often remarkably weak5.

Some experts, as Martinez-Vazquez (2013), point out that there is no unified theory of

revenue assignment that will enable an identification of the best division of taxes between

local governments and higher levels of government, even arguing that general principles

can provide useful guidance. In his paper “Subnational Taxation in Developing Countries.

A Review of the Literature”, Richard M. Bird (2010), states that “it is difficult to draw

definitive conclusions about the “ideal” subnational tax system for any particular

country”, and that even “international comparisons of intergovernmental financial

arrangements are both difficult to make and hard to interpret once made”. Following Bird,

4 Not without conflicts, of course, concerning externalities, economies of scale, administrative capacity,

etc. Consult Yilmaz et al (2012), in example, for a recent review on this topic. 5 Spahn (1995).

4

“the question is difficult to resolve because it is inextricably related to many of the same

complex and conflicting political, social, administrative, and economic issues that need

to be resolved not only in decentralizing but also in raising public revenues generally”

and “there is no one right answer in part because there is no one decision maker and in

part because since even an omnipotent decision-maker would seldom, unless also

omniscient, be able to put any evidence-based numbers” to back up the relative

convenience of the different options.

Keeping these caveats in mind, and being aware that no magical, one-size-fits-all and

free-of-problems solution can be recommended, it is still useful to consider the main

theoretical guidelines available to solve the revenue assignment problem in a

decentralized country (Figure 1).6 Below we list the most common criteria used to choose

the best taxes to decentralize and how can we try to solve the conflicts that emerge7:

1. The starting point is simple and could be expressed by common sayings such as

“finance should follow function” (Bahl 1999), “match revenue and expenditure

responsibilities” or “tax assignment should follow expenditure responsibilities”.

Revenue decentralization should follow expenditure responsibilities if the whole

process is meant to work promoting efficiency, accountability and democratic

control, giving the subnational governments not only the amount of revenue they

need but also the responsibility to get it. Putting this general recommendation into

work is much more difficult.

2. The benefit principle: good local revenue sources should link revenue collection

to locally provided benefits in order to reinforce accountability. In particular,

subnational governments should not be able to export to non-residents much of

the burden of the taxes that they impose.

3. The tax bases should be relatively evenly distributed across jurisdictions to

minimize territorial revenue raising differences.

4. Tax bases should be as immobile as possible to reduce inefficiencies and in order

to permit subnational authorities some leeway in varying rates without losing most

of their tax base.

5. The decision to levy the tax, the tax base or, much better, the tax rate choice

exerted by the subnational government should be transparent, to ensure

accountability.

6. The tax should be relatively easy to administer efficiently and effectively. The

cost of efficient administration should be a reasonable proportion of revenue

collections.

7. Even if not all revenue comes from decentralized taxes, subnational governments

should be able to affect the volume of revenues significantly at the margin through

6 Given the scope of this paper, we are not going to attend to scholar classifications of theories such as the

“standard model” or the “second-generation assignment model”, even if it is relevant to understand the

changes that have given place to the expansion of the toolbox of tax instruments open to subnational

governments. These topics are summarized, in example, in Bird (2010). 7 Synthesis based, specially, on Spahn (1995), Martínez-Vazquez et al (2006), Bird (2010), Yilmaz et al

(2012), Bahl and Linn (2014).

5

their own policy choices in order to get political accountability. That is, they

should be able to increase or decrease spending in any budget period only by

increasing or decreasing their revenues in such a way that they are publicly

responsible for the consequences of their actions8.

8. Stability, predictability, sustainability: the tax yield should both be adequate to

meet local needs and relatively stable and predictable over time. At the same time,

tax yields should be sufficiently buoyant over time to maintain fiscal

sustainability: that is, broadly, taxes should expand at least as fast as expenditures.

9. The global design of the transfers system and borrowing capacities must be taken

into account in the design of tax decentralization9 and the whole system should be

considered fair in order to avoid complaints used to curve fiscal responsibility.

10. Whatever the specific final design of the revenue sources would be, a global hard

budget constraint should exist.

2. Tax Policy Options

This set of principles is clearly useful even if it involves certain trade-offs, which are

oftentimes present in the design of a tax system10. To fully understand how to apply these

guidelines in the field, it is convenient to take into account the considerations in Martinez-

Vazquez et al. (2006): “At least conceptually, the benefit principle should be the primary

guidance for the assignment of local government taxes”, evenly distributed and immobile

tax bases “are subservient to some degree to it.” “For instance, if the benefit principle is

preserved in assigning local taxes, the potential mobility of taxpayers would not

necessarily bring about economic distortions, since taxpayers would be receiving local

benefits in accordance with local taxes paid. Meanwhile, the potential mobility of

taxpayers and tax bases can actually increase efficiency in the delivery of subnational

government services by forcing local and regional officials to provide a balanced basket

of subnational services and subnational taxes. However, if non-benefit taxes are applied

to mobile bases, inefficiencies can arise from tax avoidance costs, as taxpayers could try

to reduce their subnational tax liability by moving between subnational jurisdictions

without affecting the benefits received from publicly provided goods and services.”11 In

8 McLure (2000). This argument implies that transfers should be inframarginal, so that rich and poor local

governments alike face the full marginal tax price of their spending decisions. Bird (1993) suggests that it

would also be a good practice if subnational taxes provided sufficient revenue for at least the richest

subnational units to be essentially fiscally autonomous in the sense of being able to raise sufficient revenue

through taxes (and revenue instruments like user charges) that they control to cover the expenditures for

which they are directly responsible. 9 “The intergovernmental fiscal arrangements in any country must be thought of as a system. The pieces of

the system have to fit together properly if decentralization is to work properly. One cannot develop a good

subnational tax system without having first established clear and logical expenditure assignments to the

different levels of government. Similarly, given political realities, one cannot in most countries decentralize

significant revenues to subnational governments without having in place an intergovernmental transfer

system to offset at least some of the disequalizing effects that would otherwise occur. Nor does it make

sense to think of decentralizing exactly the same package of tax choices to all subnational governments

regardless of their scale and scope of operations”, Bird (2010), p. 43. 10 For instance, the benefit link between taxes and expenditures and the lack of visibility are always a

problem; tax bases are increasingly mobile even internationally; all tax revenues are subject to a certain

degree of instability; etc. 11 Page 82.

6

a similar vein, local taxation should ideally reflect a regionally equitable revenue pattern

for reasons of distributional justice among jurisdictions, a guideline difficult to follow in

practice since the distribution of most tax bases can be expected to be inequitable to some

degree and contradicts the neutrality argument which views the local immobility of the

tax base as efficiency improving. Once again, a balance would have to be found between

the local government's interest to link its citizens´ benefit to the wealth of local resources,

and the nation's interest to avoid large regional inequities12.

Figure 1. Tax Decentralization Guidelines

1. Tax assignment should follow expenditure responsibilities

2. The benefit principle

3. Evenly distributed tax bases

4. Immobile tax bases

5. Visibility of tax choices

6. Efficient tax administration

7. Fiscal responsibility at the margin

8. Stability, predictability, sustainability

9. Global approach: taxes-transfers-borrowing

10. Hard budget constraint

This flexible (and theoretically consistent) point of view on the application of these

guidelines and the emphasis on the relevance of the marginal tax decisions, expand the

potential toolbox for tax decentralization.

The traditional candidates

In practice, user charges, special assessments and betterment levies or fees are the best

examples of efficient and feasible instruments for decentralized taxation, because they

are connected to the provision of specific goods and services, However, they are not

always enough to finance local public goods. To do that, we have to rely on other taxes

as close to the benefit principle as possible.

The traditional ones are property taxes (ownership; transfer; value increases) reflecting

the value of local services capitalized in the value of the assets, and motor vehicle taxes,

connected with infrastructure, congestion and pollution. Property tax is the classic

theoretical best –and, sometimes, only - option for local governments, considering its

immobile tax base and its benefit link with some of the services provided, but in practice

it has to face serious setbacks. For a start, property tax administration is difficult and

12 Spahn (1995), p.5.

7

costly, particularly in the aspect of property valuation. As the tax is levied on the value of

the asset, it is not connected to an income flow and could be considered unfair or

confiscatory, especially if its level is high. In addition, the property tax can have an

important political cost due to its visibility. Another tax option, automotive taxation, also

presents a clear benefit link at a decentralized level, and can be designed to take into

account certain characteristics of the vehicle (age and engine size; axle-weight; etc.)

associated with its public costs and externalities. Policy maker must be aware, in any case,

of tax design problems such as matching car´s registered address and driver´s residence,

or the redistributive effects of tax differentiation.

As far as the above mentioned sources seldom yield enough revenue to finance all

potential subnational services, decentralization faces three options: to deal with the

vertical imbalance and its efficiency problems in the design of the transfer system; to re-

size or minimize subnational governments role; or to search for other potential tax bases.

Broad-base options: consumption; corporate income; personal income

Focusing on the third option, according to the tax decentralization guidelines, we can

explore two broad tax bases options: consumption (excise taxes; general sales taxes),

corporate income (business taxes; corporate income taxation); and personal income

(personal income taxation; pay-roll taxes). It is relevant to point out upfront that most

central governments are reluctant to concede more taxing power to subnational

governments, specially on their basic tax bases, because they are understandably

concerned about their own revenue positions13, losing macroeconomic control, the risk of

creating horizontal imbalance in favor of rich territories, the capacity to administer those

taxes or about the complexity that this decentralization could create in tax terms. These

concerns are totally rational and should be taken into account, but tax decentralization, at

least theoretically, can be designed in such a way that global revenue is not reduced, but

results in a net increase (taking advantage of the proximity advantages of decentralized

governments and reducing transfers). Tax decentralization may assist improved

responsibility and accountability of local governments and lead to improved fiscal

stability. Tax administration arrangements can help maintain efficiency in tax collection

(sharing administrative structures when feasible) and the expected complexity of a

decentralized tax system can be minimized by choosing correctly the tax powers to be

decentralized (i.e. focusing on tax rates – even introducing floors and ceilings - and not

in tax bases).

Concerning the decentralization of consumption taxes, excises are considered, in general,

more suitable for decentralization than general sales taxes. The decentralization of the

latter, nowadays VAT in most countries, would be possible only at a regional –not local-

level - and would create high administrative and compliance costs, cross-border trade

problems and evasion opportunities. Even taking into account the Canadian experience –

perhaps the only positive one - most studies recommend looking for alternative tax

13 Bird (2010).

8

bases14. Excises15, in turn, are monophasic or single stage taxes, easier to administer and

they offer some benefit links to expenditure (tobacco/alcohol/fuel-health/roads). The

problem with excise taxes16 is that some experts, as Cnossen (2005), consider the benefit

case for “sin” taxes weak in general, especially if we take into account that,

administratively, differential taxes should usually be imposed at the wholesale level,

facing afterwards the problem of distributing the revenue among jurisdictions if we want

to introduce a destination approach17.

Corporate taxation or, broadly speaking, business taxation is another option for

subnational taxation already in place in developed and developing countries18. It can

produce substantial revenue, it is more elastic than property taxation and its political costs

could be considered lower compared with direct taxation of individual citizens, income

or property. On the other hand, tax experts usually advise against decentralization of

corporate taxation on the grounds of the potential distortion to the allocation of resources,

design flaws concerning visibility and accountability, the geographical concentration of

tax bases, the barriers to small and medium enterprises´ growth, or the incentives to

informal economy development that it can induced. Clarifying and dealing with these

flaws and trade-offs requires considering the different options available to define the

specific business taxation: if we choose an indirect estimation of the firm´s ability to pay

(assets; capital; turnover; wage bill; etc.) we are going to distort the efficient location of

resources and economic activity, while focusing on corporate income will increase

complexity and administrative and compliance costs. Additionally, the destination-origin

conflict will always arise (i.e. is it fair and efficient to tax companies on fiscal residence

or should tax revenue be shared taking into account territorial distribution of assets, wages

or sales?). Summing up, it is quite difficult to consider business taxation as an optimal

option for decentralization on the grounds of the above mentioned guidelines, but as far

as decentralized governments are going to use business taxes as a source of revenue due

to their political advantages, the technical task should be to minimize their economic

distortions.

The last tax base mentioned above, personal income, could embody two different kinds

of taxes: personal income taxes and pay-roll taxes. In practice, pay-roll taxes, do not seem

to be the best option for decentralization, as they fall pretty much the same tax base as

personal income taxes –wages and taxes - with some additional disadvantages. As they

are imposed on an origin basis, accountability may be weakened, resource allocation may

be distorted as they tax just labor and, lastly, in most countries pay-roll taxes are already

used to finance social security19.

14 See Bahl and Linn (2014), p.26, for cities and metropolitan governments. 15 Leaving aside vehicle taxes, already considered. 16 An additional caveat is that excise taxes revenue is usually quite inelastic. 17 Local decentralization is, of course, much more difficult than regional. 18 Bird (2010), p. 39. 19 On the other hand, such taxes have several merits: they are easy to administer, at least when imposed on

large enterprises, and they can yield a lot of revenue even at relatively low rates.

9

In any case, decentralized taxation of personal income tax is a paradoxical option. If we

consider the developed countries experience, it is one of the main sources of tax autonomy

(and the bigger this autonomy is, the higher personal taxation role is. However, if we

attend to developing countries practice, the role of decentralized personal income taxes is

practically nil. Theoretically, personal income should be considered a clear candidate for

decentralization. Based on the tax subject’s residence, the tax shows a benefit link, it is

also quite immobile, more evenly distributed and more elastic than other possible tax

bases (especially property), potentially visible and positive in terms of accountability and

its revenue potential is clearly relevant. The problems arise when considering complexity,

administrative and compliance costs and central government’s reluctance to share this

central piece of its tax system. Nevertheless some alternatives exist to try to overcome, or

at least minimize, these disadvantages.

In the next sections we are going to explore more deeply this issue, focusing on the

potential use of personal income tax base, considering international experience, technical

options for its design and decentralization, possible tax administration arrangements and

its potential role in Philippine´s decentralization framework.

Some side considerations will also be offered concerning the need to adopt a global

approach to the implementation of this policy option, taking into account the connections,

especially, with the transfer’s system20.

Figure 2. Tax Decentralization Menu

User charges, special assessments, betterment levies or fees

Property taxes

Motor vehicle taxes

Consumption:

- Excise taxes

- General sales taxes

Business taxation:

- Indirect estimation of the firm´s ability to pay

- Corporate Income Tax

Personal income:

- Personal Income Tax

- Pay-roll Taxes

III. FISCAL DECENTRALIZATION AND LOCAL FINANCE: THE

PHILIPPINE AND INTERNATIONAL EXPERIENCE

Decentralization in the Philippines is one of the most significant political reforms that

emanated from the 1987 Constitution. The "Local Government Code of 1991" (LGC)

devolved to local government units relevant responsibilities in the provision of some

20 The need to include in the full scheme borrowing capacities and the existence of a global hard budget

constraint are also fundamental but fall out of the main goal of this report.

10

public goods and services, and stated that they “shall enjoy genuine and meaningful local

autonomy to enable them to attain their fullest development as self-reliant communities

and make them more effective partners in the attainment of national goals. Toward this

end, the State shall provide for a more responsive and accountable local government

structure instituted through a system of decentralization whereby local government units

shall be given more powers, authority, responsibilities, and resources.”21

In particular: “The vesting of duty, responsibility, and accountability in local government

units shall be accompanied with provision for reasonably adequate resources to discharge

their powers and effectively carry out their functions; hence, they shall have the power to

create and broaden their own sources of revenue and the right to a just share in national

taxes and an equitable share in the proceeds of the utilization and development of the

national wealth within their respective areas”22.

Summing up: The LGC was aimed at the devolution of expenditure and revenue

responsibilities, and, consequently, increased autonomy and accountability. How does

reality compare with these goals?

1. Tax and revenue assignments in the Local Government Code

Revenue assignment and tax and expenditure devolution are detailed in the LGC e

according to the political subdivisions (see Figure 3 and Annex 1).

Figure 3. Administrative Regions (17) Local Government Units

Source: Philippine Statistics Authority - National Statistical Coordination Board

The expenditure assignment to LGUs (Basic Services and Facilities) is contained in

Section 17 (b) of the LGC23. The main responsibilities go as follows:

1. Provinces: hospital and tertiary health services; low cost housing;

telecommunications; infrastructure facilities; social welfare services; industrial

development.

21 Local Government Code, Chapter 1, Section 2 (a). 22 Local Government Code, Chapter 1, Section 3 (d). 23 Agriculture support is shared by the different levels.

11

2. Municipalities: social welfare; primary health care; solid waste disposal; cultural

centers, parks, tourism facilities; infrastructure facilities intended primarily to

service the needs of the residents of the municipality (school building; roads;

water supply; etc.).

3. Barangay (Village): maintenance of health, day care, reading centers; services and

facilities related to general hygiene and sanitation, beautification, and solid waste

collection; maintenance of Barangay roads and bridges and water supply systems.

4. Cities: all the services and facilities of the municipality and province plus

communication and transportation facilities, and support for education, police and

fire services and facilities.

However, the Section 17 (c) allows national (central) government agencies to continue

with the implementation of devolved public works and infrastructure projects, and other

programs and services. 24 And Section 17 (f) allows the national government to or the

next higher LGU level to “provide or augment the basic services and facilities assigned

to a lower level of local government unit when such services or facilities are not made

available, of if made available, are inadequate to meet the requirements of its inhabitants”.

Concerning revenues, Section 18 of the LGC establish the power to generate and apply

resources, including the power to “create their own sources of revenue and to levy taxes,

fees, and charges”, “to have a just share in national taxes” , “an equitable share in the

proceeds from the utilization and development of the national wealth and resources within

their respective territorial” and “to acquire, develop, lease, encumber, alienate, or

otherwise dispose of real or personal property held by them in their proprietary capacity”.

Title 1 of Book II of the LGC (Local Taxation and Fiscal Matters) deals with Local

Government Taxation, exposing the Fundamental Principles – Section 130 - (taxation

should be uniform in each LGU, equitable and based as far as practicable on the taxpayer's

ability to pay; progressive, as far as possible; etc.) and the Common Limitations on the

Taxing Powers – Section 133 - (including income tax –personal and corporate, except on

financial institutions, documentary stamp tax; taxes on estates, inheritance, gifts, legacies

and other acquisitions mortis causa; customs duties, excise taxes on articles enumerated

under the national Internal Revenue Code, as amended, and taxes, fees or charges on

petroleum products; percentage or value-added tax (VAT) on sales; taxes on premiums

paid by way or reinsurance or retrocession; taxes, fees or charges for the registration of

motor vehicles and for the issuance of all kinds of licenses or permits for the driving

thereof).

Chapter II contains the Specific Provisions on the Taxing and Other Revenue-Raising

Powers of Local Government Units25 as summarized in Table 1.

Table 1: Tax assignments

24 UNHABITAT (2011), p. 27. 25 Real Property Taxation is developed in Title II.

12

Tax base Cities Provinces Municipalities Barangay

s

Transfer of real property x x

Business of printing and publication x x

Franchise x x

Sand, gravel, other quarry resources x x * *

Amusement places x x

Professionals x x *

Real property x x * *

Delivery vans and trucks x x

Idle lands x x

Business x x x

Community tax x x *

*shares in the proceeds of levy of province

Source: Local Government Code.

The LGC establish the characteristics and minimum or maximum26 levels of local taxes:

- Tax on Transfer of Real Property Ownership: rate not exceeding fifty percent

(50%) of one percent (1%) of the total consideration involved in the

acquisition of the property or of the fair market value, whichever is higher).

- Tax on Business of Printing and Publication: rate not exceeding fifty percent

(50%) of one percent (1%) of the gross annual receipts for the preceding

calendar year27.

- Franchise Tax: rate not exceeding fifty percent (50%) of one percent (1%) of

the gross annual receipts for the preceding calendar year28.

- Tax on Sand, Gravel and Other Quarry Resources: not more than ten percent

(10%) of fair market value.

- Professional Tax: an annual professional tax on each person engaged in the

exercise or practice of his profession requiring government examination not

exceeding P300.00.

- Amusement Tax: to be collected from the proprietors, lessees, or operators of

theaters, cinemas, concert halls, circuses, boxing stadia, and other places of

amusement at a rate of not more than thirty percent (30%) of the gross receipts

from admission fees.

- Delivery vans and trucks: an annual fixed tax not exceeding P500.

26 Municipalities may levy taxes, fees, and charges not otherwise levied by provinces. Cities, may levy the

taxes, fees, and charges which the province or municipality may impose. Provided, however, That the taxes,

fees and charges levied and collected by highly urbanized and independent component cities shall accrue

to them and distributed in accordance with the provisions of the Code. The rates of taxes that the city may

levy may exceed the maximum rates allowed for the province or municipality by not more than fifty percent

(50%) except the rates of professional and amusement taxes. 27 In the case of a newly started business, the tax shall not exceed one-twentieth (1/20) of one percent (1%)

of the capital investment. 28 Again, in the case of a newly started business, the tax shall not exceed one-twentieth (1/20) of one percent

(1%) of the capital investment.

13

- Tax on Business: municipalities and cities may impose taxes (most on them

fixed amounts depending on gross sales or receipts – turnover taxes-) on a list

of businesses (manufacturers; wholesalers, distributors, or dealers; exporters;

contractors; retailers; financial institutions). Municipalities within the

Metropolitan Manila Area may levy taxes at rates which shall not exceed by

fifty percent (50%) the maximum rates. The Barangays may levy taxes on

stores or retailers with fixed business establishments with gross sales of

receipts of the preceding calendar year of Fifty thousand pesos (P50,000.00)

or less, in the case of cities and Thirty thousand pesos (P30,000.00) or less, in

the case of municipalities, at a rate not exceeding one percent (1%) on such

gross sales or receipts.

- Community Tax: cities or municipalities may levy a community tax on

individuals29 and juridical persons30.

- Real property tax31: Provinces can levy a real property tax not exceeding 1%

(2% for cities and municipalities within the Metropolitan Manila Area) of the

assessed value (the fair market value of the real property multiplied by the

assessment level) of the real property (lands and buildings –residential or not-

, other structures and machinery). The Local Government Code defines the

maximum assessment level for each type of real property (Section 218). The

assessment level varies from local government to local government based on

local ordinances passed by the legislative body (“sanggunian”) and it must be

revised every three years. An additional Levy on Real Property for the Special

Education Fund may be levied by a province or city, or a municipality within

the Metropolitan Manila Area, at a rate of one percent (1%) on the assessed

value of real property.

- Idle Lands32: a province or city, or a municipality within the Metropolitan

Manila Area, may levy an annual tax on idle lands at the rate not exceeding

five percent (5%) of the assessed value of the property which shall be in

addition to the basic real property tax.

According to Section 240, a province, city or municipality may impose a special levy on

the lands comprised within its territorial jurisdiction specially benefited by public works

projects or improvements funded by the local government unit concerned. The special

levy shall not exceed sixty percent (60%) of the actual cost of such projects and

improvements. Additionally, Local government units may exercise the power to levy

29 An annual tax of Five pesos (P5.00) and an annual additional tax of One peso (P1.00) for every One

thousand pesos (P1,000.00) of income regardless of whether from business, exercise of profession or from

property which in no case shall exceed Five thousand pesos (P5,000.00). 30 An annual community tax of Five hundred pesos (P500.00) and an annual additional tax, which, in no

case, shall exceed Ten thousand pesos (P10,000.00) in accordance with the following schedule: P2.00 for

every Five thousand pesos (P5,000.00) worth of real property; P2.00 for every Five thousand pesos

(P5,000.00) of gross receipts or earnings. 31 Chapter VII establishes the distribution of proceeds. 32 This tax has not been completely implemented by LGUs due to political constraints.

14

taxes, fees or charges on any base or subject not otherwise specifically enumerated or

taxed under the provisions of the National Internal Revenue Code (Sections 186, LGC).

Local government units shall have the authority to adjust the tax rates - not oftener than

once every five years, but in no case shall such adjustment exceed ten percent (10%) of

the rates fixed under the Code (Section 191) - and may, through ordinances duly

approved, grant tax exemptions, incentives or reliefs under such terms and conditions as

they may deem necessary (Section 192).

All local taxes, fees, and charges shall be collected by the provincial, city, municipal, or

barangay treasurer, or their duly authorized deputies (Section 170 and 247, LGC).

Title III of the LGC, establishes the shares of Local Government Units in the proceeds of

national taxes. Chapter I (Section 284) defines the Allotment of Internal Revenue Taxes

(IRA) as a 40%33 the national internal revenue taxes based on the collection of the third

fiscal year proceeding the current fiscal year. The share of local government units in the

internal revenue allotment (Section 285) are34:

- Provinces: 23%

- Cities: 23%

- Municipalities 34%

- Barangays 20%

Sections 289, 290 and 291 define the share of the LGUs in the Proceeds from the

Development and Utilization of the National Wealth within their respective areas: 40%

of the gross collection derived by the national government (or the proceeds derived by

any government agency or government-owned or controlled corporation) from the

preceding fiscal year from mining taxes, royalties, forestry and fishery charges.

Additionally, revenues from other national taxes are shared with some LGUs under

special laws (such as a share from the value added tax35, share - 15% from excise taxes

on locally-manufactured Virginia type cigarettes and share -2%- from the tax on

businesses and enterprises located within the ecozones) and, depending on the fiscal

position of the central government and on its political objectives, conditional grants may

come from lump sum allocations under the central government budget, allocations made

33 In the event that the national government incurs an unmanageable public sector deficit it could be reduced

to a minimum of 30%. 34 The share of each province, city, and municipality is determined on the basis of the following formula:

(a) Population: 50%; (b) Land Area: 25%; and (c) Equal sharing: 25%. The share of each barangay with a

population of not less than one hundred (100) inhabitants shall not be less than Eighty thousand

(P80,000.00) and the rest is allocated on the basis of the following formula: (1) Population: 60%; and (2)

Equal sharing: 40%. 35 Among others, the failure of some LGUs to avail of this share is attributed to the complicated procedure

in adopting the rule on the situs of the local business tax and to the absence of computer linkages in the

VAT payment stations that makes it difficult for the BIR to monitor and verify the accuracy of the LGU

share from the gross receipts of business taxpayers maintaining branches, plants/plantations or factories in

different localities.

15

by central government sector agencies from their own budgets and lump sum and/or line

item appropriations for pork barrel funds of legislators.

Title IV completes the revenue framework of local governments36 regulating credit

financing of LGUs to finance local infrastructure and other socio-economic development

projects in accordance with the approved local development plan and public investment

program and to stabilize local finances.

Table 2. Local Government Units Revenue

- Local charges and fees

- Local Taxes

- Fiscal Transfers

o Revenue shares

Internal Revenue Allotment

Share in national wealth

Revenues from other national taxes

o Conditional Grants

- Service and Business Income

- Capital/Investment Receipts

- Credit financing

2. Local Government Units in Figures

In order to assess this legal framework, the first step is to quantify revenue and

expenditures assignments and to compare the results with international experience (Table

3). General Government (Total) revenue, tax and expenditure shares of Gross Domestic

Product (GDP) in the Philippines are low compared to OECD standards and stable for the

last decade. Nevertheless, the degree of internal decentralization in the expenditure side

is quite high and closer to international average, showing the importance of the devolution

process. The problems arise when observing the tax side of the equation: LGUs are

responsible for only a 6.4% of total tax revenue, accounting for just 24% of their revenue,

well below international canons.

Table 3. The Philippines and LGUs revenue and expenditures assignments in

figures

Philippines

OECD

36 Service and Business Income, Capital/Investment Receipts and Credit financing are not going to be

analyzed in this report.

16

2001 2012 2012

Expenditures

Total % GDP 18.4 16.8 47.5

TOTAL Non-Federal

LGU % Total 19.1 17.8 25.5 27.9

Revenue

Total % GDP 14.6 14.5 43.1

Tax Revenue

Total % GDP 12.7 12.9 34.5

TOTAL Non-Federal

LGU % Total 6.6 6.4 11.4 12.65

LGU % Revenue 23.7 24.2 37.9 36.4

LGU Taxes in % TOTAL Non-Federal Weighted by %

Local Taxes to GDP

Property 51.4 42.4 42.0 37.3 27.3

Business/Goods&S. 42.0 52.3 18.3 21.4 12.0

Personal income ---

--- 27.5 30.5 51.5

Corporate Income --- --- 5.9 6.2 4.7

Others 6.6 5.3 6.3 4.6 4.5

Sources: Bureau of Local Governments Finance - Statement of Income & Expenditures- and “The

Philippines: fiscal update (as of July 26. 2013)”, Department of Finance. OECD: OECD StatExtracts and

Fiscal Decentralization Database.

Note 1: OECD data correspond to 2012 or the last year available for individual countries. When the

classification of local taxes in the Philippines and OECD did not match exactly, the closest correspondence

has been chosen.

Note 2: Property Taxes: encompass basic tax on real property, real property tax on idle lands, special

assessment tax and special education tax. Business Taxes: Amusement Tax; Business Tax; Taxes on gross

sales or receipts of manufacturers, assemblers, wholesalers, retailers, distributors, exporters, etc.; Printing

and Publication Tax; Other Business Taxes; Franchise Tax; Tax on Delivery Trucks and Vans; Tax on

Sand, Gravel and Other Quarry Resources. Other Taxes: Community taxes; Professional taxes; Real

Property Transfers tax; fines and penalties and others. THE STATEMENT OF RECEIPTS AND

EXPENDITURES: SYSTEMS, CONCEPTS, INPUT PREPARATION AND REPORTING (BLGF).

When disaggregating LGU Taxes, the LGUs’ dependence on Property and Business taxes

is clear, with a growing role of the latter. This tax revenue structure shows relevant

differences with OECD average:

- The share of property taxation is similar to the non-weighted all-countries

average, but higher than non-federal countries and, specially, compared with

the weighted average (taking into account the relative share of local

governments in each country on its GDP37).

37 Non-weighted average just sums up all individual countries´ percentages of each tax on their total tax

revenue (not accounting for the different size of local governments in each country), while weighted

average sums up the countries´ percentage of each tax on GDP. Results show that that the higher the

17

- Business taxation role is much higher than OECD.

- No role is given to income taxation –personal or corporate- while it is a key

component of local taxation in the international experience38.

In a closer look at the different LGUs´ sources of income (Table 4), we appreciate that

the vertical imbalance due to the scarce amount of autonomous local taxes is covered by

external sources in the first place (two thirds of the income), specially the transfers out of

shares from national tax collections, headed by the IRA (around 60%, even with a slightly

declining role in the last decade). Local non tax revenue accounts for the remaining 10%,

having experience a relative grow from 2001.

Table 4. LGUs Sources of Income, (% of Total)

2001 2012

CITY PROV MUN TOT CITY PROV MUN TOT

1 LOCAL SOURCES (2+6) 50.0 15.3 20.3 31.3 55.8 18.8 20.2 34.9

2 TAX REVENUE (3+4+5) 41.1 9.5 12.9 23.7 43.9 8.5 10.9 24,2

3 Real Property Tax 20.0 7.3 6.3 12.2 16.5 6.7 5.1 10,3

4 Tax on Business 18.6 1.4 5.7 10.0 25.2 1.2 5.2 12,7

5 Other Taxes 2.5 0.9 1.0 1.6 2.2 0.7 0.6 1,3

6 NON-TAX REVENUE (7+8+9+10) 8.8 5.8 7.4 7.6 11.9 10.3 9.3 10.7

7 Regulatory Fees (Permit and Licenses) 3.0 0.3 1.9 1.9 3.1 0.4 2.1 2.1

8 Service/User Charges (Service Inc.) 1.3 1.3 0.7 1.1 1.9 2.6 1.4 1.9

9 Income from Economic Enterprises 2.7 1.2 3.3 2.5 4.3 4.6 4.2 4.4

10 Other Receipts (Other General Inc.) 1.9 3.0 1.4 2.0 2.6 2.7 1.5 2.3

11 EXTERNAL SOURCES (12+15+16+17) 50,0 84.7 79.7 68.7 44.2 81.2 79.8 65.1

12 Total Shares from National Tax Coll. 44.6 78.2 77.1 63.9 40.3 75.0 76.2 60.7

13 Internal Revenue Allotment 44.4 77.0 75.8 63.1 39.2 72.4 72.6 58.4

14 Other Shares from National Tax Coll. 0.3 1.2 1.3 0.8 1.1 2.5 3.6 2.3

15 Inter-Local Transfer 0.3 0.7 0.3 0.4 1.3 2.2 0.5 1,2

16 Loans & Borrowings 4.4 5.0 1.6 3.6 2.0 2.6 1.8 2,1

17 Ext. Receipts/Grants/Donations/Aids 0.8 0.8 0.8 0.8 0.5 1.4 1.4 1.0

18 TOTAL CURRENT OPERATING INCOME (1+11) 100,0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Source: Bureau of Local Governments Finance - Statement of Income & Expenditures-, Department of

Finance.

Note: The definition of Total Current Operating Income includes Loans&Borrowings in both years.

Besides, it has to be pointed out that fiscal autonomy indicators are very different for

cities: tax revenue accounts for more than 40% of their income, with a growing role in

the last decade thanks to business taxes (and, obviously, their dependence on transfers is

much lower, under 45% in 2012). The opposite can be observed in provinces and

municipalities: tax revenue around 10% and transfers nearly at 80% (IRA around 75%).

autonomy of local governments, the lowest the share of property taxation is, growing the role of personal

income decentralization. 38 See preceding footnote.

18

Table 5 gives details on LGUs taxes. Cities account for nearly 80% of local taxes,

followed by municipalities, 15%. Just four taxes (Business; Special Education; Real

property and Property Transfers) represent 90% of tax collection. In fact, the fifth tax item

in terms of revenue is “fines and penalties” and the last nine tax items´ collection is under

1% of total taxes (accounting globally for 3% of total tax revenue).

Table 5. LGUs Taxes. 2013

Cities Provinces Municipalities Total LGUs

% of City Tax

% of LGUs

% of Prov Tax

% of LGUs

% of Mun Tax

% of LGUs

% of Total Tax

% of LGUs

Business 51.17 85.87 0.20 0.03 46.17 14.10 46.65 100.00

Special Educ. 17.84 68.18 44.27 16.16 22.51 15.66 20.48 100.00

Real property 19.15 75.70 29.57 11.16 18.27 13.14 19.81 100.00

Property Tr. 4.10 82.43 7.60 14.57 0.82 3.00 3.90 100.00

Fines and pen. 2.42 77.23 2.60 7.94 2.55 14.83 2.45 100.00

Franchise 2.13 80.22 4.88 17.59 0.32 2.19 2.07 100.00

Community 1.40 66.15 0.00 0.01 3.93 33.84 1.66 100.00

Amusment 0.86 81.66 0.50 4.53 0.80 13.81 0.82 100.00

Sand, Gravel 0.09 8.56 6.86 64.71 1.49 26.74 0.79 100.00

Other 0.18 22.89 1.42 17.52 2.53 59.59 0.60 100.00

Occupation 0.26 69.59 0.27 6.85 0.49 23.56 0.30 100.00

Trucks &Vans 0.11 45.87 1.31 51.03 0.04 3.10 0.19 100.00

Idle Lands 0.16 78.91 0.44 20.38 0.01 0.71 0.16 100.00

Print.& Publ. 0.08 85.07 0.04 3.80 0.06 11.13 0.08 100.00

Professional 0.02 77.83 0.05 15.22 0.01 6.96 0.02 100.00

Special Ass. 0.03 96.98 0.00 0.00 0.00 3.02 0.02 100.00

Total Taxes 100.00 78.28 100.00 7.48 100.00 14.25 100.00 100.00

Source: 2013 Annual Financial Report. Local Governments. Vol.III. Commission on Audit.

Finally, Table 6 analyses global current income of the LGUs on per capita terms. During

the last decade Cities register the highest per capita income, thanks to the distribution of

tax bases devolved to LGUs, but the distance to Provinces-Municipalities´ average has

been reduced to 20% (half the difference in 2001) as a consequence of the dynamics of

the rest of the financing system.

Table 6. LGUs Per capita Income

Pesos Per capita 2001 2011

19

LGUs Total 1,804.6 4,000.5

Cities 2,243.6 4,489.9

PROV+MUN 1,586.0 3,720.5

Difference (Cities)-(Prov+Mun) 657.64 769.3

Difference in % of Cities 41.4 20.6

Source: Bureau of Local Governments Finance - Statement of Income & Expenditures-, Department of

Finance. Population figures: Census 2000 and 2010.

Note: 2001 and 2010 has been selected on their proximity to the census´ years.

How can we assess fiscal decentralization and local finance in the Philippines taking into

account the legal devolution framework, income figures and international experience?

1. On the expenditure side, devolution in Philippines fits academic prescriptions and

is aligned with best international experiences, even if the legal framework is

complicated due to the different levels of government and somewhat overlapping

functions. The degree of internal decentralization in the expenditure side is quite

high and close to international average, showing the importance of the devolution

process (even if global figures in terms of public sector´s role in the economy are

low).

2. The revenue side tells us a different story when it comes to accomplished

autonomy and accountability goals. The share of local taxes in total revenues in

the Philippines is low, especially for provinces and municipalities. The vertical

gap is met with transfers, weakening the link between expenditure and revenue

responsibilities.

3. LGUs´ tax assignment can be considered complex, inefficient and rigid:

a. Complex:

i. Embodies too many different tax items –weakening visibility-.

ii. Requires an extremely decentralized tax administration.

b. Inefficient:

i. Most taxes are relatively unproductive in terms of revenue.

ii. The burden falls specially -leaving apart Property Taxes- on

businesses with a design that taxes indirect signs of real ability to

pay.

c. Rigid:

i. Most important –and elastic- tax bases –income; consumption- are

excluded.

ii. Tax rates level and changes are limited.

iii. Tax liabilities are often expressed in nominal terms and tax base

actualization restricted.

4. The transfer system, the IRA especially, meets the vertical gap but its design

presents important flaws. IRA’s yearly amount is linked to central government’s

20

internal tax revenues with a three years lag. Thus, in case of central government

deficit (as it was the case in 2012) it can be reduced. Second, the shares of the

different LGUs are fixed and independent of any objective needs´ index. Third,

the distribution inside each LGU lacks of any short or medium term dynamic

adjustment factor (population changes –the only dynamic element- cannot be

taken into account on a yearly basis) and there is no reference to fiscal capacity in

order to equalize horizontal differences39.

Summing up, as it happens in most countries, it comes as no surprise that the revenue side

of the decentralization equation is the weak one. Autonomy, accountability, equalization,

dynamics are difficult to get, even if they are essential to take full advantage of

decentralization´s potential benefits. All the elements –taxes and transfers; status quo;

dynamics- have to be taken into account to design a successful reform.

In the next section we are going to focus in one of the factors limiting LGUs ability and

willingness to generate own-source revenues, analyzing the possibility of opening up

some of the tax bases now assigned to the central government to subnational

governments, incorporating best international practices to the Philippines context. In any

case, these options will be put into the global context of local and central finance, pointing

out other connected elements of the system that would have to be adjusted in a far-

reaching reform process.

IV. OPENING UP NEW TAX BASES: PERSONAL INCOME TAXATION AS

A POTENTIAL TOOL FOR LOCAL AUTONOMY

As we have seen above, the LGC limits the fiscal bases that LGUs can have access to,

protecting the following:

- Income: income tax, personal and corporate, except on financial institutions

- Consumption:

o percentage or value-added tax (VAT) on sales

o excise taxes on articles enumerated under the national Internal Revenue

Code, and taxes, fees or charges on petroleum products

- Customs duties

- Inheritance and donations: taxes on estates, inheritance, gifts, legacies and

other acquisitions mortis causa

- Others: documentary stamp tax; taxes on premiums paid by way or

reinsurance or retrocession; taxes, fees or charges for the registration of motor

vehicles and for the issuance of all kinds of licenses or permits for the driving

Table 7 and Figure 2 show the collecting power of all these bases in percentage of total

National Government Tax Revenue. The Bureau of Internal Revenue accounts for 74%

of total taxes (43% on net income and profits -25% Corporate; 15% Individual-; Excises

39 See Martinez-Vazquez (2011) for a complete study of LGUs´ transfer system and its reform.

21

7%; VAT 15%; Percentage 4%; Others 4%) and the Bureau of Customs for 24% (import

duties and VAT40 and excises collected at the customs).

Central Government reserves for itself the bulk of the potential tax bases and the tax

structure that emerges is quite classical in the context of developing countries41: nearly

60% of the revenue comes from indirect taxation42 and even in the direct taxation field

the role of progressive personal taxation is weak43.

Table 7. NATIONAL GOVERNMENT TAX REVENUES, 2013 (% of Total)

TOTAL BIR 73.7 IV. PERCENTAGE TAXES 3.7

I. TAXES ON NET INCOME AND PROFIT 43.5 1. Banks/Financial Institutions 1.8

1. Company, corporate enterprise 25.7 2. Insurance Premiums 0.1

a) Corporate Income Tax 10.6 3. Amusements 0.0

b) Witholding at source 15.1 4. Other Percentage 1.8

2. Individual 14.9 5. Franchise Tax 0.0

a) Individual Income Tax 0.9 V. OTHER TAXES 4.1

b) Witholding on Wages 12.2 1. Tax on Property 0.2

c) Capital Gains Tax 0.6 2. Documentary Stamp tax 3.7

d) Witholding at source 1.3 3. Travel Tax 0.0

3. Others 2.9 4. Miscellaneous 0.3

a) Bank Deposits 0.8

b) Tax on Government Securities 2.1 TOTAL BUREAU OF CUSTOMS 24.1

II. EXCISE

TAXES 7.2 Import Duties and Taxes 4.8

1. Alcoholic Products 2.0 VAT on Imports 18.0

2. Tobacco Products 4.3 Excises 1.3

3. Petroleum Products 0.5

4. Miscellaneous Products 0.2

OTHER COLLECTING

DEPARTMENTS 2.3

5. Mining/Mineral Products 0.2

III. VALUE ADDED TAX 15.1

Sources: BIR Annual Report and Budget of Expenditures and Sources of Financing, Department of Budget and

Management.

Figure 4. National Government Tax Revenue. 2013

40 Total VAT collection, including BIR and Customs, reaches 33% of total tax revenue. 41 See Martinez-Vazquez (2011) for more details on taxation characteristics in Asia. 42 Including customs duties, transformed into VAT and Excises in the opening to the international trade

process following various trade agreements. 43 We are not taking into account here a 2% of GDP revenue from Social Contributions.

22

Nevertheless, even in the Asian context, the role that the Philippines is giving to these tax

bases is limited. Table 8 shows that public sector size in Philippines is well below the

Asian average44. Revenue to GDP ratio is below the Philippines level in only four

countries (Bangladesh, Pakistan, Sri Lanka and Taipei). In addition, only two countries

report lower public expenditure to GDP ratio than Philippines (i.e. Taipei and Singapore).

Our initial assessment concludes that the nominal level of tax rates does not seem to be

the problem -in general nominal tax rates in Philippines are above the Asian average

(Table 9). However, the Philippines is limited in its revenue collection by large tax

incentives, exemptions and tax administration deficits45.

Table 8. Public Sector, (%GDP)

2013 Revenue Expenditure

Central Asia 26.4 27.4

East Asia 22.2 23.4

South Asia 22.1 24.5

Southeast Asia 18.1 22.1

Asia Total 22.1 24.7

Philippines 14.9 16.3

Source: Asian Development Outlook 2014

44 Recently, the authorities have embarked on major fiscal and governance reform, as detailed in the

2011−16 Philippine Development Plan. This encompasses revenue mobilization through tax policy and tax

administration reform, boosting social and infrastructure spending, introducing meanstested social

programs (e.g., conditional cash transfers) and universal health insurance, budget process reform (e.g.,

zerobased budgeting), and strengthened oversight of government owned corporations. For 2013−16, the

authorities are targeting a deficit of 2 percent of GDP while raising the revenue to GDP ratio to 18 percent

(from 14.3 percent in 2012) and the tax ratio to 16 percent (from 12.8 percent in 2012) in order to create

space for new spending (IMF, Philippines 2013 article IV consultation). 45 According to Usui (2011), the Philippines had the lowest ratio of tax staff to overall population (0.13) in

the region (0.49), and the highest ratio of taxpayers (609) per tax staff in the region (579). More details on

tax administration in Asian countries in Araki et al (2014). See Vicente (2006) for an evaluation of tax

leakages.

23

Table 9. Maximum Standard Tax Rates (%)

ASEAN

2014

Corporate

Tax

Indirect/Value Added

Tax

Personal Income

Tax

Brunei 20 - -

Cambodia 20 10 20

Indonesia 25 10 30

Laos 24 10 24

Malaysia 25 10 26

Myanmar 25 5 25

Philippines 30 12 32

Singapore 17 7 20

Thailand 20 7 37

Vietnam 22 10 35

Source: KPMG. Asia Pacific country tax profiles

1. Personal Income Tax as a Local Tax: technical options and international

experience.

On the basis of the theoretical framework, and taking into account the tax bases nowadays

closed to LGUs, personal income should be considered as a serious option to assign

additional fiscal space to local government units. Based on residence, the tax shows a

benefit link, it is quite immobile, more evenly distributed and more elastic than other

possible tax bases, potentially visible and positive in terms of accountability, and its

potential revenue is clearly relevant. But, how can we deal with the problems that arise

when considering complexity, administrative and compliance costs and central

government’s reluctance to share this central piece of the tax system?

Let´s begin by considering technical options for the use of personal income as a local tax

base, and possible tax administration arrangements on the basis of international

experience. We will, afterwards, discuss the potential role of a surcharge on the PIT in

the Philippine´s decentralization framework. Tables 10 and 11 below try to evaluate

different options for the decentralization of the PIT tax base and the administrative

options available for the implementation of this policy tool, respectively46.

1.1. Local PIT: Tax Base options

Beginning with the Tax Base, we can distinguish three basic options (rows in Table 10)

and seven different dimensions (columns in Table 10) that should be considered in

assessing the suitability of this proposal:

- The first two options for the design of this tax instrument correspond to a

classic piggyback tax, surcharge or surtax on central PIT:

46 Of course, this kind of qualitative assessment even if based on theoretical studies and international

experience is always difficult, subjective and relative to specific country characteristics.

24

o The first one would introduce local taxation on central PIT taxable

income, using a single tax rate or opening the chance to surtax differently

every tax bracket of central tax schedule.

o The second would use central PIT tax liability as the base for local

taxation.

- The third option, a Decentralized Personal Income Tax, implies the creation

of a totally autonomous decentralized tax with no connection with the

central one, implying different tax bases and rates.

Concerning tax design flexibility, the best options are the decentralized PIT (LGU would

be able to choose the specifics for all the tax elements according to their needs and local

characteristics) and flexible surtaxes on central tax base (local governments would be

given the chance to design the whole tax schedule, being able to discriminate according

to tax payers´ income levels).

Quite the same happens with the opportunities to introduce progressivity in the local tax.

The only option that cannot be considered progressive is the single rate surtax on central

taxable income (proportional). The autonomous decentralized PIT and the surtaxes on the

different tax brackets would open to LGUs the design of the whole decentralized tax

schedule. The surtax on central tax liability, even if less flexible, would always preserve

the same degree of progressivity of central PIT.

Table 10. Personal Income Tax Decentralization Tax Base Options

TAX BASE

Design

Flexibility

Progressive

design

Fiscal

space

autonomy

Nominal

tax rate

level

Simplicity

design

Tax

adm.

Costs

Potential

autonomy

use

Net

synthetic

score

Central PIT

taxable

income

1 tax rate - - +/- + + + +/- +1

Tax brackets + + +/- + - - - + +1

Central PIT

tax liability - + - - + + - -1

Decentralized

personal

income tax

+ + + + - - - - - - -2

*Not including passive income

*Decentralized options´ score would differ depending on their degree (provincies; municipalities; cities)

Decentralized PIT would be the best option to protect fiscal space autonomy, avoiding

the conflicts that arise when central authority’s decisions affect local governments´

revenues, while the surcharge on central PIT tax liability would be the worse as far as

every change (on the design of the taxable income, the tax rates or tax credits) would

25

affect other government´s revenue. This option –surtax on central tax liability- is also the

worse from a political point of view, as long as the nominal level of the tax rates –to

collect a certain revenue target- would be always higher, obviously, as the tax base is

lower.

Simplicity, administrative and compliance costs are the worst characteristics of the

autonomous PIT and, to a lesser extent, of the decentralized tax schedule on central

taxable income, especially when considering local, and not only regional, tax autonomy.

Finally, decentralized PIT and surtaxes on tax liability seem less suitable if we want to

encourage effective use of tax autonomy for different reasons: excessive visibility,

complexity and administrative costs in the first case; and high nominal tax rates,

vulnerability to central tax reforms and scarce flexibility to adapt their policies in the

latest.

Summing up and considering all dimensions, surtax on central PIT taxable income

would seem to be the best design option on the basis of the desired characteristics, with

the one or multiple tax rates´ choice depending on the design priorities: simplicity and

minimum administrative costs or flexibility.

1.2. Local PIT: Tax Administration Options

The two tax administration´s options available when considering the implementation of a

local PIT-based tax are to use central or local tax administration systems (Table 11).

The other critical dimension to consider is whether to focus on an employer or employee

residence basis.

Administrative and compliance costs considerations would lend support to the use of

central tax administration of the new tax, even if some problems will arise when

considering employee residence that would have to be solved improving withholding

process at central level. On the other side, tax autonomy visibility –and accountability-

would be higher with decentralized administration or, at least, employee residence basis,

an option that, in any case, reinforce the benefit link.

Table 11. Personal Income Tax Decentralization Tax Administration Options

TAX

ADMINISTRATION

Adm.

Cost

efficienc

y

Complianc

e Cost

Efficiency

Visibilit

y

Benefit

Principl

e

Jurisdicc.

Conflict

Resolutio

n

Tax

frau

d

fight

Net

syntheti

c score

Central Tax Adm.

Employer Residence Basis ++ + - +/- - +/- +1

Employee Residence

Basis - - + + + +

+2

LGUs Tax Adm.

Employer Residence Basis - - -- + +/- - - - -6

Employee Residence

Basis - - - -- ++ + - ++ -1

*Not including passive income

26

*Decentralized options´ score would differ depending on their degree (provincies; municipalities; cities)

Resolution of conflicts on tax bases that may arise among jurisdictions will always be

difficult, but easier to deal with in the central tax administration/employee residence

option. Finally, decentralized tax administrations based on employee residence could be

more efficient concerning tax fraud fight, due to its proximity to taxpayers, while it could

be the worse option on employer residence basis.

All in all, central tax administration on employee residence basis seems to be the best

design option for the tax administrative arrangements, especially in a local context, if

administrative and compliance costs are not excessive and a one-tax rate on central PIT

taxable base is considered.

1.3. Personal Income Tax Decentralization: international experience

International experience shows 13 OECD countries using decentralized PITs (Table 12),

11 of them at the local level. Most of them use central PIT taxable income as their tax

base, even if some experiences exist adjusting it to create their own tax base or charging

local or state tax on central tax liability.

Tax rates are, usually, not progressive, especially at the local level, and central (or

coordinated) tax administration is the dominant pattern. In most of these countries

decentralized PIT accounts for a relevant share of local and/or state tax revenue.

Table 12. PIT decentralization in the OECD

Country Level of government Tax base Progressive rates Tax administration % of Taxes

Belgium L CTg Yes Central 34.0

Canada S TYs Yes* Central* 36.0

Denmark L TY No Central 87.1

Finland L TYl No Central 87.1

Iceland L TY No Central 81.5

Italy R and L TY Yes Central 23.6

Japan L* TY No Local* 34.8

Korea R and L CT* No Central 9.8

Norway R and L* TY No Central 87.7

Spain S TY* Yes Central* 41.2

Sweden L* TY No Central 97.3

Switzerland S TYs Yes Central/State 62.2

L CT* No State/Local 69.2

USA* S TYs Yes Central/State 35.1

L TYl No State/Local 3.7

Source: OECD StatExtracts and countries´ legislation.

Notes: S-State; R-Region; L-Local. CT-Central government tax liability net of (central government) tax

credits; CTg-Central government tax gross of tax credits; TY-Taxable income for central government tax

purposes; TYs-Taxable income modified for state government tax purposes; TYI-Taxable income modified

for local government tax purposes.

27

* See Box 1 for details.

BOX 1. PIT Decentralization in particular countries

Belgium: Municipalities (local government areas) are entitled to levy an additional tax on taxpayers resident in

their area which generally varies from 5% to 8% of income tax payable, with a few municipalities levying no

additional tax at all.

Canada: Canada Revenue Agency collects all provincial personal income taxes on behalf of all provinces except

Quebec, through a system of unified tax returns. Alberta PIT is a flat tax.

Japan: Inhabitants Tax: Prefectural inhabitants’ tax and municipal inhabitants’ tax are collectively called

inhabitants tax. Such inhabitants taxes are levied on a per-capita basis and per-income basis for those who have

an address (domicile) as of January 1, and inhabitants taxes on a per-capita basis on those who have an office or

a house even if they do not live there. The amount of inhabitant tax is calculated on the basis of income earned

in the previous year. The tax rate of per income levy is 10% regardless of amount of income (metropolitan 4%;

city 6%). In addition a standard fixed (annual) per-capita amount of Prefectural inhabitants tax of JPY 1 000, and

a standard fixed (annual) per-capita amount of Municipal inhabitants tax of JPY 3 000 are applied (recently a

Tohoku earthquake restoration surtax has been passed: per capita 1000 yens). Local taxes are administered by

the Local Tax Bureau, an internal organ of the Ministry of Public Management, Home Affairs, Posts and

Telecommunications, which is responsible for planning local taxes such as prefectural tax and municipal tax and

for determining which governmental body has the right to levy taxes. The actual administration such as tax

assessment and collection is executed by the local government that has the right of taxation. The prefectural tax

offices and municipalities (cities, wards, towns and villages) are in charge of assessment and collection of

prefectural taxes and municipal taxes respectively.

Korea: These rates are surtax rates, that is, the sub-central rates (Provinces and Metropolitan cities including

Seoul) are a percentage of the central government tax rate. Local governments are free to set sub-central rates

between 5 and 15 per cent, but in practice all use the 10 per cent rate.

Norway: Local governments are free to reduce the sub-central rates, but in practice all use the maximum rate.

Spain: State -regional- governments can change personal exemptions and tax credits. Navarra and the Bask

Country design and administer their own PITs.

Sweden: There is a county and a municipal share. In addition to the proportional tax, every individual also has

to pay a lump sum tax of SEK 200.

Switzerland: In most cantons (middle level of government), local governments are permitted to levy surcharges

at locally established rates on cantonal income taxes, not on the income tax of the central government.

United States: Most States (41 and Washington DC) have a broad base PIT (7 States do not charge PIT and other

2 tax dividend and interest income). 29 States and DC use Federal Adjusted Gross Income as tax base, 10 use

Federal Taxable Income, and 4 define their own tax base. Most States´ PITs are progressive -7 are flat tax-. Local

PIT is not allowed in 6 States. Currently 17 States have Local PITs, 4,943 jurisdictions encompassing over 23

million Americans; in most cases local PIT works as a surcharge on state taxable income (even if some city, as

Yonkers, NY, use PIT tax liability, 15% -obviously nominal tax rate is much higher than the ones on taxable

income, around 1%). Tax administration of Local PITs is not homogeneous. For instance, in Maryland and New

York City, residents pay their local income tax when they file their state income tax. However, there are examples

of extreme compliance burdens associated with local income taxes collected by local authorities. As one example,

taxpayers in Albion, Michigan, must fill out a city income tax form of 16 pages, with instructions, separate from

state and federal income tax forms. Complexity is also a problem at the State level. The 94-page instruction

booklet issued to taxpayers in the New York State with the PIT tax form demonstrates how complicated the tax

can be. Its complexity results in a lack of transparency, an important indicator of a good tax. The booklet contains

instructions for three tax forms, several tables to assist the taxpayer in calculating tax liability and instructions

for claiming tax credits and deductions.

28

2. Evaluating a Local Personal Income Tax for the Philippines.

Once that we have analyzed personal income taxation potential to increase autonomy and

accountability of local governments (taking into account theoretical background,

international experience, public sector and decentralization figures and technical

alternatives), the final section of this report will try to assess the revenue potential of a

Local-PIT as a surtax on central PIT taxable income in the Philippines, administered by

the BIR and based on tax payers residence.

To do that we use 2012-2103 FIES (Family Income and Expenditure Survey) to

microsimulate PIT results and decentralization options. The 2012-2013 FIES was

conducted in two visits (July 2012 and January 2013) and it gathered data on family

income and family living expenditure and related information affecting income and

expenditure levels and patterns in the Philippines. The FIES covers all provinces of the

country including all cities and municipalities in NCR. The survey involves a national

sample of about 50,000 households, deemed sufficient to provide reliable estimates of

income and expenditure levels for each region47.

Taxable income will be estimated taking into account Part V and Part VI of the survey:

salaries and wages (minimum wage earners will be considered exempted48; personal

exemption -50,000P-, qualified dependents exemptions -25,000P, age<22, maximum 4

dependents49-; 13th month salary exemption) and entrepreneurial activities (net income50).

The current PIT tax rate schedule will be used (Table 13). On the other hand, Table 14

shows the results for the 2012 PIT’s revenue estimation using FIES and its contrast with

BIR collection figures.

47 In the 2003 Master Sample (MS), a stratified, three-stage sampling design was employed: the selection

of Primary Sampling Units (PSUs) for the first stage, sample enumeration areas (EAs) for the second stage,

and sampling units for the third stage. The domains are the regions which were stratified by province, highly

urbanized city (HUC), independent component city (ICC), and other factors within the geographical strata.

The overall sampling fractions vary across regions to generate adequate sample size for each region. Survey

weights are used in order to produce valid estimates of the population parameter. Base weights are

computed to compensate for the unequal selection probabilities in the sample design. These were adjusted

to account for unit nonresponse and to conform to known population distributions (eg. projected population

counts). 48 Following Tiopianco et al (2013) conservative approach, p.591, it will be set at 55.000P. 49 The survey provides the number of dependents under 18 years old. 50 Assuming 50% tax compliance for self-employment income. According to IMF (2012) “the average

amount of tax paid by the self-employed and professionals in 2010 is PHP4,360, which is 30.7 percent of

the average tax paid by wage earners” (p. 42) and “reporting of income by the self-employed mainly

depends on their voluntary compliance” (p.43). The Optional Standard Deduction (OSD) is not considered

(it allows the self-employed to opt for 40 percent deduction based on the gross sales or gross receipts of the

self-employed and has no limitations on the gross sales and gross receipts).

29

Table 13. Philippines´ PIT schedule

Net Taxable Income

Over But not over Marginal Tax Rate

0 10,000 5

10,000 30,000 10

30,000 70,000 15

70,000 140,000 20

140,000 250,000 25

250,000 500,000 30

500,000 excess over 32

Table 14. PIT: FIES Microsimulation and BIR Collection Billion PHP

2012 Salaries&Wages Salaries&Wages+Entrepreneurial Income*

FIES Simulation 177,62 216,55

Withholdings on Wages Tax on Income Individuals**

BIR 181,62 213,27

%FIES/BIR 97,80 101,54

* Self-employed income reported at 50%

* * Not including Capital Gains Tax

Source: BIR data from BIR (2014).

The results should be read cautiously, as the use of the FIES survey provides only a rough

estimation of real PIT collection. This microsimulation analysis should be tested, as any

possible tax reform, with real BIR data on PIT51.

2.1. Local-PIT Revenue Potential

Table 15 shows the results for a Local-PIT. A 1% surtax on central taxable income would

yield 10 billion pesos, 4.65% of simulated PIT tax in 2012. To reach the same revenue

outcome through a surcharge on central tax liability we would need a nominal tax rate

nearly 5 times higher as long as it would fall on a smaller tax base.

51 It has to be underlined that the sample design is reliable only at the regional level. Estimates for LGUs

are, statistically, only second-best proxies, the better the bigger the province or the city population would

be.

30

Table 15. Local-PIT

Tax Revenue

Billion PHP %

1

PIT Base Scenario

216.55

---

2

1%Taxable

Income Surtax

10.07

4.65%

3

4.65% Tax

Liability Surtax

10.07

4.65%

Administrative and compliance costs of this Local-PIT would be also minimized with this

design, even if, being realistic, some problems will arise managing the withholding

process. In any case, in order to improve administrative efficiency, employers should be

provided with yearly updated withholding software to take into account changes in tax

structure and including employee residence. This way, periodic withholding forms and

the Annual Information Return of Income Taxes Withheld on Compensation and Final

Withholding Taxes (BIR Form 2316) would be completed automatically and used to

compute Local-PIT distribution. Annual Income Tax Returns (BIR Forms 1700 –

compensation earners- and 1701 –self-employed-) would be used to assess the whole tax

base and to collect the tax and the surtax on individuals required to file income tax returns.

Ideally, all this process could be used to improve global collection and to reduce tax fraud,

specially by self-employed individuals as long as LGUs proximity to local business and

their experience managing local taxes could be used to control tax compliance if

information is shared between both levels of government. Sharing the tax base introduces

incentives to collaborate, as long as both benefit from tax evasion control.

From the juridical point of view this reform would require amendments to PIT legislation

(introducing LGUs surtax and regulating the withholding process) and to the LGC

(concerning the articles, above listed, that define tax assignments, limitations on taxing

powers and the distribution of proceeds – in a way similar to the one used for Property

31

Tax in Section 271-). Even a connection with Community Tax could be explored, given

its conceptual proximity with this Local-PIT52.

2.2. Territorial distribution of the Local-PIT

Revenue potential must be analyzed taking into account the territorial distribution of the

Local-PIT and pointing out some possible links with the transfer system. Table 16 shows

the distribution of population, taxable income and revenue collection from a proportional

Local-PIT implemented as single-tax rate surtax on central PIT taxable income.

The results are perhaps expected and reflect the differences in the territorial distribution

of personal income. The last column illustrates regional differences by the ratio between

population and income/proceeds: above 1 are the above the average income regions,

headed by the National Capital Region (NCR), and below 1 the poorest ones. As a whole,

the Cities will collect 53% of the revenue while accounting for 36% of the population,

while Provinces and Municipalities, as a whole, would benefit from the 47% of the

revenue, representing 64% of the Philippines inhabitants.

Table 16. Territorial distribution of the Local-PIT

FIES 2012

Individuals

%

Taxable

Income and

Local-PIT

proceeds

%

Income/Population

Ratio

REGION

NCR 13.41 32.33 2.4

CAR 1.72 1.82 1.1

I - Ilocos Region 4.97 2.89 0.6

II - Cagayan Valley 3.43 2.08 0.6

III - Central Luzon 11.15 10.95 1.0

IVa - Calabarzon 13.98 20.99 1.5

IVb - Mimaropa 2.93 1.52 0.5

V - Bicol Region 5.74 2.49 0.4

VI - Western Visayas 7.25 4.69 0.6

VII - Central Visayas 7.52 5.10 0.7

VIII - Eastern Visayas 4.30 2.24 0.5

IX - Zamboanga Peninsula 3.65 1.75 0.5

X - Northern Mindanao 4.65 3.62 0.8

XI - Davao Region 4.93 3.29 0.7

XII - SOCCSKSARGEN 4.67 2.39 0.5

Caraga 2.58 1.39 0.5

ARMM 3.13 0.46 0.1

TOTAL 100.00 100.00 1.0

Total CITIES 35.98 53.13 1.5

52 This tax, as currently designed, performs poorly in revenue terms and its administration and control are

quite complicated, but can be considered as a valuable precedent.

32

Total Provinces/Municipalities 64.02 46.87 0.7

Table 17 contains the same information for the Cities inside the NCR53, where personal

income –and taxable income- is higher. Makati City leads the ranking, accounting for 0.5

of the population and nearly 2% of the revenue/income, while all the other cities´ records

in the Region are also above the average. In a 1% Local-PIT scenario Makati´s revenue

would account for 20% of its external resources (transfers from IRA and Other National

Tax Collections), that in 2012 account only for 7% of its total current operating income.

This scenario brings the Philippines closer to Bird´s suggestion54 that it would also be a

good practice if subnational taxes provided sufficient revenue for at least the richest

subnational units to be essentially fiscally autonomous in the sense of being able to raise

sufficient revenue through taxes that they control to cover the expenditures for which they

are directly responsible.

Table 17. Territorial distribution of the Local-PIT

NATIONAL CAPITAL

REGION (NCR)

Individuals

%

Taxable Income and Local-PIT

proceeds %

Income/Population

Ratio

CALOOCAN CITY 1.53 2.59 1.69

CITY OF LAS PIÑAS 0.61 1.61 2.6

CITY OF MAKATI 0.51 1.96 3.8

CITY OF MALABON 0.45 0.61 1.4

CITY OF MARIKINA 0.46 1.22 2.6

CITY OF NAVOTAS 0.27 0.29 1.1

CITY OF PARAÑAQUE 0.74 2.47 3.3

PASAY CITY 0.52 1.39 2.7

CITY OF PASIG 0.61 1.64 2.7

QUEZON CITY 3.35 9.93 3.0

CITY OF SAN JUAN 0.17 0.33 1.9

TAGUIG CITY 0.60 0.97 1.6

CITY OF VALENZUELA 0.73 1.13 1.5

TOTAL 10.56 26.11 2.5

But, how do we deal with the differences in size and tax productivity? Should all LGUs

be able to manage Local-PIT tax rates? How can we organize overlapping between

Provinces, Cities and Municipalities?

The answer to the last two questions depends on the development and experience of tax

administration, and at the first stage of the process it would be advisable to limit tax rate

decentralization to Cities and Provinces. This option would limit overlapping to Provinces

53 Individual figures for all the other Cities are also available, but estimates´ reliability is lower due to the

survey design. 54 Bird (1993).

33

and Cities, relatively easy to solve by tax administration, while Municipalities (and

Barangays) participation should be determined in a way similar to the Property Tax55,

establishing the distribution of proceeds in the LGC.

The range of tax rate autonomy and its ceilings or floors could evolve in time according

to experience, but arguably the departing scenario should set a uniform 1% minimum tax

rate56 for all LGUs across the country, leaving them the autonomy to modify it by, for

instance, a 20% up or down after three years (a 0.8 - 1.2 tax rates margin). This way,

departing from a uniform tax scenario across the country, LGUs and BIR would have the

time to evaluate the mechanism, to solve its administrative challenges and to know better

their taxable basis in order to evolve to higher steps in the decentralization process57.

On the other side, differences in per capita taxable income could be offset in the first steps

of the reform adjusting the Cities share in IRA. The revenue that they would get in the

baseline scenario (homogeneous 1% Local-PIT) in excess to their population share could

be balanced reducing their IRA share. This liberated space in the transfer formula could

be used to finance Provinces and Municipalities and, even, to consider the introduction

of Fiscal Capacity variables in the formula, equalizing differences in per capita income.

Table 18. Local-PIT Baseline Scenario

Local-PIT autonomy: single tax rate on central PIT taxable income

BIR joint administration of central and local PIT

Tax rate autonomy to Cities and Provinces

Proceeds distribution formula for Municipalities and Barangays

Uniform tax rate for three years – learning process

Tax rate autonomy after three years, for instance, 20% up or down

Differences in per capita taxable income could be offset in the first steps of the

reform adjusting the Cities share in IRA

This liberated space in the transfer formula could be used to finance Provinces and

Municipalities and, even, to consider the introduction of Fiscal Capacity variables

in the formula, equalizing differences in per capita income.

55 Section 271, LGC. 56 The actual level of the tax rate is not relevant, it could be the one needed to reach revenue goals. 57 The 1% baseline scenario could be used to measure fiscal effort and fiscal capacity in case these variables

are introduced in the transfer system.

34

2.3.Central PIT´s reform and the role of a Local-PIT

Nowadays there is a strong pressure in the Philippines to reform PIT at the central level

based on different arguments (excessive number of tax brackets; too high tax rates,

especially the top one; no indexation of tax brackets since 1997, giving place to bracket

creep58; excessive burden falling on middle class salaries; etc59). There are currently eight

(8) bills filed in the House of Representatives and three (3) bills in the Senate seeking to

lower income tax rates or initiate re-bracketing (Table 19). As far as these proposed

reforms of PIT would affect IRA (40% of the revenue lost will reduce LGUs income from

this source), we will explore if the parallel creation of a decentralized PIT could be

implemented looking for a triple-dividend: reforming structural problems of central PIT,

offsetting LGUs revenue lost and improving their autonomy and accountability.

Table 19. PIT Reform´s Bills

Romero “Miro” S. Quimbo (HB

4829)

Adjusting the taxable income brackets and setting a flat for Self-

Employed and Corporations

Salvacion “Sally” S. Ponce-Enrile

(HB 210)

Increasing the tax brackets from 7 to 13 with a rate ranging from

2.5% - 32%

Magtanggol I T. Gunigundo (HB

4099)

Reducing the top bracket tax rate from 32% to 30% and a flat

rate of 15% for Corporations

Arthur C. Yap (HB 4849) Increasing tax brackets from 7 to 8 with a rate ranging from 2%

to 30%

Roman T. Romulo (HB 4880) Reducing tax brackets from 7 to 6 and two-part implementation

with a rate ranging from 13%-30% for 2016 that will become

10%-28% in 2017

Rodrigo A. Abellanosa, Angelina

“Helen” D.L. Tan, Maximo B.

Rodriguez Jr., Rufus B. Rodriguez

(4278, 4372, and 4890)

Reducing tax brackets from 7 to 5 and three part implementation

with a rate of 15%-32% this 2015, 13%-28% this 2016, and

10%-25% this 2017

Dakila Carlo E. Cua (HB 4600) Imposing a flat rate of 10% for professionals

Victoria G. Noel (HB 4925) Reduction of tax brackets from 7 to 6, three part implementation

of individual tax rates of 15%-32% fro 2015, 13%-28% for

2016, and 10%-25% for 2017 as well as for Corporation Income

Tax Rates of 30% for 2015, 27% for 2016, and 25% for 2017

Juan Edgardo “Sonny” M. Angara

(SB 2149)

Adjusting tax brackets and lowering income tax rates, with the

highest rate to be reduced from 32% to 25% by 2017

Paolo Benigno “Bam” A. Aquino

(SB 1942)

Adjusting tax brackets, lowering income tax rates, and

exempting Marginal Income Earners (not Over P60,000); with

automatic indexation to inflation every 6 years

Ralph G. Recto (SB 716) Adjusting tax brackets and lowering income tax rates, with

automatic indexation to inflation every 6 years without need for

legislative action

Source: Quimbo et al (2014)

58 If the tax brackets are not adjusted for inflation over time and nominal incomes increase, a growing

number of income taxpayers are pushed into higher tax brackets, even if their real (or inflation-corrected)

incomes have not (or not by as much) increased. 59 See Tiopianco et al (2013) and Quimbo et al (2014).

35

Table 20 evaluates different PIT reforms in terms of their revenue lost with respect to the

baseline scenario (PIT simulated collection), identifies central government and LGUs

(IRA60) revenue losses and identifies the surtax´s rate on PIT taxable income that would

offset LGUs loss.

Table 20. PIT Reform Options

Tax

Revenue

Revenue Loss

Central

Loss

IRA

Loss

Surtax

Comp.

Billion

PHP

Billion

PHP

% Tax

Revenue

Billion

PHP

Billion

PHP

Tax rate

%

1 Base Scenario 216.55

2 Infl. Adj. Schedule 175.39 41.16 19.01 24.69 16.46 1.64

3 Max. Tax rate 30 213.90 2.65 1.22 1.59 1.06 0.11

4 Max. Tax rate 25 198.78 17.77 8.20 10.66 7.11 0.71

5 Inf.+ Max rate 30 174.54 42.01 19.40 25.21 16.80 1.67

6 Inf.+ Max rate 25 168.11 48.44 22.37 29.06 19.38 1.92

7 Red. 1 point 206.48 10.07 4.65 6.04 4.03 0.40

8 Inf.+ Red 1 + 25 159.33 57.22 26.42 34.33 22.89 2.27

9 5 Brackets (5-25) 166.39 50.16 23.16 30.10 20.06 1.99

10

1%Taxable Income

Surtax

10.07

4.65% of PIT Revenue

The PIT reforms considered are:

- (2) Inflation-adjusted tax brackets (1998-2012 inflation factor: IMF, 2004) is

the most demanded reform. The new schedule would be:

Net Taxable Income


0 20,403 5

20,403 61,210 10

61,210 142,825 15

142,825 285,650 20

285,650 510,090 25

510,090 1,020,181 30

1,020,181 excess over 32

60 40% LGUs participation on PIT through IRA.

36

- (3) Top tax rate reduced to 30%

- (4) Top tax rate reduced to 25%, as CIT tax rate

- (5) Combining alternatives (2) and (3)

- (6) Combining alternatives (2) and (4)

- (7) Reducing 1 point all brackets´ tax rates (new tax rates: 4, 9, 14, 19, 24, 29,

31); this option is useful to evaluate linear-non losers-reforms; additionally, it

is the schedule reform that creates the fiscal space for the creation of a Local-

PIT as exposed in (10)

- (8) Combining alternatives (2), (4) and (7), a global reform attending different

goals

- (9) Reducing the number of tax brackets from 7 to 5 without losers –sliding

up the tax rates- and reducing maximum PIT tax rate to CIT level; the new

tax schedule would be:

Net Taxable Income


0 30,000 5

30,000 70,000 10

70,000 140,000 15

140,000 250,000 20

250,000 Excess over 25

- (10) A 1% piggyback or surtax on central PIT taxable income (Local-PIT),

intended to be assigned to LGUs expanding their autonomy and

accountability, as we have explained above; last column evaluates the Local-

PIT´s tax rate needed to recover LGUs costs in each of the reform alternatives

Results show the feasibility of this kind of triple-dividend reform:

- A Local-PIT (based on central PIT taxable income, administered by BIR and

assigned to LGUs) could be used to minimize global tax revenue´s costs –

something essential given Philippines´ tax revenue to GDP figures-. A tax rate

between 1 and 2% yields enough revenue to recover LGUs losses in most of

the scenarios.

- It creates some room to mitigate PIT structural deficiencies61. As long as it

increases average tax rate it allow to face tax schedule and marginal tax rates

alleged flaws while preserving, at least partially, PIT redistributive potential.

61 Distribution effects are not explored here, but are relatively easy to estimate as it would not change central

PIT progressivity due to its proportional design. As long as PIT is considered progressive the Local-PIT

surtax would increase its redistributive potential due to its positive revenue effect.

37

- Increases LGUs´ autonomy and accountability as long as they are given the

possibility to change to some extent the baseline tax rate (it´s level depending

on central PIT´s reform costs).

V. FINAL REMARKS

Decentralization creates a promising framework to improve democracy and public sector

efficiency, but putting it into work is exigent concerning expenditure and revenue

assignment.

Theoretical guidelines provide useful help, even if it is impossible to avoid the obvious

trade-offs among competing goals, such as autonomy and equity, and international

experience can help showing the road undertaken previously by other countries.

This report deals with this topic focusing in Philippines actual situation and figures,

exploring different options to improve devolution at the revenue side and identifying

personal income taxation as a likely field to work on.

But Political Economy considerations are fundamental to make a reform work in practice.

Administrative and juridical challenges could be easily overcome if the positions of the

different stakeholders are taken into account, balancing benefits, and the appropriate

timing is chosen.

The Philippines face now a window of opportunity not to waste. Central government

could be clearly better off if it decides to lead a global reform including central taxation,

specially PIT, and Local Government Units finance arrangements, creating a Local-PIT

and strengthening their accountability. On their side, LGUs could benefit from the reform

protecting their revenues, improving autonomy and transforming horizontal relationships.

At the first stage of the process it would be advisable to move forward step by step,

limiting tax rate decentralization to Cities and Provinces, setting a uniform 1% minimum

tax rate for all LGUs across the country and offsetting differences in per capita taxable

income adjusting the Cities share in the IRA.

This kind of no-losers no winners approach does not transform the scenario radically at

the first stage, but allow all the participants to participate in the agreement, while setting

up the basis for future developments. The dynamics of the system and the learning process

would the protagonists in future stages, once the cornerstones of the reform are settled in

a vertical and horizontal cooperative decentralization process.

BIBLIOGRAPHY

38

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“The Oxford Handbook of State and Local Government Finance “, Oxford

University Press, Oxford and New York, 2012, pages 105-136.

ANNEX 1

http://web.undp.org/evaluation/documents/decentralization_working_report.PDF

40

Region - A sub-national administrative unit comprising of several provinces having more

or less homogenous characteristics, such as ethnic origin of inhabitants, dialect spoken,

agricultural produce, etc.

Province - The largest unit in the political structure of the Philippines. It consists, in

varying numbers, of municipalities and, in some cases, of component cities. Its functions

and duties in relation to its component cities and municipalities are generally coordinative

and supervisory.

City - There are three classes of cities in the Philippines: the highly urbanized, the

independent component cities which are independent of the province, and the component

cities which are part of the provinces where they are located and subject to their

administrative supervision. (see City Classification)

City Classification:

Highly Urbanized Cities - Cities with a minimum population of two hundred thousand

(200,000) inhabitants, as certified by the National Statistics Office, and with the latest

annual income of at least Fifty Million Pesos (P50,000,000.00) based on 1991 constant

prices, as certified by the city treasurer.

Independent Component Cities - Cities whose charters prohibit their voters from voting

for provincial elective officials. Independent component cities shall be independent of the

province.

Component Cities - Cities which do not meet the above requirements shall be considered

component cities of the province in which they are geographically located. If a component

city is located within the boundaries of two (2) or more provinces, such city shall be

considered a component of the province of which it used to be a municipality.

Municipality - Is a political corporate body which is endowed with the facilities of a

municipal corporation, exercised by and through the municipal government in conformity

with law. It is a subsidiary of the province which consists of a number of barangays within

its territorial boundaries, one of which is the seat of government found at the town proper

(poblacion).

Barangay - The smallest political unit into which cities and municipalities in the

Philippines are divided. It is the basic unit of the Philippine political system. It consists

of less than 1,000 inhabitants residing within the territorial limit of a city or municipality

and administered by a set of elective officials, headed by a barangay chairman (punong

barangay).

Source: Philippine Statistics Authority - National Statistical Coordination Board

http://www.nscb.gov.ph/activestats/psgc/articles/con_lgu.asp

http://www.nscb.gov.ph/activestats/psgc/articles/con_lgu.asp

REFORM OF THE REGULATORY FRAMEWORK

FOR LOCAL GOVERNMENT DEBT AND CREDIT

FINANCING UNDER THE 1991 LOCAL

GOVERNMENT CODE

Rosario G. Manasan

ADB Consultant

[email protected]

JANUARY 2015

mailto:[email protected]

i

TABLE OF CONTENTS

Page

List of Figures ............................................................................................................................ i

List of Tables ............................................................................................................................. i

EXECUTIVE SUMMARY………………………………………………………………….iii

I. INTRODUCTION.................................................................................................. 1

II. CURRENT FEATURES OF REGULATIONS ON LGU BORROWING ...... 2

1. Statutory Ex-Ante Rules ........................................................................................ 2

2. Central Government Administrative and Procedural Controls ........................ 3

III. EVALUATION OF LGU BORROWING REGULATIONS ............................ 6

1. Weaknesses in the Statutory Basis of the Regulatory Framework ................... 8

2. Inefficiencies in the Implementation of Procedural Controls on LGU

Borrowing .............................................................................................................13

IV. RECOMMENDATIONS ..................................................................................... 17

1. Addressing Weaknesses in the Statutory Basis of the Regulatory Framework

................................................................................................................................ 17

2. Addressing Inefficiencies in the Implementation of Procedural Controls on

LGU Borrowing ................................................................................................... 17

List of Figure

Figure 1. Schematic Diagram of Central Government Regulations Affecting LGU Debt 4

List of Tables

Table 1. Documentary Requirements for BLGF Certificate of Borrowing Capacity

and Certificate of Debt Service Capacity Prior and After April 2012 .............. 5

Table 2. Documents required by BSP for MB Opinion .................................................... 7

Table 3. LGU Debt Outstanding and LGU Borrowing, 2002-2013 ................................. 7

Table 4. LGU Capital Spending, 2009-2013 ...................................................................... 7

Table 5. LGUs with negative net operating primary surplus or with DS exceeding

100% of their net operating primary surplus, by level of local government,

2009-2013 .............................................................................................................. 10

ii

Table 6. Debt service as percent of NOPS for selected percentiles, by level of local

governments, 2009-2013 ...................................................................................... 11

Table 7. LGUs with negative adjusted net operating primary surplus or with DS

exceeding 100% of their adjusted net operating primary surplus, by level of

local government, 2009-2013 ............................................................................... 12

Table 8. Debt service as percent of LGUs’ adjusted NOPS for selected points in the

percentile distribution, by level of local governments, 2009-2013 ................... 13

Table 9. Local Government Debt Service as % of Regular Revenues, 2009-2013 ....... 13

Table 10. Debt service as percent of regular income for selected percentiles, by level of

local governments, 2009-2013 ............................................................................. 14

Table 11. COA Audit Opinion by type of opinion and level of local government, 2009 -

2011........................................................................................................................ 15

iii

EXECUTIVE SUMMARY

Subnational borrowing is one of the four pillars that form the foundation of a

decentralized fiscal system and is the primary source of finance for local infrastructure projects,

which is critical for the delivery of local services. However, local government borrowing is

associated with risks related to fiscal distress and fiscal insolvency which may result from

excessive or inappropriate local government debt accumulation.

The regulatory framework for local government borrowing is typically comprised of

ex-ante control and regulation of local government borrowing and debt and ex-post insolvency

mechanisms. The regulatory system governing sub-national debt in the Philippine is largely

oriented toward the enforcement of ex-ante rules and procedures that apply before local

government units are actually able to access the credit market and does not include ex-post

remedies, i.e. procedures to work out cases of fiscal distress and insolvency. The system may

actually be described as one that is focused solely on the prevention of borrowing default and

fiscal distress but one that is extremely weak in mitigating their ex-post impact. The ex-ante

fiscal rules for LGUs that are defined in the Local Government Code of 1991 take two forms:

(i) balanced budget constraint (i.e., current fiscal balance is not allowed to be in deficit) and

(2) cap on debt service capacity (i.e., LGC provides that appropriations for DS shall not exceed

20% of LGUs’ regular income).

The ex-ante fiscal rules and other central government controls governing LGU access

to debt finance appears to be too restrictive and time consuming in the context of low levels of

outstanding LGU debt and LGU infrastructure investment. The regulatory regime does not

appear to recognize the importance of LGU borrowing in financing local infrastructure for

service delivery. In fact, some aspects of the regulatory regime appear to act as a disincentive

for LGUs to borrow. In addition to this, the current regime which prevents some lending

institutions, especially private commercial banks, to be part of the sub-national debt market

also serves as a disincentive for LGUs to borrow. Given this perspective, the focus of this

study will be on the review of the statutory provisions that govern LGU borrowing.

Although the current regulatory regime appears to have highly restrictive procedures,

there are gaps in the legal basis of regulatory regime which serve to anchor the procedural

regulations that are currently being implemented. These gaps pertain to the discretion given to

LGUs by the LGC to borrow for stabilization purposes, the appropriateness of the indicator

used to compute the capacity of LGUs to service their debt, the absence of ex-post remedies in

the LGC and the need for the Monetary Board to review loan applications of individual LGUs

as mandated under the New Central Bank Act. For the most part, correcting these weaknesses

will require legislative action that will form part of the long-term reform of LGU debt

regulation. On the other hand, there are also inefficiencies arising from the manner by which

the procedural controls over LGU borrowings are actually implemented. These can be resolved

through means which do not require legislative action and are doable in the short term such as

simplifying and limiting the number of requirements, focusing on and strengthening those

which are indicative of the LGU’s paying capacity through approaches. In sum, this study

recommends addressing both the: (i) weaknesses in the statutory basis of the regulatory

framework and (ii) inefficiencies in the implementation of procedural controls on LGU

borrowing.

1

REFORM OF REGULATORY FRAMEWORK FOR LGU BORROWING AND

CREDIT FINANCE UNDER THE 1991 LOCAL GOVERNMENT CODE*

Rosario G. Manasan

I. INTRODUCTION

The overarching goal of a decentralized fiscal system is the delivery of good quality

local public services in sufficient quantity in support of national and local economic

development and improved equity while maintaining macroeconomic stability. Subnational

borrowing is but one of the four pillars that form the foundation of a decentralized fiscal system.

Functional/ expenditure assignment, own-source revenue assignment and generation, and

intergovernmental transfers are the other elements of this system.

Subnational borrowing is a primary source of finance for local infrastructure which is

critical for the delivery of local services. This is so because financing local infrastructure from

local taxes and other forms of recurrent revenues tends to be inefficient for a number of reasons.

First, if local government units (LGUs) have no recourse but to finance local infrastructure

from their recurrent revenues, the lumpy nature of most infrastructure investments means the

amount of resources needed to finance the same is typically too large to be adequately sourced

from the recurrent revenues of LGUs in any given year. Thus, this situation would tend to

result in the underprovision of local infrastructure as local communities wait for several years

until their local governments have accumulated enough savings before they are able to access

and enjoy the benefits from said capital investments. Also, given the close association between

infrastructure investment and economic growth, the underprovision of local infrastructure

necessarily constrains local economic growth and development. Second, because the benefits

from infrastructure investments are spread out over several years, borrowing allows for a more

equitable way of financing long-lived infrastructure investments (i.e., those with long life

spans) as it provides a venue for the matching of the economic life of the investment with the

maturity of the loan. As such, the cost of infrastructure services is essentially paid for by those

who use them over the entire life span of the investment. Third, LGUs which access the credit

and capital markets are necessarily exposed to the discipline of the market place as banks and

other financial institutions subject them to rigorous creditworthiness assessment and reporting

requirements, thereby strengthening fiscal transparency and public financial management (Liu

2008).

However, local government borrowing is associated with risks related to fiscal distress

and fiscal insolvency which may result from excessive or inappropriate local government debt

accumulation. The fiscal risks arising from local government borrowing are magnified under

the following conditions: (i) absence of a hard budget constraint as manifested through a history

of central government bail-out of fiscally distressed local government units, and/ or (ii)

borrowing is used to finance operational fiscal deficits (i.e., borrowing is used close the gap

between current revenues and current operating expenditures).

________________________ * This paper is essentially an updated version to the author’s contribution to the paper “Enhancing the

Regulation and Monitoring of Local Government Debt in the Philippines,” World Bank, May 2014.

2

Given this perspective, the direction of the review of regulatory regime governing local

government borrowing aims to: (i) to facilitate sound, prudent, and sustainable local

government borrowing, and (ii) to mitigate the risks of fiscal distress and fiscal insolvency that

are associated with local government borrowing. The regulatory framework for local

government borrowing is typically comprised of ex-ante control and regulation of LGU

borrowing and debt and ex-post insolvency mechanisms. On the one hand, ex-ante regulations

are aimed at preventing fiscal distress due to excessive borrowing. Ex-ante rules specify the

sources, types, and uses of LGU borrowing. In many countries, for instance, ex-ante

regulations mandates the adherence to the “golden rule” which in essence restricts the use of

the proceeds from borrowing to long-term capital investment only.1 Ex-ante rules usually

include statutory and/ or administratively defined limitations on key fiscal variables like the

fiscal deficit, primary deficit and debt service ratios. They may also take the form of procedural

and documentary requirements that LGUs have to comply with before they can access credit

financing.

On the other hand, ex-post remedies are meant to work out actual cases of fiscal

insolvency when they do occur. Insolvency mechanisms are intended not only to help insolvent

LGUs to maintain essential services while undergoing debt restructuring but also to assist

affected LGUs improve their creditworthiness so that they can reenter the credit/ capital market.

Ex-post insolvency mechanisms typically include the definition of the insolvency trigger for

the procedure, the debtor’s fiscal consolidation plan, and predetermined rules to allocate default

risk to ensure that both debtor and creditors “share the pain of insolvency.” In this way, ex-

post remedies reinforce the effectiveness of ex-ante rules in promoting the hard budget

constraint and enhance the credibility of the central government’s no bail out policy (Liu and

Waibel 2008). As a corollary, it creates incentives for the market to monitor LGU borrowing

and debt.

Given the study team’s mandate to provide technical support to the review of 1991

LGC, this study’s focus will be on the review of the statutory provisions that govern LGU

borrowing. However, it does acknowledge the importance of central government documentary

and procedural requirements in effectively restricting LGU borrowing.

II. CURRENT FEATURES OF REGULATIONS ON LGU BORROWING

The regulatory system governing sub-national debt in the Philippine is largely oriented

toward the enforcement of ex-ante rules and procedures that apply before LGUs are actually

able to access the credit market. However, it does not include ex-post remedies, i.e. procedures

to work out cases of fiscal distress and insolvency. Thus, the system may be described as one

that is focused solely on the prevention of borrowing default and fiscal distress but one that is

extremely weak in mitigating their ex-post impact.

1. Statutory Ex-ante Rules

By and large, the regulation of LGU debt in the Philippines operates largely through

ex-ante fiscal rules for LGUs that are defined in the Local Government Code (LGC) of 1991

(Republic Act 7160) and take two forms: (i) balanced budget constraint and (2) cap on debt

service capacity.

1 In some of these countries, short-term borrowing for working capital is still allowed, but provisions are put in

place to prevent governments from rollover borrowing as a way of long-term borrowing for operating deficits (Liu

and Waibel 2010).

3

Balanced budget constraint. Local governments in the Philippines are subject to some

form of the balanced budget constraint (golden rule), albeit somewhat weaker relative to those

in other countries. One of the fundamental principles of local fiscal administration set forth in

Section 305 of the LGC says: “The local government unit shall endeavor to have a balanced

budget in each fiscal year of operation” (Section 205 - m).

The LGC also provides that the aggregate amount appropriated in the budgets of LGUs

for any given fiscal year shall not exceed the estimates of income (Section 324). Taken

together, these three provisions of the Code have generally been interpreted to mean that

proposed and approved budget appropriations for current operating expenditures during any

given fiscal year shall not exceed current revenues in that year. In other words, the operating

fiscal balance or current fiscal balance (i.e., current revenues less current expenditures) is not

allowed to be in deficit.

At the same time, the LGC also allows LGUs to borrow from the credit and the capital

markets through loans, credits and other forms of indebtedness as well as through the issuance

of bonds, debentures, securities and other obligations for the purpose of financing the

construction, installation, improvement, expansion, operation or maintenance of public

facilities, infrastructure facilities and self-liquidating, income-producing development or

livelihood projects (Section 297 and Section 299). For many, these provisions have also meant

that LGU borrowing can only be undertaken to finance investment expenditure. This view is

further reinforced by the Updated Budget Operation Manual (UBOM) which includes

borrowings as one of the income sources that has to be estimated as part of budget preparation

and which specifies that the proceeds from borrowings are to be used to finance the

development of capital projects (DBM 2005 p. 53).

However, Section 296 (b) of the Local Government Code (General Policy on Credit

Financing) says: “A local government unit may avail of credit lines from government or private

banks and lending institutions for the purpose of stabilizing local finances.” This provision

implies that LGUs may also borrow to bridge short-term cash flow shortfalls that may result in

negative actual current operating fiscal balances.

Debt service cap. Section 324(b) of the 1991 LGC provides that appropriations for debt

service shall not exceed 20% of LGUs’ regular income. Enforcing this provision is at the core

of central government control of LGU borrowing in the Philippines as can be seen below.

Monetary Board Opinion. Section 123 of the New Central Bank Act (Republic Act No.

7653) provides that “whenever the Government (including all its political subdivisions and

instrumentalities) contemplates borrowing from within or outside the Philippines, the prior

opinion of the Monetary Board shall be sought with regard to the probable effects of the

proposed operation on monetary aggregates, price levels, and the balance of payments.” While

the law has been in effect since 1993, the Bangko Sentral ng Pilipinas (BSP) did not enforce

this requirement with respect to LGU loans until 2012, when it issued a circular requiring all

LGU borrowings to secure a Monetary Board before loan transactions can be processed.2

2. Central Government Administrative and Procedural Controls

2 Bangko Sentral Circular No. 769, Series of 2012.

4

Changes in the procedural and documentary requirements put in place to enforce the

ex-ante fiscal and monetary rules outlined in the Local Government Code and the New Central

Bank Act that were instituted in 2012 have made the regulatory regime governing LGU

borrowing more complicated and burdensome. Prior to 2012, central government controls over

LGU access to the credit market is limited solely by the BLGF’s issuance of the Certificate of

Debt Service Capacity and the Certificate of Borrowing Capacity. In April 2012, new central

government regulations on LGU access to loans were put place which involve more

documentary requirements from more central government agencies.

The current regulatory system in the country employs a number of additional central

control mechanisms which cut across five central agencies namely, the Bureau of Local

Government Finance (BLGF), Bangko Sentral ng Pilipinas (BSP), Department of the Interior

and Local Government (DILG), Commission on Audit (COA), and the Department of Finance

(DOF). Starting in 2012, after securing the Certificate of Debt Service Capacity and Certificate

of Borrowing Capacity from the BLGF, LGUs are required to obtain a Monetary Board opinion

before their loans can be released by the lending institution (Figure 1). Furthermore, the

BLGF requires LGUs to have a Seal of Good Housekeeping from the DILG, Audit Certificates

from the COA showing no adverse findings in the last three years, and a certification from

lenders that it will not require LGU deposits as compensating balance for the loan. Key

informant interviews with DOF and Monetary Board officials suggest that the shift towards a

more restrictive regulatory regime came about because of concerns with poor governance on

the part of both LGUs and lending institutions.

Figure 1. Schematic Diagram of Central Government Regulations Affecting LGU Debt

Source: WB 2014

Requirements for the BLGF Certificates Before and After April 2012. Table 1 shows

that the documentary requirements needed for securing the Certificates of Borrowing Capacity

and the Certificate of Debt Service Capacity from the Bureau of Local Government Finance

(BLGF) increased from five in the period prior to April 2012 (as per DOF Local Finance

Circular No. 1-2000 to twelve in the period after April 2012 (as per Local Finance Circular 1-

2012). Note that the Bronze Seal of Good of Housekeeping (item 13 of Table 1) requires

LGUs to satisfy two requirements, namely, (i) full compliance to the Full Disclosure Policy of

Local Budget and Finances, Bids and Public Offerings, and (ii) possession of an unqualified or

qualified COA opinion on its financial statements for the immediately preceding year prior to

Lender

• Negotiations

BLGF

• Certificate of Borrowing Capacity

BSP

• Monetary Board

Opinion

Lender

• Release of loan

DILG

Seal of Good Housekeeping

DOF

Approval to open an account

COA

3-year audit reports with no adverse

findings

Latest audit report with no adverse

finding

LGU

Full Disclosure Policy

Lender

Certify that they are not

requiring deposits

5

the conduct of the SGH assessment. Annual nationwide assessment of LGUs for the SGH is

conducted by the Department of the Interior and Local Government

Table 1. Documentary Requirements for BLGF Certificate of Borrowing Capacity

and Certificate of Debt Service Capacity Prior and After April 2012

Source: WB 2014

Jan 2000-

Mar 2012

1. Statement of Actual Income and Expenditures

for the past three years duly signed by the Local

Accountant

x x a/

2. Certification from the Local Treasurer of the

Internal Revenue Allotment (IRA) received (gross

and net) for the past three years;

x

3. Certificate from the Local Assessor of Taxable

Assessed Value of real property for the past three

years the dates of the last successful conduct of the

general revision of real property assessments

x

4. Certification of existing loans with details

regarding (a) kind of loans and other obligations, (b)

purpose of loans and other obligations, (c) lending

agencies, (d) date of approval and maturity, (e)

terms and conditions, and (f) amortization

x x b/

5. COA Annual Audit Report for the past three

fiscal yearsx

6. Letter of request from the local chief executive

indicating the lending institution, terms and

conditions, and purpose of loan

x

7. Certification of absence of loan/s, when

applicablex

8. Certification by the Local Accountant that the

LGU has not incurred default in the payment of

amortization

x

9. Certification from the secretary of the

Sanggunian that the proposed project to be financed

by the loan is included in the Approved Annual

Investment Plan for the current year

x

10. Authenticated copy of the Sanggunian

resolution or ordinance authorizing the local chief

executive to negotiate in behalf of the LGU

x

11. Certified Statement of Income and Statement of

Fund Operation for loan applications that are foreign-

assisted

x

12. Proof of compliance with the DILG’s Full

Disclosure Policyx

13. DILG Bronze Seal of Good Housekeeping or

betterx

14. Certification from lending instituion that it will

not require LGU deposits as compensating balance

for the loan if lending instituion is either (i) not an

authorized government depository bank, nor (ii) an

authorized government depository bank required to

obtain prior approval of the Department of Finance.

x

15. COA Audit Certificate showing no adverse

findings in last 3 yearsx

a/ For April 2012 onwards, Statement of Receipts and Expenditures for the last 3 years

uploaded and approved by the BLGF Central Office

Apr 2012

onwards

6

(DILG) upon the release of the Annual Audit Reports of the LGUs’ financial statements for the

previous fiscal year by the COA sometime in July of each year. The assessment is normally

expected to be completed and the SGH awarded to qualified LGUs by October of the same

year (DILG Memorandum Circular 2012-078).3 Once the official list of LGUs conferred the

SGH has been released, certifications of the SGH can be issued to the LGU by the DILG upon

request. As a rule, the BLGF recognizes the seal awarded to the LGU in the year immediately

preceding the year when the Certificates of Borrowing Capacity and Debt Capacity are

requested.

While RA 7160 does not prohibit LGUs from having deposit accounts in private banks,

Local Finance Circular 1-2012 requires the lending institutions to issue a certification stating

that it will not require LGU deposits as compensating balance for the loan if said lending

institution is not an authorized government depository bank or if said lending institution is an

authorized government depository bank that is required to secure prior DOF approval. The

LGU, however, may still create a depository account in the private lending bank after seeking

prior DOF approval. DOF sometimes allows LGUs to open deposit accounts with private banks

provided the balance is limited to equivalent of one month amortization. Some of the bank

officials interviewed in the conduct of this study argue that such requests are usually denied

even when deposits for said minimum maintaining balance are requested.

Requirements for the Monetary Board Opinion. Starting September 2012, LGUs are

required to obtain a Monetary Board Opinion after their certificates of Borrowing and Debt

Service Capacity have been issued by the BLGF. The BSP requires LGUs to submit a written

letter from the borrowing LGU, together with other documentary requirements (Table 2), to

support their request for MB opinion pursuant to Bangko Sentral Circular No. 769 Series of

2012. After the MB opinion has been released, LGUs are then required to submit another set

of documents to the lending bank prior to the release of loan proceeds (Table 2).

III. EVALUATION OF LGU BORROWING REGULATIONS

The ex-ante fiscal rules and other central government controls governing LGU access

to debt finance appears to be too restrictive and time consuming in the context of low levels

of low levels of outstanding LGU debt and LGU infrastructure investment. There is some

evidence that the more restrictive debt regulatory regime which took effect in 2012 has led to

a slowdown in LGU borrowings. To wit, the growth in the aggregate levels of LGU

borrowings (i.e., acquisition of loans) decelerated from an average of 12% yearly in 2002-

2011 to an average of 2% in 2011-2013 (Table 3). Similarly, the growth in the outstanding

stock of LGU debt decelerated from 12% yearly on the average in 2002-2011 to an average

of 3% yearly in 2011-2013. Thus, LGU borrowing declined from an average of 0.17% of GDP

in 2009-2011 to an average of 0.11% of GDP in 2012-2013 while LGU debt stock dipped

from an average of 0.74% of GDP in 2009-2011 to an average of 0.68% of GDP in 2012-

2013. Moreover, said slowdown in LGU borrowing appears to be associated with a

concomitant reduction in LGU capital spending in the aggregate in 2011-2012, a development

that does not augur well for local economic development given the large unmet needs for local

infrastructure (Table 4).

Even at its peak, Philippine LGU debt is low relative to national government debt which

was equal to 62% of GDP in 2009-2011. It is also low relative to that of other developing

3 Prior to this, the 2011 SGH which was based on the 2010 COA Annual Audit Reports was awarded in three

rounds: in July 2011, in September 2011; in January 2012.

7

countries whose subnational debt stock was estimated to be equal to 5% in the mid-2000s (Liu,

Llanto, and Petersen 2013).

Table 2. Documents required by BSP for MB Opinion

Source: WB 2014

Table 3. LGU Debt Outstanding and LGU Borrowing, 2002-2013

Table 4. LGU Capital Spending, 2009-2013

Alas, the regulatory regime does not appear to recognize the importance of LGU

borrowing in financing local infrastructure for service delivery. In fact, some aspects of the

A. To support request for MB opinion

1. Information on the terms and conditions of the proposed loan(i.e., loan

amount, purpose of the loan (whether infrastructure or importation of

equipment, etc.,), interest rate, maturity, fees and other charges);

2. Certification on the debt service and borrowing capacity of the LGU

obtained from the BLGF

3. Designation of a contact person and Sanggunian Resolution on what the

person is authorized to perform

4. Indication from the lending bank on the source of the funds to be lent to

the LGU

B. To support release of loans

1. Sanggunian ordinance approving proposed terms and conditions as well

as the specific purposes and corresponding amounts of the projects

financed by the loan

2. Validation of the ordinance of a municipality or component city by the

provincial Sanggunian (or by the municipal/ city Sanggunian of the

barangay ordinance)

3. Waiver on the confidentiality of investment and bank deposits

supported by a “waiver resolution”

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Ave g.r. 2002-

2010

Ave g.r. 2010-

2013

LGU borrowings (in million pesos) 4,090.3 4,936.9 6,806.3 6,372.9 8,211.3 10,285.5 9,578.0 14,361.6 19,768.0 11,759.6 11,992.7 12,224.7 12.5 2.0

LGU borrowings (% of GDP) 0.10 0.11 0.13 0.11 0.13 0.15 0.12 0.18 0.22 0.12 0.11 0.11

LGU loans outstanding (in million pesos) 25,100.2 28,162.4 31,781.6 37,840.9 36,798.0 45,844.5 46,778.9 57,559.7 68,346.3 72,038.9 74,803.5 76,189.7 12.4 2.8

LGU loans outstanding (% of GDP) 0.60 0.62 0.62 0.67 0.59 0.67 0.61 0.72 0.76 0.74 0.71 0.66

LGU overall surplus/ (deficit) (in million pesos) 18,893 20,864 18,081 25,962 30,264 26,872 40,775 44,670 39,916 58,509 45,779 54,170

LGU overall surplus/ (deficit) (% of GDP) 0.45 0.46 0.35 0.46 0.48 0.39 0.53 0.56 0.44 0.60 0.43 0.47

NG Debt (% of GDP) 67.10 73.80 74.40 68.50 61.40 53.90 54.70 54.80 52.40 51.01 51.45 49.20

NG overall surplus/ (deficit) (% of GDP) (5.0) (4.4) (3.7) (2.6) (1.0) (0.2) (0.9) (3.7) (3.5) (2.0) (2.3) 14.9

Source: Acquisition of Loans and Loans outstanding from COA, GDP from NSCB and NG debt from BTr

2009 2010 2011 2012 2013

0.5 0.4 0.5 0.4 0.3

Provinces 23.5 24.7 24.7 23.6 22.7

Cities 48.0 46.8 49.1 44.5 54.7

Municipalities 28.5 28.5 26.2 31.9 22.6

Authors estimates based on 2009-2013 SREs from BLGF

All LGUs (% of GDP)

Percent distribution

8

regulatory regime appear to act as a disincentive for LGUs to borrow. This is illustrated by a

number of COA audit reports which fault LGUs for borrowing beyond the term of the

incumbent chief executive. This is unfortunate because if the maturity of LGU loans were to

be limited to the term of the incumbent LGU chief executives, LGU loans will tend to finance

low-cost projects rather than infrastructure projects with long gestation periods, which are

generally more expensive. All the lenders interviewed for WB 2014 study and other subject

matter experts argue that limiting the tenor of loan to the term of the incumbent would defeat

the development orientation of credit financing. Rather, the tenor of the loan should largely

be based on life of the projects or assets being financed, and should be calibrated further to

LGU’s capacity to service its debt.

As indicated earlier, the Philippine regulatory system for LGU debt may be described

as one that has a single-minded focus on the prevention of borrowing default and fiscal distress

but one that is weak in terms of providing ex-post remedies in case an LGU actually defaults

on its indebtedness. The regulatory system governing sub-national debt in the Philippine is

largely oriented toward the enforcement of the debt service cap and compliance with other

central government regulations before LGUs are actually able to access the credit market. As

described above, central government controls governing LGU borrowing involves five central

government agencies: the BLGF, the BSP, the DILG, the COA and the DOF. The extent of

central controls in the Philippines is quite unusual by international standards.4 However, the

system does not include ex-post remedies, i.e. procedures to work out cases of fiscal distress

and insolvency.

In addition to this, the current regime which prevents some lending institutions,

especially private commercial banks, to be part of the sub-national debt market also serves as

a disincentive for LGUs to borrow. Officers of private banks and LGU officials who were

interviewed for the WB 2014 study underscore the importance of leveling the playing field.

They argue that competition among banks will ensure better borrowing terms, i.e. interest rates

and tenor, for LGUs.

1. Weaknesses in the Statutory Basis of the Regulatory Framework

LGC provision allowing LGUs to borrow for stabilization purposes. As indicated

earlier, the balanced budget constraint set forth in Section 305 (m) and Section 324 of the Local

Government Code is weakened by Section 296 which allows LGUs to borrow for the purpose

of stabilizing local finances. This provision stands in sharp contrast to the practice in many

countries which have enacted fiscal rules mandating a balanced budget net of capital

investments or borrowing for purposes of capital spending only, i.e., the “golden rule” (Liu and

Waibel 2010). Other countries do permit short-term borrowing for working capital. However,

said countries typically out in place rules that will “prevent the rollover of short-term borrowing

in such a manner as to result in creating long-term borrowing for operating deficits” (Liu 2010).

In line with this, the IMF (2012) has recommended that Section 296 be amended so to mandate

LGUs to repay “loans for the purpose of stabilizing local finances: within the budget year.

Alternatively, one can simply mandate that LGU borrowing be used solely for capital

investments only.

Appropriateness of defining debt service cap relative to LGU income. Concerns have

been raised in the literature (e.g., IMF 2012, COA 2009) and in the focus group discussions

and key informant interviews conducted as part of the WB 2014 on whether regular LGU

4 The author thanks Blane Lewis for pointing this out.

9

income is the best indicator of LGUs’ capacity to service their debt. In particular, COA (2009)

points out that the some LGUs encounter problems in amortizing their indebtedness even if

their actual debt service capacity is less than 20%. This is so because the computation of the

debt service capacity does not take into account the net available fund available to the LGU to

service its debt. The COA recommends that the computation of debt service capacity should

take into account not just regular revenues but also mandatory expenditures and cash flow of

the LGU. Given this consideration, the net operating primary surplus (i.e., savings from current

operations before interest payments or current revenue less expenditures on wages and salaries

and maintenance and other operating expenditures [or MOOE] net of interest payments) of an

LGU in any given year is a better measure of the amount that is actually available for either

investment and/ or interest/ amortization payments.5 As such, an LGU which has a net

operating primary deficit has no capacity to service its debt much less invest unless it incurs

additional indebtedness. On the other hand, an LGU whose interest/ amortization payments

exceed 100% of its NOPS may be characterized as one which has to supplement its savings

from current operations with additional borrowing in order to service its debt, a situation which

could potentially lead to fiscal distress in the future.

The implication of adopting the NOPS in computing debt service capacity is not

insignificant. For instance, about 7% of all LGUs for data is available in 2013 either have

negative NOPS or have debt service (DS) in excess of 100% of their NOPS. In particular, 50

out of 1,381 or 4% of the total number of LGUs for which data is available in 2013 posted

negative NOPS. In particular, 3% of provinces, 1% of cities and 4% of municipalities registered

negative NOPS during the same year (Table 5). During the same year, 41 out of 1,381 or 3%

of the total number of LGUs for which data is available had DS in excess of 100% of their

NOSP. To wit, 1% of provinces, 3% of cities and 3% of municipalities had DS in excess of

100% of their NOPS (Table 5). More importantly, 16 out of 181 or 9% of the total number of

LGUs that accessed new or additional borrowing in 2013 either have negative NOPS or have

DS in excess of 100% of their NOPS. In other words, despite being less-than-creditworthy

when viewed vis-a-vis their NOPS, said LGUs were still able to access fresh credit in 2013.

On the other hand, the variation in DS-to-NOPS ratio for provinces, cities and municipalities

in 2009-2012 is shown in Table 6.

In the Philippine context, however, the net operating primary surplus may still

overestimate the amount of financial resources from current operations that are available for

debt service for two reasons. First, the Local Government Code allows LGUs to carry over

unobligated appropriations to the next fiscal year. Corollary to this, the NOPS overestimates

an LGU’s true capacity to service its debt obligations by the amount of continuing

appropriations that are carried forward to the next year which are to be funded from current

year’s income. Second, the NOPS will overestimate the true capacity of LGUs to service

their debt by the amount of their arrears to contractors, and suppliers, and even to the Bureau

of Internal Revenue (BIR) and Government Service Insurance System (GSIS). It is normal to

have accounts payable at the end of the fiscal year because delivery of the goods and services

of some obligations/ contracts entered into during the budget year may spillover to the next

year. However, some LGUs incur large accounts payable in an attempt to mask the dire state

of their fiscal position. For these reasons, adjusting the NOPS by netting out continuing

obligations and accounts payable will result in a more realistic and honest measure of LGUs

ability to service their debt.

5 This is consistent with the IMF (2012) recommendation that debt service capacity be computed relative to LGUs’

net operating surplus (NOS) instead of regular income.

10

Table 5. LGUs with negative net operating primary surplus or with DS exceeding

100% of their net operating primary surplus, by level of local government, 2009-

2013

No. % No. % No. % No. % No. %

57 3.5 73 4.6 34 2.2 86 6.0 50 3.6

Provinces 1 1.3 4 5.2 2 2.5 3 4.1 2 2.5

Cities 3 2.5 0 0.0 1 0.8 2 1.8 1 0.7

Municipalities 53 3.7 69 5.0 31 2.3 81 6.5 47 4.1

49 3.0 47 3.0 46 2.9 40 2.8 41 3.0

Provinces 3 3.8 1 1.3 0 0.0 1 1.4 1 1.3

Cities 7 5.8 2 1.7 1 0.8 5 4.4 4 2.8

Municipalities 39 2.7 44 3.2 45 3.3 34 2.7 36 3.1

106 6.5 120 7.6 80 5.1 126 8.8 91 6.6

Provinces 4 5.1 5 6.5 2 2.5 4 5.4 3 3.8

Cities 10 8.3 2 1.7 2 1.7 7 6.2 5 3.5

Municipalities 92 6.4 113 8.1 76 5.6 115 9.2 83 7.2

12 5.6 11 5.1 5 2.5 9 5.5 5 2.8

Provinces 0 0.0 1 4.3 0 0.0 0 0.0 0 0.0

Cities 3 7.7 0 0.0 0 0.0 1 2.3 0 0.0

Municipalities 9 5.9 10 6.5 5 4.0 8 7.9 5 4.7

18 8.3 16 7.4 9 4.4 10 6.1 11 6.1

Provinces 2 8.3 1 4.3 0 0.0 0 0.0 1 4.3

Cities 5 12.8 1 2.6 0 0.0 4 9.1 1 2.0

Municipalities 11 7.2 14 9.2 9 7.1 6 5.9 9 8.4

30 13.9 27 12.6 14 6.9 19 11.7 16 8.8

Provinces 2 8.3 2 8.7 0 0.0 0 0.0 1 4.3

Cities 8 20.5 1 2.6 0 0.0 5 11.4 1 2.0

Municipalities 20 13.1 24 15.7 14 11.1 14 13.9 14 13.1

216 13.2 215 13.6 203 13.0 163 11.4 181 13.1

Provinces 24 30.4 23 29.9 26 32.9 18 24.3 23 29.1

Cities 39 32.5 39 32.8 51 42.9 44 38.9 51 35.7

Municipalities 153 10.6 153 11.0 126 9.2 101 8.1 107 9.2

LGUs with data 1,640 1,585 1,561 1,434 1,381

Provinces 79 77 79 74 79

Cities 120 119 119 113 143

Municipalities 1,441 1,389 1,363 1,247 1159


LGUs with either negative NOPS or with DS

exceeding 100% of NOPS( % of all LGUs with

data)

LGUs able to access credit even with negative

NOPS (% of LGUs with new loans)

LGUs with DS exceeding 100% of NOPS (% of all

LGUs with data)

LGUs able to access credit even with DS

exceeding 100% of NOPS (% of LGUs with new

loans)


adjusted NOPS or with DS exceeding 100% of

adjusted NOPS (% of LGUs with new loans)

LGUs which accessed new/ add'l borrowing

during the year (% of LGUs with data)

2009 2010 2011 2012 2013

LGUs with negative NOPS (% of all LGUs with

data)

11

Table 6. Debt service as percent of NOPS for selected percentiles, by level of local

governments, 2009-2013

In all years during the period 2009-2013, the proportion of LGUs whose

creditworthiness may be suspect is significantly larger when reckoned from the perspective of

the adjusted NOPS6 rather than the NOPS. To wit, 27% of all LGUs for which data is available

in 2013 either have negative adjusted NOPS or have debt service (DS) in excess of 100% of

their adjusted NOPS (Table 7). The equivalent figure is 25% in the case of provinces, 27% in

the case of cities and 26% in the case of municipalities. At the same time, the prevalence of

LGUs with less than sterling creditworthy qualities which were able to access new or additional

borrowing in 2013 is not small. More specifically, 78 out of 181 or 43% of the total number

of LGUs that access new or additional borrowing in 2013 either have negative adjusted NOPS

or have DS in excess of 100% of their adjusted NOPS. The equivalent figure is 35% for

provinces, 37% for cities and 48% for municipalities (Table 7). On the other hand, Table 8

shows the variation in the DS-to-adjusted-NOPS ratio of provinces, cities and municipalities

in 2009-2013.

The discussion above suggests that the adjusted NOPS is a better indicator of LGUs’

capacity to service their debt. However, switching from regular income to the adjusted NOPS

as the basis of computing debt service capacity would require legislation since the debt service

cap defined relative to regular income is enshrined in the Local Government Code of 1991.

Furthermore, if the debt service cap were to be reckoned relative to the adjusted NOPS the debt

service ratio should be increased from the present 20%, otherwise the cap would be too

restrictive. Moreover, the cap can be set very close to 100% but should not be set above 100%.

Lack of ex-post remedies. The Local Government Code does not include any provision

that define ex-post remedies, i.e. procedures to work out cases of fiscal distress and insolvency

when they do occur. Ex-post insolvency mechanisms typically include the definition of the

insolvency trigger for the procedure, the debtor’s fiscal consolidation plan, and debt

restructuring procedures. These remedies are meant to reinforce the effectiveness of ex-ante

rules and the credibility of government’s no bail-out policy by ensuring both burden sharing

between debtor and creditors (Liu and Waibel 2008). Thus, these ex-post remedies are an

essential component of the overall debt regulatory framework in mature systems.

6 In this paper, the adjusted NOPS is defined to be equal to the net operating primary surplus less continuing

appropriations and accounts payable.

2009 2010 2011 2012 2013 2009 2010 2011 2012 2013 2009 2010 2011 2012 2013

10th Percentile 2.9 3.7 5.2 4.2 1.4 2.5 4.7 3.8 5.3 3.5 3.1 2.2 2.6 2.9 6.1

25th Percentile 6.1 6.7 7.6 9.8 10.0 8.1 9.9 11.6 16.9 8.6 8.2 8.6 8.8 9.1 14.6

50th Percentile 14.2 13.8 16.0 17.9 16.9 18.6 17.9 19.3 27.1 23.5 20.1 20.9 21.3 21.9 29.3

75th Percentile 24.2 27.2 30.3 38.4 33.8 31.9 28.2 30.8 45.3 42.2 37.7 44.9 40.0 43.0 55.7

90th Percentile 50.9 43.3 47.6 73.6 59.8 59.7 51.7 50.3 68.8 61.6 68.2 88.6 74.5 80.6 85.2

100th Percentile 469.2 127.7 82.9 105.7 137.3 276.7 2,501.6 211.5 1,044.8 563.1 1,282.7 686.0 11,343.3 2,063.3 3,140.2


Cities MunicipalitiesProvinces

12

Table 7. LGUs with negative adjusted net operating primary surplus or with DS

exceeding 100% of their adjusted net operating primary surplus, by level of local

government, 2009-2013

No. % No. % No. % No. % No. %

224 13.7 267 16.8 192 12.3 280 19.5 255 18.5

Provinces 10 12.7 13 16.9 10 12.7 10 13.5 14 17.7

Cities 22 18.3 20 16.8 1 0.8 24 21.2 26 18.2

Municipalities 192 13.3 234 16.8 181 13.3 246 19.7 215 18.6

49 3.0 74 4.7 38 2.4 78 5.4 112 8.1

Provinces 3 3.8 2 2.6 1 1.3 6 8.1 7 8.9

Cities 7 5.8 5 4.2 1 0.8 13 11.5 14 9.8

Municipalities 39 2.7 67 4.8 36 2.6 59 4.7 91 7.9

273 16.6 341 21.5 230 14.7 358 25.0 367 26.6

Provinces 13 16.5 15 19.5 11 13.9 16 21.6 21 26.6

Cities 29 24.2 25 21.0 2 1.7 37 32.7 40 28.0

Municipalities 231 16.0 301 21.7 217 15.9 305 24.5 306 26.4

38 17.6 47 21.9 22 10.8 33 20.2 39 21.5

Provinces 3 12.5 4 17.4 1 3.8 1 5.6 4 17.4

Cities 12 30.8 7 17.9 0 0.0 11 25.0 11 21.6

Municipalities 23 15.0 36 23.5 21 16.7 21 20.8 24 22.4

18 8.3 15 7.0 10 4.9 20 12.3 39 21.5

Provinces 2 8.3 1 4.3 0 0.0 1 5.6 4 17.4

Cities 5 12.8 0 0.0 0 0.0 9 20.5 8 15.7

Municipalities 11 7.2 14 9.2 10 7.9 10 9.9 27 25.2

56 25.9 62 28.8 32 15.8 53 32.5 78 43.1

Provinces 5 20.8 5 21.7 1 3.8 2 11.1 8 34.8

Cities 17 43.6 7 17.9 0 0.0 20 45.5 19 37.3

Municipalities 34 22.2 50 32.7 31 24.6 31 30.7 51 47.7

216 13.2 215 13.6 203 13.0 163 11.4 181 13.1

Provinces 24 30.4 23 29.9 26 32.9 18 24.3 23 29.1

Cities 39 32.5 39 32.8 51 42.9 44 38.9 51 35.7

Municipalities 153 10.6 153 11.0 126 9.2 101 8.1 107 9.2

LGUs with data 1,640 1,585 1,561 1,434 1,381

Provinces 79 77 79 74 79

Cities 120 119 119 113 143

Municipalities 1,441 1,389 1,363 1,247 1159

1/ Adjusted net operating primary surplus is NOPS less account's payable and continuing appropriations.




LGUs with DS exceeding 100% of adjusted

NOPS (% of all LGUs with data)

LGUs able to access credit even with DS

exceeding 100% of adjusted NOPS (% of LGUs

with new loans)


adjusted NOPS or with DS exceeding 100% of


LGUs which accessed new/ add'l borrowing

during the year (% of LGUs with data)

LGUs with either negative adjusted NOPS or

with DS exceeding 100% of adjusted NOPS( %

of all LGUs with data)

2009 2010 2011 2012 2013

LGUs with negative adjusted NOPS (% of all

LGUs with data)

13

Table 8. Debt service as percent of LGUs’ adjusted NOPS for selected points in the

percentile distribution, by level of local governments, 2009-2013

Need for Monetary Board opinion. Key informant interviews and the focus group

discussion conducted as part of the WB 2014 study suggests that the Monetary Board review

of individual LGU borrowing appear to be more or less pro-forma but time consuming. The

Monetary Board, for example, has apparently never issued a negative finding against LGU

borrowing. This is not surprising considering that LGUs are not allowed to borrow externally

and as such their borrowing will not have any impact on monetary aggregates unless the lending

bank will source all or part of the loan from its deposits with the BSP. Moreover, given the

very low level of aggregate LGU borrowing compared to total lending portfolio of the banking

system at present it is not likely that any individual LGU loan will be found to have an impact

on the monetary aggregates and the price level. At the same time, individual LGU borrowing

is not likely to have an impact on the balance of payments except when the borrowing involves

the importation of capital equipment. But again, given the very low levels of LGU borrowing,

the impact on the balance of payments is likely to be insignificant even if LGU loan involves

the importation of capital.

2. Inefficiencies in the Implementation of Procedural Controls on LGU Borrowing

Lack of clarity in the definition of regular income. Because the Certificates of

Borrowing Capacity and Debt Service Capacity are at the core of the central government

control mechanisms, ensuring the effectiveness of the BLGF Certificates in assuring that debt

service outturns are in line with the debt service cap is crucial. Although the average debt

service ratios for all LGUs combined as well as for the different levels of local governments in

the aggregate are well within the debt service limit of 20% in 2009-2013 (Table 9), some LGUs

have actually breached the debt service cap ex-post during the same period. In this sense, the

BLGF issuance of the Certificate of Debt Service Capacity has been less than effective in

ensuring compliance with the debt service cap in about 1% of all cities and municipalities with

some indebtedness in 2013 (Table 10).

Table 9. Local Government Debt Service as % of Regular Revenues, 2009-2013

2009 2010 2011 2012 2013 2009 2010 2011 2012 2013 2009 2010 2011 2012 2013

10th Percentile -7.7 -7.3 2.7 4.2 -25.9 -19.5 -19.3 -6.3 -13.9 6.1 -3.0 -8.2 -2.2 -18.7 -12.5

25th Percentile 6.4 4.8 8.0 14.7 2.1 3.4 4.7 10.2 13.0 13.2 5.7 5.2 7.2 5.4 10.9

50th Percentile 14.0 13.8 16.2 28.0 26.0 20.2 17.6 21.5 34.0 30.5 21.1 22.7 21.2 21.3 34.1

75th Percentile 26.5 27.3 42.4 61.4 56.5 39.6 36.0 37.3 59.9 60.9 43.1 52.0 43.4 51.4 72.7

90th Percentile 64.7 61.6 63.1 103.9 101.8 71.2 66.9 61.8 120.5 140.0 85.7 100.6 74.4 97.8 120.4

100th Percentile 256.6 822.0 118.0 1,463.4 401.8 3,309.0 790.0 823.6 1,177.0 59,439.9 595.4 5,851.6 967.1 8,246.7 1,722.7


Provinces Cities Municipalities

2009 2010 2011 2012 2013

Provinces 3.4 4.1 4.6 4.4 4.4

Cities 5.6 4.7 6.4 4.1 4.3

Municipalities 2.7 2.5 2.9 2.9 3.1

All LGUs 4.1 3.8 6.1 3.8 4.0


14

Table 10. Debt service as percent of regular income for selected percentiles, by level

of local governments, 2009-2013

Poor outturns in the debt service ratio in 1%-2% of LGUs with some indebtedness is

attributed by LGU officials and bank officials interviewed for the WB 2014 study to the manner

by which the debt service capacity is computed. First, there appears to be some confusion on

what constitutes regular income. At present, debt service capacity is computed relative to

regular income as shown in audited financial statements for the last three years. The definition

of regular income appears to be straightforward at first glance. In computing the debt service

capacity, regular income is deemed by the BLGF to consist of (i) real property taxes, (ii)

business taxes, (iii) fees and other charges, (iv) income from economic enterprise, (v) internal

revenue allotment and (vi) share in national wealth when recurring. However, there is lack of

clarity as to what constitutes regular income. The confusion appears to primarily result from

the extent to which LGUs share in national wealth is deemed to be a predictable source of funds

for extended periods as well as the degree of discretion that LGUs have over the use of said

funds. Although LGUs’ claim over their share in national wealth has a firm legal basis,

predictability of their access to said funds tends to vary depending on the specific kind of

national wealth and/ or national taxes being shared.

Second, there is some discussion as to whether the computation should be relative to

past income or to prospective income. For instance, some of the banks argue that debt service

capacity should be based on projected regular income and should also include projected income

from income generating projects that are to be financed from the loan. However, the BLGF

argue that it is better to err on the side of conservatism when computing the debt service

capacity. Also, some of the LGU officials interviewed for the WB 2014 study note that one

has to approach the inclusion of projected income from self-sustaining projects in the

computation of debt service capacity because of the incidence of poor feasibility studies used

to support borrowing for said projects. They point out that some banks tend to be overly

dependent on the IRA intercept and do not undertake adequate due diligence in approving LGU

loans.

Relevance of some requirements to LGUs’ capacity to service their debt. Some BLGF

requirements appear to be unrelated to the LGUs’ debt service capacity. While compliance with

the full disclosure policy helps promote fiscal transparency is considered a critical element of

good sub-national regulatory framework and “ought to be a policy priority,” by encouraging

LGUs to make available to the public comprehensive fiscal information in a timely manner

(Liu and Waibel 2008), it is not clear that the “no adverse/ no disclaimer” COA finding is a

good indicator of borrowing capacity. Although lenders generally agree that the COA audited

2009 2010 2011 2012 2013 2009 2010 2011 2012 2013 2009 2010 2011 2012 2013

Percentile 10 0.7 1.3 1.6 1.7 0.8 1.1 1.2 1.4 1.4 1.0 0.7 0.8 0.8 0.8 1.0

Percentile 25 2.0 2.3 2.8 3.1 2.7 2.6 2.7 3.4 3.5 2.8 1.6 2.0 2.1 2.3 2.4

Percentile 50 3.5 3.6 4.5 5.2 5.1 5.7 5.5 5.7 6.5 5.4 3.4 4.0 4.1 4.6 4.5

Percentile 75 7.0 6.7 7.3 7.8 7.9 8.8 8.0 8.9 9.5 8.4 6.2 7.0 7.0 7.4 7.1

Percentile 90 10.3 11.0 10.3 10.9 10.2 13.1 10.9 11.3 12.9 12.7 10.1 10.4 10.1 10.9 11.0

Percentile 100 14.7 19.4 20.4 17.8 15.3 54.4 37.4 115.6 35.1 34.8 135.7 32.3 128.2 135.4 71.1

No. of LGUs with DS

ratio > 20% 0 0 1 0 0 2 2 3 1 1 8 5 7 7 5

% of LGUs with

outstandng loans 0.0 0.0 1.7 0.0 0.0 2.1 2.0 2.5 1.1 0.9 1.4 0.8 1.0 1.1 0.8

Source of basic data: BLGF SRE

MunicipalitiesCitiesProvinces

15

financial statements are the best source of data for assessing the credit worthiness of LGUs,

many of them note that the basis for COA adverse/ disclaimer opinions may have no bearing

on LGUs’ debt service capacity. Moreover, some lenders and some LGUs point out that the

COA audit opinion is highly subjective on the part of individual auditors. Cases have been

cited where one LGU gets an adverse opinion while another LGU which is similarly situated

gets a qualified opinion. Table 11 provides an indication of the importance of this issue in

2009-2011. It shows that 7% of all LGUs received either an adverse or a disclaimer opinion in

2011. The proportion of LGUs receiving either an adverse or disclaimer opinion is highest for

cities (14%), followed by provinces (9%) and municipalities (6%). It should also be pointed

out that barangays are not subjected to the SGH and, as such, may be excluded altogether from

the LGU credit market if the SGH requirement is made to apply to barangays.

Still another BLGF requirement that appears to have no bearing on the debt service

capacity of LGUs is the certification of private lending institution that it will not require LGU

deposits as compensating balance for the loan. Instead, this requirement simply prevents

private banks from participating in the LGU debt market and discourages LGUs from

borrowing. All of the officials of private commercial banks and some LGU officials who were

interviewed as part of the WB 2014 study point out that increased competition among banks

will be more beneficial to LGUs as it will not only lower the cost of borrowing but also result

in more favorable loan terms and conditions for the LGUs.

Table 11. COA Audit Opinion by type of opinion and level of local government,

2009-2011

Redundant requirements. Some of the documentary requirements for the BLGF

Certificates are duplicative. For instance, it is surprising that the BLGF requires LGUs to

submit separate certifications for the SGH and compliance with the full disclosure policy from

the DILG. As indicated earlier, for an LGU to qualify for the bronze SGH, the LGU must

comply with the following criteria: compliance with the full disclosure policy of the DILG and

must have received either an unqualified opinion or a qualified COA opinion on its financial

statements for immediately preceding the year prior to the conduct of the SGH assessment.

On the other hand, the BLGF requirement for the LGU to show an Annual Audit

Certificate from the COA for the past three years showing no adverse is not only restrictive but

Unqualified % Qualified % Adverse % Disclaimer % Total

165 12% 1,121 83% 11 1% 52 4% 1,349

Provinces 7 9% 67 87% 1 1% 2 3% 77

Cities 15 12% 94 75% 2 2% 14 11% 125

Municipalities 143 12% 960 84% 8 1% 36 3% 1,147

168 13% 1,007 78% 15 1% 95 7% 1,285

Provinces 9 12% 58 76% 5 7% 4 5% 76

Cities 22 18% 87 70% 3 2% 12 10% 124

Municipalities 137 13% 862 79% 7 1% 79 7% 1,085

196 12% 1,383 82% 44 3% 71 4% 1,694

Provinces 13 16% 59 75% 6 8% 1 1% 79

Cities 13 9% 105 77% 8 6% 11 8% 137

Municipalities 170 12% 1,219 82% 30 2% 59 4% 1,478

Source: 2009-2010 LGU Annual Audit Reports

2009

2010

2011

16

unnecessary as it duplicates the SGH requirement. Moreover, COA officials interviewed as

part of the WB 2014 study noted that an unqualified or qualified COA opinion in the

immediately preceding year prior to the year the LGU applies for the Certificate should suffice

to show sound fiscal management even if the LGU received an adverse or disclaimer opinion

in earlier years.

Time consuming procedures. Central government controls appear to be quite time

consuming from a compliance point of view. Central government officials interviewed as part

of the WB 2014 study claim that approval can be done quickly if all documentary requirements

have been submitted. But LGU officials and bank officials have the opposite opinion. For

example, the BLGF holds that the Certificates are released within 15 days after all the

documentary requirements have been successfully submitted by the LGU. However, according

to LGU officials and bank officials interviewed, the processing of the said Certificates takes an

average of two to three months. In addition to this, processing takes place at the BLGF central

office, causing more delay and making applications more tedious for LGUs outside of the NCR.

While there is minimal complaint on the processing time of the BLGF Certificates, some LGUs

encounter problems in coming up with the documents required for the said certificates.

Other bottlenecks for the issuance of the BLGF Certificates include the time lag in the

completion of COA audit reports, as well as the delays in the release of the official list of LGUs

which are awarded the Seal of Good Housekeeping. For instance, the number of BLGF

Certificates processed in the first three quarters 2013 was lower than normal because of the

delay in the awarding of the 2012 SGH (which is based on the 2011 COA Annual Audit

Reports). This came about because the BLGF required the 2012 SGH for the processing of

applications submitted in 2013 for the BLGF Certificates. It was only in October 2013 when

an agreement between the BLGF and DILG was reached to use the 2011 SGH in processing

applications for 2013. Surprisingly, some LGUs were already able to present the 2012 SGH

even without the official list of 2012 SGH awardees from DILG.

In addition to the difficulties in obtaining the certificates of Borrowing and Debt Service

Capacity, securing the MB opinion is considered by most to be the main cause of delay in loan

application and release. While the BSP holds that the process only takes two weeks, length of

time it takes to obtain the MB opinion as experienced by banks and LGUs interviewed varies:

fastest processing time experienced is four to five weeks, average processing time is two to

three months, while the longest is eight months.

Finally, long processing time combined with the short validity of some of the

documentary requirements disrupt the processing of loan applications. The certificates issued

by the BLGF are valid up to one year, as more recent data has the potential to change the

estimates of the LGU’s borrowing capacity. The MB opinion, on the other hand, has a shorter

validity of 6 months. Thus, if at least one of the documentary requirements lapses before the

approval and release of the loan, LGUs have to go through some of the processes and re-submit

the required documentary requirements. This problem is further compounded by the need to

amend the Certificate of Borrowing Capacity and go through the entire process of applying for

a new one when changes in the loan terms and conditions (e.g., interest rate and maturity) are

made while waiting for the MB opinion.

17

IV. RECOMMENDATIONS

1. Addressing Weaknesses in the Statutory Basis of the Regulatory Framework

Although the current regulatory regime appears to have highly restrictive procedures

there are gaps in the legal basis of regulatory regime which serve to anchor the procedural

regulations that are currently being implemented. These gaps pertain to the discretion given to

LGUs by the Local Government Code to borrow for stabilization purposes, the appropriateness

of the indicator used to compute the capacity of LGUs to service their debt, the absence of ex-

post remedies in the Local Government Code and the need for the Monetary Board to review

loan applications of individual LGUs as mandated under the New Central Bank Act. For the

most part, correcting these weaknesses will require legislative action that will form part of the

long-term reform of LGU debt regulation. To improve the legal framework of LGU debt

regulation, this study recommends that:

Section 296 (b) of Local Government Code be amended to specify that credit availed

of for the purpose of stabilizing their finances must be repaid within the same budget

year in which it is incurred.

In the short term, BLGF should seek legal opinion if it is possible to modify the

provision of the Implementing Rules and Regulations for the LGC governing Section

296 (b) by administrative issuance so as to mandate that LGU credit obtained for the

purpose of stabilizing local finances be repaid within the same budget year in which it

was incurred of.

Section 324 (b) of the Local Government Code be amended so as to set the debt service

limit to be equal to 95% of the adjusted net operating primary surplus.

DOF/ BLGF should formulate ex-post remedies which will govern actual cases of fiscal

distress and insolvency; these ex-post mechanisms will include:

o definition of the insolvency trigger for the procedure,

o the debtor’s fiscal consolidation plan, and

o debt restructuring procedures.

Section 323 of the New Central Bank Act be amended to reflect a “lighter touch”

evaluation of LGU borrowing that will possibly involve:

o having a more perfunctory review of individual LGU loan applications than

what is being done at present unless and until certain pre-determined parameters

affecting monetary aggregates and the BOP are breached; said parameters may

involve any one or a combination of the following:

- aggregate LGU borrowing relative to GDP (or relative to total loan

portfolio of the banking sector),

- aggregate LGU importations financed from loan proceeds, or

o limiting its evaluation of individual LGU loan applications exceeding a pre-

determined amount.

In the short term, the BSP/ Monetary Board should seek legal opinion if Section 323 of

New Central Bank Act will be satisfied if Bangko Sentral ng Pilipinas were to expedite

processing of applications for Monetary Board opinion following the “lighter touch”

procedures suggested above.

2. Addressing Inefficiencies in the Implementation of Procedural Controls on LGU

Borrowing

18

Section III above highlights the inefficiencies arising from the manner by which the

procedural controls over LGU borrowings are actually implemented. First, there appears to be

lack of clarity as to what constitutes regular income for the purpose of the computing the debt

service capacity o LGUs. Second, documentary requirements for the issuance of the BLGF

certificates appear to be duplicative. For instance, the BLGF requires proof of compliance with

the DILG’s full disclosure policy even if compliance with the said policy is one of the

conditions for the award of the Seal of Good Housekeeping, On the other hand, the BLGF

requirement for the LGU to show an Annual Audit Certificate from the COA for the past three

years showing no adverse/ no opinion findings is not only restrictive but unnecessary as it

duplicates the SGH requirement. Third, other requirements are deemed irrelevant or unrelated

to the LGUs’ capacity to service its debt. For instance, many of the key informants interviewed

for this study suggest that requirements like the SGH’s “no adverse/ no disclaimer” finding in

COA audit reports and the certification of private lending institutions that it will not require

LGU deposits have no bearing on the debt service capacity of the LGUs. Fourth, some controls

are time consuming from a compliance point of view. In particular, the short validity of the

Monetary Board opinion adds to the long processing time for loan applications. Hence, there

is a need to simplify and limit the number of requirements, focusing on and strengthening those

which are indicative of the LGU’s paying capacity. Specifically, this study makes the following

actionable -term recommendations, most of which will not require legislative action and, as

such, are doable in the short-term:

BLGF should eliminate unnecessary controls, including:

o the requirement of “no adverse” opinion COA finding in the last three years

o the Seal of Good Housekeeping but not the proof of compliance with the full

disclosure policy which enhances fiscal transparency, an essential element of a

good regulatory framework

o the certification by the lending institution that it will not be requiring LGU

deposits as compensating balance for the loan as this will increase competition

in the local LGU credit market which has the potential to result in more

favorable loan terms and conditions for the LGUs

If the SGH will not be removed from the list of BLGF requirements as recommended

above, BLGF should clarify the validity period of the SGH award for purposes of the

BLGF requirement to avoid recurrence of problem that occurred in 2013 when 2012

SGH was not awarded on time.

The Monetary Board should make the validity period of the Monetary Board opinion

one year instead of six months.

* TA-8390 PHI: Local government finance and fiscal decentralization reform program. Senior financial management

expert (legal and regulatory) (44253-012). The author wishes to thank the valuable inputs, comments and observations

to earlier drafts made by Juan Luis Gómez Reino, Rosario Manasan and Antonio Avila Jr. The opinions expressed are

those of the author, who is also the unique responsible for the remaining errors. The proposals and opinions do not

represent the will neither of the ADB nor the DILG.

STRENGTHENING INTER-LOCAL

COOPERATION AND ALLIANCES IN THE

PHILIPPINES

Roberto Fernández Llera, PhD

ADB Consultant*

[email protected]

As Edited by:

Joy Valerie L. Lopez

OCTOBER 2014

mailto:[email protected]

i

TABLE OF CONTENTS

Page

LIST OF FIGURES ................................................................................................................. ii

LIST OF ANNEXES ................................................................................................................ ii

ACRONYMS .......................................................................................................................... iii

EXECUTIVE SUMMARY ..................................................................................................... iv

I. INTRODUCTION ......................................................................................................... 1

1. A Brief Theory: Amalgamation versus Cooperation ................................................... 1

2. Background and Objective of the Review of Inter-Local Cooperation under the

Local Government Code of 1991 ................................................................................ 2

II. INTER-LOCAL COOPERATION IN THE PHILIPPINES ..................................... 3

1. Legal Framework ........................................................................................................ 3

2. Challenges of ILCs in the Philippines ......................................................................... 4

III. PROPOSED AMENDMENTS TO THE LOCAL GOVERNMENT CODE OF

1991 AS THE LEGAL BASIS OF ILC IN THE PHILIPPINES .............................. 6

1. Proposed Concepts for the Amendments .................................................................... 6

2. New Legal Framework for Alliances as Juridical Entities .......................................... 9

3. Strengthening the Legal Basis of New Alliances ...................................................... 10

4. Design of New Alliances ........................................................................................... 12

IV. PROPOSED GUIDELINES AND IMPLEMENTING REGULATIONS ON THE

FORMATION OF NEW ALLIANCES ..................................................................... 13

1. Strengthening the Institutionalization of ILC ........................................................... 13

1.1. Role of the LGU Sanggunian ............................................................................. 13

1.2. Governing bodies of the alliance ....................................................................... 14

1.3. Articles of cooperation, strategic plan and long-term financial provisions ....... 14

1.4. Organizational structure, functions and general criteria of the NRA ................ 15

1.5. Guidelines on the internal Statute and other by-laws ........................................ 16

1.6. Individual default, dispute resolution and liquidation of the alliance ................ 16

2. Financing New Alliances .......................................................................................... 17

ii

2.1. Monetary and in-kind contributions of the member LGUs ............................... 18

2.2. Fees, charges and fines ...................................................................................... 19

2.3. Grants, subsidies and transfers ........................................................................... 21

2.4. Revenues ............................................................................................................ 23

2.5. Borrowing .......................................................................................................... 23

2.6. Other resources including windfall revenues ..................................................... 24

3. Provisions on Budget, Accounting, Audit, and Personnel......................................... 25

V. CONCLUSION AND FINAL REMARKS ................................................................ 25

REFERENCES ....................................................................................................................... 27

LIST OF FIGURES

Page

Figure 1. The New Alliances as a Formal ILC .......................................................................... 8

Figure 2. Different Options for Institutionalization of ILC ....................................................... 8

Figure 3. Possible Organizational Structure for the New NRA under the DILG..................... 15

Figure 4. Simulations for LGU Contributions ......................................................................... 19

Figure 5. Types of Grants Accessed by Alliances .................................................................... 22

Figure 6. Three Main Types of Public-Sector Audit ................................................................ 25

LIST OF ANNEXES

Annex A. Legal Basis of New Alliances ................................................................................ 299

Annex B. Design of New Alliances ...................................................................................... 311

Annex C. Strengthening the Institutionalization of ILC ....................................................... 333

iii

ACRONYMS

ADB Asian Development Bank

COA Commission on Audit

DBM Department of Budget and Management

DILG Department of the Interior and Local Government

DOF Department of Finance

ILC Inter-local cooperation

IRA Internal Revenue Allotment

LCE Local chief executive

LGC Local Government Code of 1991

LGU Local government unit

MNDC Metro Naga Development Council

MOA Memorandum of Agreement

NRA National Registry of Alliances

NGO Non-governmental organization

PO People’s organization

RA Republic Act

SEC Securities and Exchange Commission

iv

EXECUTIVE SUMMARY

It is efficient for local government units to cooperate in providing services while

preserving its local self-government (Slack and Bird, 2013). Important lessons on inter-local

cooperation can be learned from international experiences but a tailored model for each country

has to be developed. It remains clear that there is no common framework because each country

has its own peculiarities. A more predictable, updated, coherent and accessible legal framework

for inter-local cooperation (ILC) in the Philippines is necessary. A more solid framework can

take advantage of unexploited economies of scale in service delivery and huge investment

projects. The objective of this paper is to promote a new and more stable legal framework for

ILC in the Philippines through general revision of fiscal provisions in the Local Government

Code of 1991. Further, to enable the empowerment of LGUs to build and consolidate alliances,

as a way to improve efficiency, transparency and accountability of local governance.

The Philippine Development Plan 2011-2016 requires a new agenda of decentralization

reforms. LGUs have a challenging role to play in attaining inclusive growth, employment

creation, improved governance, and fiscal sustainability. Reinforcing the regulatory support for

ILC, as well as intergovernmental fiscal relations, will therefore be essential for LGUs to be

able to deliver on their responsibilities.

Article X, Section 13 of the 1987 Constitution provides that “local government units

may group themselves, consolidate or coordinate their efforts, services, and resources for

purposes commonly beneficial to them in accordance with law”. Similarly, Section 33 of the

LGC provides for the cooperative undertakings among LGUs. However, despite sustained and

significant efforts in the creation of different formulas of ILC in the Philippines, only a few of

them have proven solid.

While the LGC allows for a variety of financing mechanisms and internal structures for

ILC, the existing ILCs in the Philippines face several challenges. ILCs are merely based on

memorandum of agreement, which has not been proven to be sufficiently binding for the

constituent LGUs. Under Section 33 of the Local Government Code (LGC), they are not a

juridical entity and thus lack corporate powers and legal personality. For instance, they are not

allowed to levy fees or borrow. This situation can provoke severe financial constraints and

might even wholly jeopardize the mere survival of ILC. This paper supposes that these

challenges stemmed from the absence of a national registry in the country formalizing the

creation of ILC together with the lack of clear specific guidelines implementing Section 33 of

the LGC; and the lack of an integrated auditing (financial, performance and compliance) over

ILCs, which represents non-transparency, corruption and inefficiency.

The reform being proposed in this paper will, thus, move in two complementary

directions. First, towards the reform of the LGC, and second, towards the regulatory

development through the DILG guidelines and implementing regulations. The key of the

reform is focused on, but not limited to, Section 33 of the LGC. To address the challenges/

issues and to enhance the role of ILC as a mechanism for efficient service delivery, a new legal

framework that goes beyond the current legislation is proposed.

This paper mainly recommends expanding the provision of Section 33 of the LGC,

where ILC is regulated. Proposed Section 33 shall include the establishment of the National

Registry of Alliances under the DILG for the creation and monitoring of ILC in the country.

v

The registration with the NRA bestows ILCs with legal personality and directs their behavior.

In addition, this paper recommends a preliminary guide for the DILG to assist them in crafting

the comprehensive guidelines and implementing regulations that will clarify the proposed

provisions in the LGC. Likewise, a common set of rules for ILCs, which shall strengthen the

institutionalization of ILCs in the country and discusses the fundamental aspects of the guide,

is created. Furthermore, this paper identifies a number of proposals for sections closely linked

to Section 33 of the LGC. For example, the revision of sections of the LGC related to local

taxation and fiscal matters; insertion of new sections devoted to other revenue-raising powers,

grants and credit financing of alliances; among others; and in all of these, the powers and

functions of the DILG and the DOF, when appropriate, are considerably reinforced.

1

I. INTRODUCTION

1. A Brief Theory: Amalgamation versus Cooperation

There is a broad academic literature on the relationship between local government size

and efficiency in service delivery (Olson, 1969; Oates, 1972; King, 1984). The usual belief that

larger-sized governments are more efficient has driven the call for cooperation in order to

address the supposed inefficiencies of associated with smaller-sized local government units

(LGUs). However, the ‘optimal’ size of an LGU –if such threshold exists- crucially depends

on a variety of economic, political, financial, and geographic features that makes the ‘real’

average size of LGUs very different across countries and territories.

Each local service has also different efficiency requirements. For example, capital-

intensive services and labor-intensive services differ in a way that the former can only be

delivered in a cost-effective manner by bigger LGUs while the latter may be delivered

efficiently even by smaller LGUs. A complete review of the literature by Gómez Reino (2010)

has reinforced this view and suggests that economies of scale are sector specific and temporary

in their range and size.

The formation of LGUs is a multifaceted historical issue, and thus, amalgamation of

LGUs may not always be an option in improving local service delivery. For instance, a

municipality is a compendium of multiple services (public administration) and a political and

democratic entity (public government). It is neither concerned with the administration r

delivery of a single service nor does its formation rests solely on economic grounds. Similarly,

LGUs are built to last for a long period of time, therefore, it is extremely difficult to change

their basic structure every few years. Consequently, it is difficult to fine-tune the theoretical

‘optimal’ size and the realistic ‘political’ size.

History also shows that fruitful occurrences of mergers and full integrations of local

governments happened in two occasions only: (i) during or after severe economic recessions

and financial crisis (economic motivation); and (ii) after a war or long dictatorship (political

motivation). The former could be the case of Greece, a country that reduced the number of

municipalities to a third between 2010 and 2012 due to the requirements of the financial troika1

as a condition for the bailout. The latter occurred in some countries in Europe after the fall of

the Berlin wall in 1989. Other experiences are even more infrequent and can be the case for

mature federations through financial incentives, specific laws and political guidelines

(Switzerland is a good example since the 1950-s).

Several demographic thresholds in terms of population have also been proposed by

academics and institutions (10000, 20000 inhabitants….). The reality, as the Council of Europe

(2012: p. 68) states, is that “larger municipalities should spend a smaller proportion of their

resources on administrative overheads and achieve greater economies of scale”. However,

“while amalgamation may enable local authorities to provide a larger range or quality of

services, there is no evidence that it saves money overall”. And it concludes: “quite apart from

the one-off costs of re-organization, there is a tendency for merged authorities to adopt the most

expensive habits of their individual forerunners”. Instead of this controversial amalgamation,

1 Comprising representatives of the European Commission, the European Central Bank and the International

Monetary Fund.

2

“increasing partnership between municipalities is recommended because it is a quicker route

to economy with less political cost”.

One may suggests privatization of local services as an alternative to amalgamation or

inter-local cooperation (ILC) (Warner and Hebdon, 2001). However, a private firm would not

find incentive in providing some local services since the profits will be minor given the

insufficient size of the smallest LGUs. In the same vein, the transaction costs that LGUs may

bear as a result of privatization may outweigh the potential benefits of privatization (Bel and

Miralles, 2003).

The discussions above reveal a number of reasons why it may be more economical and

efficient for LGUs to cooperate in providing some services while preserving its local self-

government (Slack and Bird, 2013) rather than to amalgamate. Nonetheless, the ILC formulae

have to solve several deficiencies. The method based on “functional jurisdictions and ad hoc

service precincts” is not a cure, as Dafflon (2012) points out. They contribute to solve the

economic problems of too small municipalities but they also create a new situation and new

difficulties. According to Dafflon (2012), there are two categories of risks associated with the

intricate institutional arrangements, as well as the lack of transparency due to the multiplication

of administrative divisions.

Important lessons on ILC can be learned from international experiences but a tailored

model for each country needs to be developed. It remains clear that there is no common

framework because each country has its own peculiarities. Different kinds of ILC are found in

many countries around the world: Asian states like Indonesia (Pardede, 2013); Western

European countries (Hulst et al., 2009); American nations like Bolivia (Molina Saucedo, 2011)

and Brazil (Ferrari, 2013); and, also specific territories like New York State at the US (Division

of Local Government and School Accountability, 2007, 2009) and British Columbia at Canada

(Spicer, 2013), among others.

2. Background and Objective of the Review of Inter-Local Cooperation under the

Local Government Code of 1991

A more predictable, updated, coherent and accessible legal framework for ILC is needed

in Philippines. Hence, the objectives of this paper are (i) to promote a new and more stable

legal framework for ILC in the Philippines through general revision of fiscal provisions in the

Local Government Code (LGC) of 1991, and further, (ii) to enable the empowerment of LGUs

to build and consolidate alliances, as a way to improve efficiency, transparency and

accountability of local governance.2

A more solid framework for ILC can take advantage of unexploited economies of scale

in service delivery and huge investment projects. It can also contribute to reduce transaction

costs.3 On the other hand, formal alliances can likewise contribute to political and technical

coordination of national policies and may be justified on the grounds of internalizing positive

externalities and even those spillover effects associated with the supply of local services. In

particular, the new alliances can generate synergies because they produce effects and results

greater and more efficient than the sum of each LGU working separately. Following Lefèvre

(2003), it is a road map of “governance through institutional building”.

2 See Niazi et al. (2010) for a general perspective of fiscal decentralization in the Philippines. 3 See the monograph edited by the European Union / Delegation to the Philippines (2010).

3

The Philippine Development Plan 2011-2016 requires a new agenda of decentralization

reforms. LGUs have a challenging role to play in attaining inclusive growth, employment

creation, improved governance, and fiscal sustainability. Reinforcing the regulatory support for

ILC, as well as intergovernmental fiscal relations, will therefore be essential in enabling LGUs

to deliver on their responsibilities.

Given these premises, it must be clear that the objective of this paper is not to restructure

the mapping of LGUs. Instead, the main goal is to try to help the LGUs and the national

government to rationalize the use and delivery of local services through ILC. With an improved

framework for ILCs, the management of some existing local services may be passed to the said

formal alliances. This paper contains specific measures to promote and underpin the voluntary

formation of these new schemes.

II. CURRENT FRAMEWORK GOVERNING INTER-LOCAL COOPERATION

IN THE PHILIPPINES

As of March 2013, there are 51 ILC initiatives among LGUs in Philippines. Almost half

of the ILCs recorded are working together to address environmental issues or pursue

environmental programs.4

1. Legal Framework

While formal mergers of LGUs is not in the policy agenda of the Philippines at present,

conversion of municipalities to cities and breaking up of existing provinces/municipalities/

barangays into two or more new LGUs has been a growing trend in the country. Such trend

tends to result in inefficiently-sized jurisdictions. Given this, the unique feasible alternative for

amalgamation –except for some concrete cases- has to do with reinforcing ILCS. If it is well-

designed, politically supported and backed by the Local Government Code, many satisfactory

results may be achieved, specifically in terms of efficiency.

Article X, Section 13 of the 1987 Constitution provides that “local government units

may group themselves, consolidate or coordinate their efforts, services, and resources for

purposes commonly beneficial to them in accordance with law”. The provision denotes that

ILCs are a politically desirable way to improve local governance, and that ILCs are always a

voluntary approach for the LGUs. The same literalness is found in Section 3 of the LGC, where

the operative principles of decentralization are presented as the guides for the “formulation and

implementation of policies and measures on local autonomy”. It states that:

- “(f) Local government units may group themselves, consolidate or coordinate their

efforts, services, and resources for purposes commonly beneficial to them”; and

- “(k) The realization of local autonomy shall be facilitated through improved

coordination of national government policies and programs and extension of adequate

technical and material assistance to less-developed and deserving local government

units”.

4 See European Union/Delegation to the Philippines (2010): Critical Ingredients in Building and Sustaining Inter-

Local Cooperation

4

Section 3 (f) of the LGC stresses the constitutional mandate while Section 3 (k) directly

involves the national government –through its policies and programs- on the promotion of local

development, which must necessarily include the promotion of ILC.

Section 33 of the LGC regulates the “Cooperative undertakings among local

government units”. On the one hand, the well-known provision is repeated5 but the novelty is

the second part, which states “In support of such undertakings, the local government units

involved may, upon approval by the Sanggunian concerned after a public hearing conducted

for the purpose, contribute funds, real estate, equipment, and other kinds of property and

appoint or assign personnel under such terms and conditions as may be agreed upon by the

participating local units through Memoranda of Agreement”. This signifies the important role

of the Sanggunian, the monetary and in-kind contributions of the LGUs, and the Memorandum

of Agreement (MOA) as the legal instrument to establish ILC.

The LGC additionally covers provisions for relationships between LGUs and the non-

profit private subsector – people’s organizations (POs) and non-governmental organizations

(NGOs) - in Sections 34 to 36. However, it must be clear that this paper focuses solely on

cooperation among LGUs, thus, the cooperative arrangements between LGUs and POs/NGOs

is separate and not a central part of the study.

The joint analysis of the constitutional and legal provisions allows us to extract some

important preliminary conclusions. First of all, it is clear that LGUs (provinces, cities,

municipalities and barangays) are defined as public institutions with a cooperative nature. Their

position as “public institutions” comes from their constitutional basis, which, in turn, implies

autonomy, full legal personality, vertical supervision6 and public auditing by the Commission

on Audit (COA). On the other hand, the “cooperative nature” of the LGUs is derived from

Sections 3, 33 and 35 of the LGC as explained earlier.

The initial recommendation is that ILC must continue to keep the ex-ante voluntary

character –this issue is not in dispute- but, at the same time, it should be reinforced ex-post.

Summing up, it should be a “voluntary within mandatory”. In an interview with the Metro Naga

Development Council (MNDC)7, it is learned that while MNDC would like to have a legal

personality of its own, it prefers to maintain its voluntary nature. In addition, ILC should be

politically supported and promoted both by the national government and the LGUs themselves.

Finally, the LGC and any legislative follow-up should be able to guarantee that ILC is effective,

efficient, transparent, sustainable and durable.

2. Challenges of ILCs in the Philippines

Despite sustained and significant efforts in the creation of different ILCs in the

Philippines, only a few of them have proven solid. The LGC allows for a variety of financing

mechanisms and internal structures for ILC, which is an advantage in terms of flexibility, but,

5 “Local government units may, through appropriate ordinances, group themselves, consolidate, or coordinate

their efforts, services, and resources for purposes commonly beneficial to them.” 6 Section 4, Article X, of the Constitution states that “The President of the Philippines shall exercise general

supervision over local governments. Provinces with respect to component cities and municipalities, and cities and

municipalities with respect to component barangays, shall ensure that the acts of their component units are within

the scope of their prescribed powers and functions”. 7 The author interviewed the MNDC on August 11, 2014 at Naga City. MNDC was represented by Executive

Director, Ms. Sieglinde Bulaong and ex-Executive Director, Mr. Reuel Oliver, who is presently the Executive

Director of Naga City Investment Board and the Acting Manager of Metro PESO of the Naga City Government.

5

conversely, it is also a source of weakening for the ILCs. The following are their main

challenges:

- The existing ILCs are merely based on MOA, which has not been proven to be

sufficiently binding for the constituent LGUs. The MOA is signed by the local chief

executives (LCEs) as the representatives of the member LGUs, and upon endorsement

of their Sanggunians. As a consequence, the ILC becomes a contract binding for all

member LGUs but, of course, the institutional linkage is weaker than if compared to a

hypothetical LGC-based provision.

- Under Section 33 of the LGC, ILC is not a juridical entity and lacks corporate powers

and legal personality. For instance, these undertakings are not allowed to levy fees or

borrow. This situation can provoke severe financial constraints and might even wholly

jeopardize the mere survival of ILC.

- Historically, the establishment and operation of ILC based on Section 33 of the LGC

has been vulnerable to wavering political commitment, especially when local chief

executives who initially signed the MOA of an ILC are replaced by new LCEs after

their term of office; and likewise if the political parties of the LCEs in each LGU varies.

- Many LGUs do not have permanent staff or key personnel assigned to handle specific

tasks on coordination and planning, which are the most common responsibilities faced

by the ILC undertakings. The shortage of key personnel to support the activities of the

ILC often results to delays and inefficiencies in management and implementation of

activities of the ILC. In the case of MNDC, they have a project management office

(PMO) headed by an executive director whose main responsibility is to oversee the

PMO. The executive director is assisted by the project management officer who is in-

charge of the administrative operations of the MNDC. Both personnel work solely for

the ILC. Despite having these exclusive personnel, the MNDC still lacks human

resources to assist in the several works/activities of the ILC. Thus, they result in

borrowing an administrative assistant who is concurrently working in another office of

the host LGU; and likewise, in forming a technical working group composed of

representatives from the member LGUs who spearhead the various projects of the ILC.

- There is quite often a fragmented leadership that creates misunderstanding and unclear

division of powers and functions amongst the member LGUs (and also with the private

partners, if that is the case).

- The existing ILCs have been concentrating their activities in management of natural

resources and economic development zones, with few initiatives focused on basic

service delivery and almost none on broad-range / multitasking schemes.

From a strictly legal point of view, there are at least two other critical problems with

existing ILCs. First, the absence of a national registry involving certain formal requirements

for the creation of an alliance8. There is also a lack of clear specific guidelines implementing

Section 33 of the LGC. To that end, registration is precisely a possible solution to that weakness

because it is the operative act granting juridical personality to a proposed undertaking and is

8 Even the national census or inventory is quite unreliable because it lists a welter of very different formal and

informal structures of ILC.

6

evidenced by an official certificate9. In many cases, there is confusion between the diversity

and multiplicity of cooperative systems, those that are under the purview of Section 33 of the

LGC, and even those that can include POs and/or NGOs under the provisions of the Section

35. In closing, some of those ILC formulas are registered in the Securities and Exchange

Commission (SEC), one agency whose procedures were established for another very different

purpose10. Some of the existing ILC undertakings attempt to secure legal personality in

registering with the SEC but this procedure is defective because: (i) only natural persons or

individuals can be incorporators under SEC, and (ii) the resulting entity is a private corporation.

Second, the COA does not have direct jurisdiction to audit funding, spending, internal

organization, procurement and implementing programs of the existing alliances. It is clear that

the problems arising from registration also result in problems with COA. Units registered with

SEC are private entities but the legal personality of ILC should be public in nature because

resources involved are public funds11. Notwithstanding the foregoing, there is another critical

clarification over the member LGUs contributions because “GO [government organizations]

funds granted the NGOs/POs shall retain their character as public funds”, with all the legal

consequences that this implies with respect to collection, use and auditing12. As a final point,

the lack of an integrated auditing (financial, performance and compliance) over ILCs,

undoubtedly represents a very important loss of transparency and is a source of corruption and

inefficiency.

III. PROPOSED AMENDMENTS TO THE LOCAL GOVERNMENT CODE OF

1991 AS THE LEGAL BASIS OF ILC IN THE PHILIPPINES

The reform being proposed in this paper should move in two complementary directions:

(i) amendment of the LGC and (ii) regulatory development through the DILG (or another

national government oversight department) of guidelines and implementing regulations. The

key of the reform is focused on, but not limited to, Section 33 of the LGC.13

1. Proposed Concepts for the Amendments

ILC will continue to be a voluntary union among LGUs. The difference is that the term

“alliance” –alternatively, “cluster”- should be legally and exclusively preserved for the cluster

of LGUs, and only LGUs, that shall be based on a revised Section 33 of the LGC and some

concrete regulatory requirements. In this respect, it should be noted that up to the present “the

term ILC can also be interchanged with alliance” (DILG, 2013). From now on, these two terms

will not be equivalent.

The new alliances shall attain their own legal personality as a precondition to manage

their own resources, strategies, personnel, and any other issue related to service delivery and

auto organization. Other cases of ILC, different from alliances (Section 33 of the LGC) and

9 For an analogy, see the Cooperative Code of the Philippines, RA 6938. 10 See Section 5 of the Securities Regulation Code, RA 8799. 11 In using the cooperative analogy (RA 6938), is must be emphasized one major difference, i.e., while legal

personality of cooperatives registered under the Cooperative Development Authority is private in nature, the legal

personality of ILC envisioned to be registered under the DILG will be public in nature. 12 COA Circular 2007-001 dated October 25, 2007. 13 It should be noted that the general review of the LGC being conducted by the ADB and the DILG includes

connected topics in expenditure and revenue assignment, intergovernmental transfers, borrowing and credit

finance, creation of LGUs and fiscal administration.

7

local-private associations (Section 35 of the LGC), shall not be prohibited, but they shall not

acquire their own legal personality through the proposed amendments to Section 33 of the

LGC14.

The basic structural idea of this model of regulation is the need to consider the

alliance—a particular formalization of ILC—as a permanent instrument through which LGUs

that share economic, financial, historical, social or cultural realities, can work together in a

joint service delivery. Likewise, including the formulation and execution of common

development policies while respecting the singularities of each member LGU.

At this stage, before starting with the formulation of specific proposals for the legal and

regulatory reform, it is necessary to define a set of key concepts to avoid confusions or

misunderstandings. The first concept is that of ILC. An ILC is defined as any kind of grouping

or coordination among LGUs, and only among LGUs, based either in formal or informal

agreements15. In the proposed framework, NGOs, POs or any other private organizations only

can collaborate as partners, but not as formal members of the ILC. Also, each LGU shall

preserve its own identity and its own legal personality. Indeed, the ILC explicitly exclude

mergers or amalgamations of LGUs, regulated under the provisions of Sections 6 to 10 of the

LGC, which are outside the scope of this paper.

The second concept is that of alliance. An alliance refers to a new legal category of

formal ILC based on the provisions of the revised Section 33 of the LGC and the DILG

guidelines and implementing regulations. The new alliances shall be strictly and uniquely

formed by LGUs, and only by LGUs.

In Figure 1, the cluster of LGU_2 and LGU_3 – supposing they have fulfilled all the

formal requirements- shall form an alliance which shall have been vested its own legal

personality. In the same graphic example, LGU_1 voluntarily has decided not to cooperate with

the other LGUs in the new formal alliance but, needless to say, nothing precludes it from

working together with LGU_2 and/or LGU_3 in an informal manner.

Outside the strict perimeter of the alliances are the local-private associations, namely,

any kind of joint ventures and such other cooperative arrangements between one or several

LGUs and POs and/or NGOs. This sort of agreements shall be regulated by Sections 34 to 36

of the LGC and they cannot accede to a separate legal personality under the proposed

amendments to Section 33 of the LGC. In Figure 2, LGU_2 and LGU_3 together with NGO_1

and NGO_2 have initiated a local-private association founded on this method. Note that the

creation of the formal alliance among LGU_2 and LGU_3 does not prevent any other form of

ILC and/or local-private association.

14 They can acquire a legal personality through other provisions of LGC or other laws. 15 For simplicity, the term ILC is used in Philippines to denote any kind of cooperative arrangements involving

provinces, cities, municipalities and barangays. In highly-decentralized or federal countries like Brazil or Spain

the distinction between “vertical” and “horizontal” cooperation is relevant because the former applies to

collaborative ventures between different government tiers (e.g. consortium between regional and local or even

national, regional and local governments) and the latter operates only for inter-municipal cooperation.

8

Figure 1. The New Alliances as a Formal ILC

Source: Own elaboration.

In sum, the existence of an alliance implies that ILC is functioning but the inverse

proposition is not always true because not all the ILC schemes are able to satisfy the

requirements of a revised Section 33 of the LGC and the DILG regulations and guidelines that

are so formulated in support of the proposed amendment of Section 33. It is also essential to

clearly distinguish –in the LGC and in the guidelines- between ILCs and alliances (Section 33

of the LGC) and local-private associations (Sections 34 to 36 of the LGC).

Figure 2 shows the different stages of the completion of an ILC and the increasing

empowerment in terms of legal personality and normative status. The scheme begins with the

total absence of cooperation and may conclude in the merger of the former LGUs resulting to

a newly-created LGU.

Figure 2. Different Options for Institutionalization of ILC

Individualism ILC

(MOA-based)

Alliance

(Section 33 LGC) Amalgamation

- LGU_1:

constitutional basis

- LGU_2:


- LGU_1:


- LGU_2:


- LGU_1:


- LGU_2:


- New alliance: own

legal personality

- New LGU:



In a different vein, it is necessary to make a clear distinction between ILC-building

(alliances) and guild-formation or LGU-association (leagues and federations). The former is a

way to improve and formalize local service delivery. The latter consists of a political interaction

in order to advocate the interests of local governments on behalf of the members; to provide

9

services to members; and to offer a platform for the exchange of experience among members

(Dakoli-Wilson et al., 2007). The role of the leagues and federations –of provinces, cities,

municipalities or barangays- should be only reinforced as a tool for protection and promotion

of their common interests, technical and material assistance –in particular to the smallest and

least developed LGUs- and also for monitoring of ILC. Nevertheless, this is not the central aim

of this paper nor of the review of the LGC.16

2. New Legal Framework for Alliances as Juridical Entities

To address the aforementioned issues and problems and to enhance the role of ILCs as

a mechanism for efficient service delivery, a new legal framework that goes beyond the current

LGC is proposed. The main components involved the existing features, which shall be

considered, are the following:

- The establishment of a National Registry of Alliances (NRA), within the DILG or

another oversight national government department, in order to regulate the creation and

monitoring of the performance of the new ILCs. This office (which may be an entirely

new unit within DILG or an office within DILG which will be tasked with the

administration of the official registration of alliances.

- The exact requirements for the creation of ILC as a juridical entity.

- The implications of the legal personality for the new alliances.

The proposed amendment to Section 33 shall include the statement “the new alliance

shall have own legal personality, different from the constituent local government units, as a

public corporation” after the formal registration. The juridical consequences and practical

implications, in terms of corporate powers and prerogatives of this new entity, shall be detailed

in the guidelines and implementing regulations of the DILG. These rules shall at a minimum

contain the following rights, duties and limitations for the new public corporation:

a) Rights:

- To define its own internal structure and decision-making procedure.

- To manage its own assets and liabilities.

- To enter into contract, public procurement, own properties and other proprietary

powers.

- To hire people for personnel and to recruit a technical staff.

- To levy fees and charges for services rendered.

- To impose fines and penalties.

- To accede to national funds, and to receive grants and technical assistance from

external donors.

- To incur indebtedness by itself.

- To initiate legal proceedings acting in its own name and rights.

b) Duties:

- The adoption of an internal Statute.

- The board of directors and the remaining governing structure must operate on a

democratic and pluralist manner, as well as with the active involvement of the entire

set of participant LGUs. A clarification in the decision-making procedures is

required. The ordinary voting rule in the board of directors shall be the plurality,

16 The provisions for leagues and federations of LGUs are regulated in Sections 491-510 of the LGC.

10

except for particularly important decisions, which must be pre-established in the

internal Statute (e.g. 2/3 or 3/4 vote of all members). In the absence of the required

unanimity, supermajority or majority for those concrete actions, increased

cooperation between some member LGUs shall be permitted in specific areas,

which must also be pre-set in the internal Statute.

- Recruitment, career development, promotion, training and reward for all employees

of the alliance must be committed to equal opportunity and recognition of personal

and professional merit.

- The adoption of an annual budget to finance the operations of the alliance, based on

its expected income, projected investments and current expenditures. The budget

must be consistent with the long-term financial provisions and national budgetary

rules. The annual budget of the alliance shall also annex detailed information on the

list of job posts, with specification of tasks and types of engagement.

c) Limitations: - Alliances are created only for service delivery for the general welfare of the people,

and thus not allowed to engage in other business activities like banking, insurance,

trading, and other activities reserved for the private sector.

- Alliances have no legislative powers.

- Alliances cannot impose taxes.

The identified proposals are not only addressed to Section 33 of the LGC. Other related

provisions should be reviewed and revised accordingly, in order to make the LGC consistent

both in their institutionalization and financing. Once the LGC have been revised, the DILG

should issue the guidelines and implementing regulations to further clarify and expound the

LGC provisions.

3. Strengthening the Legal Basis of New Alliances

Section 3 of the LGC sets out the operative principles of decentralization. However, the

ILC as an inspiring principle of local political action, is not sufficiently detailed and protected

until Section 33. For this reason, it is deemed necessary that the concept of alliance, as a

particular formalization of ILC, be set out in the explicitly of the LGC. The proposed Section

3 (f) makes this provision and also establishes the basic conditions. (See Annex A.)

At no time shall it be required that the constituent LGUs should be contiguous or

adjacent, or even in the same province or region. The same flexible clause will be applied in

accordance with the present LGC, although territorial continuity has been the usual situation

for ILC formation. A more stringent regulation might not be useful for a country with much

territorial fragmentation and insularity like the Philippines, although in practice it seems logical

that the constituent LGUs are closer geographically, but not strictly contiguous.

Similarly, the proposed Section 3 (f) does not outlaw that one particular LGU can be

part of several alliances or other forms of ILC, subject to the fulfilment with the required

conditions.

On the other hand, it is appropriate to explicitly state in Section 3 (k) that policies,

programs and grants from the national government should promote and facilitate local

autonomy and ILC, specifically, alliance formation. It could be argued that ILC is nothing more

11

than a concretization of local autonomy, but even in such an interpretation, it would be worthy

to explicitly recognize it in the LGC. (See Annex A.)

The proposed Section 33 introduces several headings and clarifies existing wordings to

define the basic characteristics of new alliances and to regulate the procedure of its creation,

which shall obtain juridical entity. The following changes in the proposed Section 33 are

reflected (See Annex A.):

- Section 33 (a) adds the word “cluster” –as in the proposed Section 3 (f) - to recognize

such kind of cooperation. In addition, the word “policies” is introduced since it is one

of the key elements of ILC, which has been absent in the LGC provisions.

- Section 33 (b) clearly defines and creates the legal concept of “alliance”, subject to the

provisions of the LGC and DILG regulations.

- Section 33 (c) reiterates the voluntary nature of ILC and recognizes the decision powers

of the legislative body (Sanggunian) of the constituent LGUs. Three critical

fundamentals are also identified here: (i) LGUs contributions, (ii) indefinite term of the

alliance –as an evidence of a lasting willingness, and (iii) financial sustainability as a

prerequisite.

- Section 33 (d) introduces a newly minted document: the articles of cooperation. This

formal script, public nature, general scope and binding character, will be signed by the

local chief executives (once they have achieved the approval of their respective

Sanggunians). It shall include all the basic constituent elements of the projected

alliance, including, as a minimum requirement, the name of the constituent LGUs, and

the initial staff and equipment. Regarding local autonomy, the exact form for the articles

of cooperation will be flexible, although the DILG shall be given some common

elements to all of them.

- Section 33 (e) introduces two additional documents: the strategic plan and the long-

term financial provisions. Both shall be prepared by the constituent LGUs that form the

projected alliance, and then both should be submitted to the DILG and the DOF for

examination. Referral to the DILG found its legal accommodation in the constitutional

mandate of general supervision of the President of the Philippines over the LGUs.

- In Section 33 (f), the fundamental NRA is created under the structure of the DILG. New

alliances shall be registered only if they comply with the provisions established by the

LGC and with the guidelines and requirements that have been established by the DILG,

in which case the DILG will also oversee. The favorable opinion of the DOF over the

financial sustainability will also be necessary for the registration of the new alliance17.

If the procedure concludes with the final registration in the NRA, after the completion

of their publication in the Official Gazette of the Republic of the Philippines or in a

newspaper of general circulation, the new alliance will formally be created, and from

that moment onwards shall have its own legal personality, different from the constituent

17 At this point, it should be clarified that, although the natural function of the COA is ex-post auditing, it would

be possible and very reasonable to introduce reform in its functions (maybe through the LGC, the State Audit

Code of The Philippines or other general legislation) to incorporate this kind of advising and ex-ante opinions. An

international reference is The High Council of Public Finance (www.hcfp.fr), a newly established independent

institution whose board of directors is chaired by the President of the Court of Auditors.

http://www.hcfp.fr/

12

LGUs, and it will be subject to the jurisdiction of the COA. The position as a public

corporation implies capacity of self-organization, but not to become an LGU because

the Constitution only defines provinces, cities, municipalities and barangays. Finally,

in the new Section 33 (f) the internal Statute is regulated as the basic by-law that shall

govern the new alliance18. The internal Statute shall have to be consistent with the

previous articles of cooperation, the strategic plan, the long-term financial provisions,

and also be agreed upon the provisions of the LGC and other national regulations.

The proposed extension of the Section 33 of the LGC has two additional

‘closing’ clauses:

- Section 33 (g). It is designed to provide for the situation in which a projected

alliance fails to meet the requirements established by the LGC and the DILG, as

well as the favorable report of the DOF. If that were the case, it shall not be

registered in the NRA. In regard to local autonomy, it will not prevent its

configuration (except that could endanger national objectives, for example,

aggregate budgetary stability), but that ILC shall be maintained only as an informal

agreement between LGUs. Also, the so-called ‘positive silence’ is explicitly

regulated, in order to encourage administrative efficacy of the DILG. This implies

that in the absence of reaction from the NRA, it shall be intended as a tacit approval

for the projected alliance, and this will produce full and direct effects from that

moment onwards.

- Section 33 (h). The DILG is authorized to approve any additional regulation, as well

as to clarify any doubtful interpretation. This general authorization is again based

on the Constitutional supervision that the President of the Philippines exerts over

the LGUs.

Enacting such extensions of the LGC can be a controversial political issue due to

objective difficulties in passing a detailed comprehensive reform of the Section 33.

Anticipating resistance to modify the current legal framework in an intense way, this paper

presents an alternative intermediate option. Note this is a ‘second best’ alternative, but may be

more feasible and politically acceptable for the Congress, the DILG and the LGUs. In return,

all the remaining general provisions relative to alliances, as well as the in-house organization

of each one of them, shall be respectively developed in detail by the DILG and the internal

Statute.

In sum, the proposed changes in Section 33 (a) to (e) aim to guarantee the basic defining

elements of alliances, as follows: (i) voluntary nature during the initial stage of the alliance;

(ii) central role of the internal Statute; (iii) intervention of the DILG and the DOF; (iv)

approval/endorsement of the Sanggunian concerned; (v) indefinite duration of the alliances;

(vi) binding cooperation for all the constituent LGUs; (vii) creation of the NRA; and (viii)

practical consequences of the separate legal personality.

4. Design of New Alliances

18 Another possibility is to adopt a set of several by-laws, rather than a unique internal Statute. We have opted for

a single internal Statute to avoid potential legal inconsistencies and dispersion. In any event, this is a political

choice that cannot be solved in this report.

13

Additional reforms in the LGC are proposed, however, only a few concrete ideas are

suggested in order to recognize and make explicit the role of the new alliances built under the

provisions of the extended Section 33 of the LGC.

The review of the LGC applies to the Book II of the LGC on “local taxation and fiscal

matters” (Sections 128 to 383). The general idea is that when the LGC relates to the LGUs –in

particular, with respect to budgeting and fiscal administration- does so also to new alliances,

with their specificities. Acting this way, it would have two general options depending on the

legislative technique:

- Amend each and every section of the Book II of the LGC to introduce the alliances,

with its particularities; or

- Consider a general provision of reference at the beginning of Book II of the LGC

to extend a general authorization to the new alliances so that they can dispose their

own resources. (See Annex B)

If the legislative body chooses the second option –as it is easier than the first one- it

would ‘displace’ the specific regulations of the income of the alliances from the LGC to the

DILG guidelines and implementing regulations and, ultimately, to the internal Statute of each

alliance. The generic clause shall allow new alliances to have access to enact fees and charges19;

accede to national funds and grants; and be able to borrow by themselves. Three new sections

(152 bis, 284 bis and 289 bis) and Section 295 shall be added and amended, respectively, to

complement the said provisions devoted to taxing and other revenue-raising powers, grants and

credit financing of alliances, which shall be consistent with the powers of LGUs. It is also

proposed to expand Sections 347 and 354 of the LGC to explicitly state the role of the alliances

in the rendition of accounts and the contents of the Budget Operations Manual. In any event,

this should also be specified in the articles of cooperation. (See Annex B)

IV. PROPOSED GUIDELINES AND IMPLEMENTING REGULATIONS ON THE

FORMATION OF NEW ALLIANCES

1. Strengthening the Institutionalization of ILCs

This section shall serve as a ‘guide of guidelines’ for the DILG in clarifying the

proposed provisions of the LGC. It is not an articulated text nor is it intended to be so.

Once the LGC creates a legal basis for new alliances, they should have a common set

of rules of statutory range, which can provide minimal courses of action to complete their

institutionalization while respecting local autonomy. The following parts of this section will

discuss the fundamental aspects of the guide.

Role of the LGU Sanggunian

The Sanggunian is the legislative body and supreme democratic council in each LGU.

Consequently, it must be commended for the final decision powers in the issues related to

alliances, mainly, by a plurality rule. While almost all the following powers are already

19 Observe that the alliance is not an LGU, thus, it cannot have taxing powers. Only the State has the power to tax,

and the power of LGUs to tax is a delegated power.

14

recognized in the LGC, the proposed new regulation clarifies some functions of the

Sanggunian. (See Annex C)

Governing bodies of the alliance

The DILG guidelines should take into account the articles of cooperation and the

enactment of the internal Statute as the main by-law of the alliance. Unless otherwise agreed

by the parties in the articles of cooperation, there shall be an interim governing body, that is,

the provisional board of directors of the alliance, which shall pass the internal Statute. (See

Annex C)

Once the internal Statute has been approved, the provisional board of directors shall be

dissolved. Then, the representative of the board of directors, as well as the Chair, the Vice-

Chair, the Secretary and the remaining executive staff shall be elected or appointed in the

manner prescribed by those particular provisions in the internal Statute. If no particular mention

in the internal Statute is given, the term for the members of the board of directors, the Chair,

the Deputy Chair and the Secretary of the alliance shall be three (3) years, which is only

renewable once.

The alliance, once organized and registered with the NRA, shall have the board of

directors as its decision-making body. The board of directors shall carry out the powers,

functions and competences that had been transferred to the alliance. The political

representativeness of the Sanggunian must be replicated in this governing body of the alliance.

Also, the board of director shall always maintain at least one (1) representative of each one of

the constituent LGUs.

The powers of the Chair, the Vice-Chair and the Secretary of the alliance shall be the

same powers that their respective counterparts in the LGUs have and shall be exclusive over

the functions and competences that had been transferred to the alliance.

Articles of cooperation, strategic plan and long-term financial provisions

The articles of cooperation is the foundational chart of the alliance, which shall be

signed by the LCEs who were authorized by their respective Sanggunian. The articles of

cooperation must be signed and notarized. (See Annex C)

The strategic plan is a document used to communicate the initial goals of the alliance

and shall also serve as a roadmap including concrete objectives in the long run. It shall identify

the actions needed to achieve the goals. Among others, it shall define and quantify objectives

of cost reduction and increased efficiency compared to the service delivery by individual

LGUs. Moreover, the strategic plan shall frame the personnel and staff requirements of the

projected alliance, including provisions for hiring people and appointments of public servants

from the constituent LGUs.

The long-term financial provisions shall contain at least the initial allocation of

revenues and expenditures of the alliance, as well as a multi-year budget document for the next

three (3) fiscal years, which shall be consistent with the annual budget planning. It shall also

exhibit the projections of the main items of revenues including borrowing and expenditures, as

well as the main economic, political and financial assumptions on which such projections are

15

based. Likewise, it shall include a sensitivity analysis and the expected effects of legislative

and regulatory changes if that was the case. Fiscal sustainability and budgetary stability must

be ensured in the provisions at all times. Fiscal sustainability refers to the ‘golden rule’, that is,

that the projected alliance will borrow only to invest and not to fund current spending. As for

the budgetary stability and deficit objectives, these shall be established by the Department of

Budget and Management (DBM) on an annual and individual basis. Should the long-term

financial provisions be affected by critical changes or unexpected circumstances, the said

document shall be revised and resubmitted to the DILG and the DOF for supervision as Section

33 of the LGC states. If the new conclusions from the DILG and the DOF are not fully positive,

the alliance could be unregistered from the NRA.

Organizational structure, functions and general criteria of the NRA

One of the main powers of the DILG is to assist the President of the Philippines in the

exercise of general supervision over LGUs, as the Constitution mandates. This fundamental

function should include alliance formation and the ex-post supervision and monitoring of ILC,

and public auditing by the COA. The DILG has also the power to establish and prescribe rules

and other regulations on the promotion of local autonomy, ILC, transparency and

empowerment of LGUs. Without prejudice to the binding opinion of the COA over the financial

provisions, the DILG shall always have ‘the last word’ on the registration of the projected

alliances. The common criteria for them to be registered shall be detailed in specific guidelines.

For the mentioned reasons, this paper recommends the creation of a new institution,

with its own administrative staff and premises, within the Bureau of Local Government

Development, into the general organizational structure of the Undersecretary for Local

Government at the DILG (Figure 3).

The NRA shall keep a continuously updated census of alliances complete with data

sheets and attachments;20 and shall maintain an online directory of these alliances.21 All the

data and documents of the alliances shall be made publicly available.

Figure 3. Possible Organizational Structure for the New NRA under the DILG

20 Data sheets of the alliances must include the name of the alliance; the constituent and member LGUs; the

province and region in which it is located; both the name of the governing bodies and the name of the incumbent

members of the board of directors and the executive staff; and the powers and functions of the alliance.

Attachments include articles of cooperation, strategic plan, long-term financial provisions, DILG judgments and

COA opinions, internal Statute, the exact reference of the publication in the Official Gazette or in a newspaper of

general circulation, the accurate date for effectiveness of the alliance, and any other relevant records. 21 Directory must include postal, phone and Internet address of each alliance based on the provisions of the Section

33 of the LGC.

16

Source: http://dilg.gov.ph and own elaboration.

Any modification in the initial conditions of the alliance must be reported to the NRA

by the Chair of the alliance. If any of the changes is sufficiently relevant, the DILG shall initiate

a new procedure of formal registration for the alliance as defined in Section 33 of the LGC.

Provided, further, that in the event the NRA detects fundamental changes in the initial conditions

of the alliance, or if its financial sustainability can be jeopardized, the DILG shall formulate a

petition to the board of directors of the alliance and to the member LGUs seek clarification or

even formally initiate the dissolution of the alliance, in exceptionally serious cases.

Guidelines on the internal Statute and other by-laws

The alliances shall be governed by the provisions of the LGC and their own internal

Statute, which must be consistent with the provisions of the LGC.22 The alliance shall, within

six (6) months from its formal registration, adopt their internal Statute. Notwithstanding the

autonomy of the LGUs, the internal Statute of the alliance shall ascertain the common

compulsory provisions of an internal Statute in full detail. (See Annex C)

Individual default, dispute resolution and liquidation of the alliance

The proposed Section 33 provides that new alliances are born with indefinite duration.

The internal Statute shall establish the detailed and exceptional conditions in which the alliance

could be disbanded or liquidated.

No alliance will be dissolved by the simple desire to one or several of its constituent

LGUs, requiring the unanimous decision of the board of directors, supported by all, and every

one of the Sanggunian concerned. This implies that as long as the alliance remains constituted,

the obligations and commitments of all member LGUs will remain in force, in particular, the

financial contributions and other monetary commitments. Nonetheless, LGUs may still leave

22 Should the internal Statute be substituted by several by-laws, it must be ensured that all the basic regulations

are properly contained.

NRA

http://dilg.gov.ph/

17

an alliance but subject to approval of the Sanggunian concerned, and with the financial and

political consequences that are established in the internal Statute.

On the other hand, it is crucial that new alliances remain sustainable. The DILG

guidelines should explain that the enactment of new roles, competences, and projects shall be

authorized, if and only if, the alliance has sufficient savings and/or stable grants, and/or low

outstanding debt. Any change in the financial condition, as well as powers or functions of the

alliance, shall be examined by the COA and the DILG. Should one or several of these reports

and opinions were negative, the projected changes shall not be passed, unless the board of

directors of the alliance decides to continue with the strategy. If the latter occurred, the alliance

must formally justify its decision and present a detailed long-term budgetary planning in order

to guarantee financial sustainability.

Should any member LGU default the payment of any amount stated in the internal

Statute for a period exceeding thirty (30) days without any formal written apology or

explanation, or in the event of any breach of their obligations, the board of directors of the

alliance, excluding the defaulting LGU, shall act on the matter. (See Annex D)

The expulsion of a member LGU, or the termination of the alliance, shall not release

any member LGU from any obligation or cause of action accrued or liability incurred prior

thereto, in particular, those that are endorsed in the internal Statute of the alliance. If the

member LGUs are unable to resolve by mutual agreement any dispute or controversy between

them, the board of directors shall initiate the procedure to convene a binding arbitration through

the DILG. At the end, if the board of directors of the alliances shall not adopt the resolutions

and decisions of the arbitrators, the governing bodies of the alliance shall immediately cease to

exist. From that moment onwards, the DILG shall proceed to liquidate and settle the entire set

of assets and liabilities of the alliance, as well as the personnel. In the event of liquidation of

the alliance, the board of directors of the alliance and the Sanggunian concerned shall establish

a procedure in order to transfer the personnel, assets and the corresponding liabilities to another

institution or to the member LGUs, according to their respective contributions. Finally, it must

be ensured that in case of disaggregation of the alliance, the sum of public grants perceived by

the resulting shares is not going to exceed the amount of public funds than the ‘original’ alliance

had been gathering. The aim is to curb "divisions" contrived only to capture subsidies.

2. Financing New Alliances

The administrative procedure for the design and official registration of a new alliance

is deemed costly and time-consuming. This is precisely the reason why the LGC and the DILG

guidelines and implementing regulations must provide sufficient incentives in order to make

the new formal ILC more appealing for the LGUs. Once the member LGUs perceive that they

do not benefit adequately from their involvement, they might stop paying their individual

contributions. Hence, there is a pressing need to motivate the LGUs through showing them that

by pooling their efforts and resources, they can surpass what each LGU can individually attain.

To make the new alliances more appealing, the LGUs must see the advantages, such as,

recognition of the alliance’s legal personality; broader expenditure powers; and higher

revenues through the access to funds and credit financing, which in the past were attributed

exclusively to the LGUs. The legal provisions over resources of LGUs will apply to the

alliances, with the specialties that may be applicable in each case. Given this, the new alliances

must be able to cover the cost of its activities and other internal necessities (sufficiency

principle), with the following resources below.

18

2.1 Monetary and in-kind contributions of the member LGUs

One issue to address is the total amount of the common fund based on the LGUs

contributions, with reference to total budget of the alliance. If the total amount is too small in

relative terms, or even negligible, it will mean that the total budget of the alliance will likewise

be very small, and therefore, will have a very limited capacity23. On the contrary, if the

contributions of the member LGUs account for the vast majority of the total budget of the

alliance, then there is a risk that the alliance is captive with respect to these resources. The latter

implies that, in the event of default or delay of one of the member LGUs for whatever reason,

the financial sustainability of the alliance and its activities may be jeopardized.

There is no ‘ideal’ percentage for the contributions to the alliance. Nonetheless, this

paper recommends that the common pool financed by the aggregation of the member LGUs

contributions must not account, as indicative reference, for more than 2/3 (66.66%) of the

annual budget of the alliance. Once the total amount of contribution is agreed, there is a need

for a policy of reinforcing the individual contributions for more transparency, stability and

predictability. These shall ensure financial sustainability to be able to endure the daily activities

and service delivery of the alliance.

It has been proposed earlier that the new alliances “have an indirect share in the national

internal revenue taxes” (new Section 284 bis) and “an indirect share in the proceeds derived

from the utilization and development of the national wealth within their respective areas”. Both

shall be chargeable against the respective shares of each constituent LGU, which are, in turn,

directly dependent on the population and land area of the LGUs. The exact financial

relationships between national government, member LGUs and the alliance by itself must be

specified in the internal Statute as detailed as possible.

Another financial issue has to do with the sufficiency principle for the member LGUs

and the equity among them. In other words, how is each member LGU going to attain the

necessary resources to cover its contributions to the alliance? The internal Statute must specify

the formula and the details. It is compulsory that the respective quota in the common pool is

consistent with particular conditions of each LGU: (i) category of LGU whether province, city,

municipality or barangay; (ii) size as measured by the number of inhabitants; (iii) fiscal

capacity as measured by the per capita income or an analogous indicator reflecting fiscal bases;

and (iv) financial conditions (for example, if one LGU is highly-indebted or not). To the extent

possible, it shall be avoided that individual contributions be financed with a charge to additional

indebtedness because it denotes a severe latent insolvency problem. If the individual

contributions of the member LGUs are partially or totally in-kind (i.e. in form of labor, land,

facilities, equipment and the like), the alliance shall quantify them in terms of equivalent

monetary resources, by means of an external auditor.

To reinforce the sustainability of the alliance, Section 287 of the LGC may be amended

to increase the percentage of the IRA that is earmarked to development projects, including the

contributions to an alliance. However, IRA is a very controversial issue because it is by

definition, an unconditional transfer for the LGUs. A less provocative alternative would involve

the establishment of a fixed percentage of the individual development funds in the internal

23 Except, obviously, a situation in which the budget is financed with borrowing or contributions from external

donors. In such cases, there would not be a desirable financial scheme.

19

Statute, no matter how exactly denominated, which should be exclusively assigned for the

common development purposes of the alliance. The exact percentage should not be less than

10% of the individual development funds to ensure adequate endowment for the common pool.

As an example, the member LGUs of MNDC contribute 2% of their city/municipality's local

development fund to the common fund. This can be explored further in the future. Maybe the

5% of the development fund can be utilized for the projects of the alliance, in addition to the

20% development fund. Nevertheless, the proposed contributions of member LGUs can

substantially differ and/or even be inaccessible or unaffordable to much of the LGUs because

they are based on their respective IRA, which is, in turn, directly dependent on the size of the

LGU (population and land area criteria). Strictly speaking, the optimal basis for the individual

contributions should be the local per capita income, together with the size, but this is a utopia

since the necessary quantitative data for local income do not exist. On the basis on the equity

principle it can be discussed the possibility to establish a range of –say- 2% to 12% in order to

attain a similar contribution for a similar fiscal effort.

The associated risks to the second alternative are the uncertain total collection target;

the “excessive” burden on the biggest LGUs with the consequent political cost for their local

chief executives; and the arbitrariness of the respective quotas, which will be subject to

manipulation. A preferred alternative can be possible if a minimum threshold is preset for the

smallest LGUs, and a common percentage for the remaining LGUs, which shall be the exact

proportion that allows for the global fundraising target. Whichever solution is adopted, the

internal Statute of the alliance must ensure that all the member LGUs get their equal share of

whatever type of assistance is obtained. The numerical simulation in Figure 4 is only an

example of the three mentioned options.

Figure 4. Simulations for LGU Contributions

(monetary units)

As a proportion of the individual

development fund (proxy for fiscal effort) As a proportion of total common fund

LGU_1 LGU_2 LGU_3 TOTAL LGU_1 LGU_2 LGU_3 TOTAL

Individual development

fund* 100 500 800 1,400 7.1% 35.7% 57.1% 100%

Fixed contribution (10%)

10 (10%)

50 (10%)

80 (10%)

140 (10%)

7.1% 35.7% 57.1% 100%

Progressive rate

(2%-5%-12%)

2

(2%)

25

(5%)

96

(12%)

123

(8.8%) 1.6% 20.3% 78.0% 100%

Rate of 2% for the smallest LGUs

(others being equal

among them)

2

(2%)

53

(10.6%)

85

(10.6%)

140

(10%) 1.4% 37.9% 60.7% 100%

*Based on the size of the LGU, which is, in turn, a weighted indicator that includes population and land area.


All the options fully respects local autonomy and entails clear reinforcement for the

common fund of the alliance. It is clear that member LGUs have two fundamental duties over

their contributions to the alliance: to enter the full amount in their respective budgets (which

shall be considered as mandatory and preferential payments), and to pay the entire amount

committed, according to accounting and auditing rules. Otherwise, provided dunning

procedures shall be initiated.

2.2. Fees, charges and fines

It has to be understood that under the LGC (Book II), a set of taxes are assigned to

provinces, cities, municipalities and barangays. Nevertheless, all the levels of LGUs are highly-

dependent on transfers. Further, revenues from local taxes have been reduced markedly during

20

the last two decades because the LGUs still have not been able to adjust to their new roles of

LGUs and to deal with many socioeconomic challenges.

Local revenue autonomy and collection efficiency are narrow because partly, only the

real property tax appears to be revenue-productive among local taxes. In 2012, own-source

revenues of LGUs represent around a third of their total resources. Among the LGUs, the most

self-reliant of which are the cities (56%). Taxing rules have not been sufficiently modernized

to take into account fundamental social and technical features.

Other main problems of local taxation, among others, are the perverse incentives for

the taxpayer; broad differences from one location to another; de-indexing of tax rates –and also

fees and charges- that are fixed in peso terms; and a weak accountability of local executives.

Furthermore, Section 129 of the LGC allows LGUs to create their own fees and charges only

subject to the provisions of the LGC.

Within this general framework, the new alliances should play a leading role in a new

model of local taxation. As the amendment of Section 128 of the LGC is proposed earlier, the

power of the new alliances to levy their own fees, charges and special contributions shall be

explicitly recognized, based on their legal personality and the rights and duties to which they

are entitled in the new Section 33 of the LGC. In the initial moment, contributions of the

member LGUs are, by definition, the major –or even the unique- resource of the alliance but

this imply two serious problems: excessive transfer-dependency for the alliance, and short

leeway on the yearly budget for the constituent LGUs. If the alliance is able to collect their

own fiscal revenues, and if these revenues are sustainable and high enough, member LGUs can

gradually reduce their respective contributions.

Returning to the broad analysis of fiscal provisions of the LGC, it could be possible to

conclude that some of the taxes that are currently assigned to cities, municipalities and

barangays would be, under specific conditions, delegated to alliances. The general rule should

be that, in the case that an LGU is not attaining a sufficient degree of fiscal efficiency nor is

able to collect a minimum standard in a certain tax, the alliance can assume the management,

settlement, inspection, collection and review procedures of said tax. Nevertheless, this is a

complicated legal issue since the Constitution states that “taxes, fees, and charges shall accrue

exclusively to the local governments”. Another course of action would be to use special

delegations or devolutions of powers to the new alliances. In that scenario, the member LGUs

would retain their constitutional taxing powers but their practical implementation would be

executed by the alliance24.

By contrast, it is apparently easier for an alliance to levy fees25 and charges26 because

both are based on the benefit principle and on fiscal efficiency since the taxpayer is perfectly

identifiable as service user, and the tax liability can be individually attributed. There is no major

threats to the interpersonal or inter-LGU equity here, according to the general provisions on

local government taxation (Sections 128 to 133 of the LGC) and the remaining specific

regulations in the Book II of the LGC. Explicitly, by analogy to Section 132 of the LGC, the

power to impose a fee or charge to generate revenue shall be exercised by the board of directors

of the alliance through the internal Statute and enabling ordinances.

24 This controversial topic clearly exceeds the specific aims of this paper. 25 A charge fixed by law or ordinance for the regulation or inspection of a business or activity. 26 Monetary liability, as rents or fees against persons or property.

21

ILC has been traditionally focused on a set of areas like coastal and fisheries

management, solid waste management, social and health services, and culture, among others.

There are many activities in these areas in which the fiscal powers of the alliances may extend.

The following are examples, which can be compatible with existing taxes, fees, charges and

special contributions of the member LGUs: (i) entrance fees to museums, fisheries, monuments

and any other natural or touristic resource where the alliance can extract the consumers’

willingness to pay; (ii) issue of licenses, titles, certificates and any other official document; and

(iii) special contributions for public works or services that are executed in a very concentrated

territory.

The internal Statute may establish specific provisions over earmarking revenues to fully

reimburse services rendered by the alliance. Also, the internal Statute shall regulate the

financial, technical and fiscal relations between the member LGUs and the alliance itself. For

instance, it is crucial to make clear the initial allotment of resources and the attribution of future

fiscal revenues.

2.3. Grants, subsidies and transfers

As previously stated, the new alliances shall avoid excessive reliance on any particular

revenue, in particular, member LGUs contributions. For income diversification, it is

recommended to give the alliance a room in the IRA and other targeted funds and grants from

other governmental agencies, external or foreign donors. Nevertheless, it goes without saying

that the dependence from the LGUs contributions should not be ‘substituted’ by other

dependence on national transfers and grants. A proper equilibrium between different revenue

sources should be attained. Grants are openings to carry out a project or an activity of the

alliance but should not be seen as a fixed steady income paid by the donor.

In that sense, there are two new provisions in the LGC (Sections 284 bis and 289 bis)

being proposed, respectively on allowing alliances to accede to IRA and the proceeds derived

from the utilization and on development of the national wealth within their respective areas. It

can reasonably be assumed that the LGC is not going to be modified in a profound manner in

the short run unless the Congress opts for a full revision of revenue assignment and

intergovernmental transfers. Given that assumption27, what is actually proposed here is a

reform that could be achieved at zero net cost, because the “quota” of the alliance shall be

chargeable against the share of the constituents LGUs. No additional or extra resources would

have to be supported by additional extra-budgetary resources in the national government.

Again, this clause puts forward a minimum proposal, in order to maximize the probability of

success. In the more unlike hypothesis of a filled revision of financial provisions in the LGC,

it should include extended functions and powers for the new alliances by themselves, different

from the member LGUs. Nevertheless, the revision of the IRA and the whole system of

intergovernmental transfers is analyzed in the specific area of the LGC review.

The second source of income, and the most important in order to foster the development

of alliances, are grants and targeted funds paid by the national government, as well as any other

public or private institution or entity, for whatever marked purpose. Unfortunately, conditional

grants have been adopted only by a few government agencies and only for very specific goals.

It is relevant to remember that these kinds of resources have negative connotations for the

27 If there would be a filled revision of financial provisions in the LGC, it should include extended functions and

powers for the new alliances.

22

preceptors because LGUs can perceive that the central government is imposing its political

preferences over ILC and alliances, and as a consequence it is seriously encroaching upon their

local autonomy. Furthermore, accessing external funds in competitive calls requires clear

political vocation and technical skills, both including preparation of project proposals, general

documentation over grants and donors, and lobbying for the submitted proposals. LGUs and

alliances are not always prepared for this political and technical effort. Despite these political

problems, conditional grants can be much more effective than unconditional funds (IRA and

other revenue sharing) in guiding and incentivizing LGUs to cooperate according to LGC

provisions and national government’s priorities, assuming that alliance formation for local

development is one of those concerns. Besides, conditional grants can align sectoral programs

with national policies as well as with local goals in a way to maximizing effectiveness and

efficiency.

Conditional grants are commonly aimed at achieving a specific goal, thus, the money

are expected to be spent on a particular public expenditure. From the LGUs’ point of view, the

“specific goal” could be ILC in general; alliance formation in particular; and, if the alliance is

already registered and working, the grant shall be addressed to a particular investment project

or operational costs. The role of the payer or donor is central in deciding the exact destiny of

the funds. The types of grants accessed by alliances are presented in Figure 5.

Figure 5. Types of Grants Accessed by Alliances Grant source Description and application

Provincial grant Usually monetary assistance to augment alliance funds

for operation or to finance special projects or activities

Grants from lawmakers Usually monetary assistance to finance special projects or

activities

National government grant Usually monetary assistance to augment alliance’s funds

for operation and to finance special projects or activities

Grants/support from national government agencies Technical assistance for specific programs or activities

Grants from foundations, NGOs, POs, private sector Monetary, technical assistance, or equipment for specific

projects and activities of the alliance

Grants from international funding agencies Monetary, technical assistance, or equipment for specific

projects and activities of the alliance Source: European Union / Delegation to the Philippines (2010: p. 72).

As a general guide, we can categorize grants in two:

- A package of conditional matching grants that politically support the initial phase

after the enactment of the extended Section 33 of the LGC. For every monetary unit

that the constituent LGUs are going to spend on alliance formation and

consolidation, the national government will contribute a fixed additional proportion.

The main goal is the formation of new solid alliances under these provisions, thus,

the best entity to pay such grants is the DILG and all their departments, bureaus,

offices, agencies and instrumentalities of the national government, including

government owned or controlled corporations and government financial

institutions.

- A set of non-matching conditional grants in the consolidation phase of the alliances,

when the foundational goals have been achieved. To be able to develop joint

investment projects, the alliance shall receive a fixed amount of money that must

be spent on a particular category of public expenditure (health, communications,

and elementary education, among others). The DILG is deemed the best payer for

this purpose, accompanied by adequate support from external and foreign donors.

23

It is important to clearly distinguish investment projects and current social

expenditures because only the former could be completed with credit financing (the

so-called debt ‘golden rule’).

The role of the DILG is crucial both for stimulation of alliance formation and

consolidation of the existing ones. The proposed amendment to Section 33 of the LGC states

that “the duration of the projected alliance must be open-ended” and “the constituent local

government units shall be indefinitely engaged with the new alliance”. This implicitly assumes

that the alliance is compelled to define a wide-ranging spectrum of functions and activities,

instead of a unique project. Hence, it is essential to define a more active role for the DILG in

the task of promoting broad-based alliances versus “mono-sector” alliances, and both being

preferred to informal ILC and public-private association. The use of non-matching conditional

grants as opposed to the direct delivery of services by the national government can be an

alternative for service provision in a more efficient manner.

In summary, national grants could be quite diverse, depending on:

- Main goal: formation and consolidation of alliances versus execution of specific

works or services.

- Payment method: grant-in-aid, subsidies, or loans.

- Complementariness with other national policies: exclusive or paired with other

national funds. A maximum proportion of the total amount is suggested for each

alliance, once the general criteria have been implemented.

- Means of access: either by a direct award procedure or by a competitive procedure.

The former is based on total population; the latter is based on specific projects.

- Final use by the alliance: conditional or unconditional.

2.4. Revenues

The new alliances shall effort to extract the maximum performance from their property,

inheritances, gifts, rents receivable, interest income and dividends so as to make optimal use

of the means available in order to avoid any vacuum or curb inefficiencies.

However, the board of directors of the alliance shall decide over the final destination of

any unforeseen income. Unless the internal Statute expressly states otherwise, the windfalls

revenues must go exclusively to reduce the stock of outstanding debt and to promote

investment projects.

2.5. Borrowing

LGUs are granted borrowing powers under the LGC but the same clause does not apply

to ILC. Extending the borrowing powers to the new proposed alliances may be an issue for

LCEs, at least, because of two reasons:

- Credit financing is an incentive to obtain additional resources for joint investment

projects that otherwise could not be attained by each LGU, separately; and

- The total amount of local indebtedness is at the moment quite reasonable in terms

of national GDP and in relation to local revenues.

24

Alliances’ borrowing, irrespective of their legal structure and financial formalization,

shall be determined on the provisions of the LGC and the orthodox ‘golden rule’ that is already

in place for LGUs. Remember that Sections 296 and 297 of the LGC state that credit financing

must be exclusively devoted to investment and development projects (capital outlays), which

immediately excludes current and operational expenses.

DILG guidelines and implementing regulations shall also establish additional

requirements for fiscal discipline, following international best practices that allow national

government to exert coordination over local subnational finances through direct controls and

fiscal rules (balanced budget, debt ceiling, procedural budgetary laws, institutional schemes for

coordination, and any other legal and administrative possibility). Similarly, within the general

framework of the LGC review and other connected laws, the DILG shall regulate the juridical

implications for the new alliance for the following issues, among others:

- A stronger link between conditional grants, debt financing and LGUs contributions

in order to ensure an adequate budgetary balance. The main goal is to avoid

excessive dependence from one of these resources.

- “Back-to-back” financial transactions between member LGUs and the alliance

itself, including securities, loans and guarantees.

- A revision in the provision of Section 311 of the LGC, which establishes a clause

regarding preferential treatment for government-owned financial institutions. This

should only be a part of a complete re-definition of roles of the national government,

private sector and Central Bank requirements in the provision of credit finance for

LGUs.

- A softening of the legal requirements in Section 324 of the LGC. Particularly, the

one that obliges LGUs and the alliances, to borrow to the extent that their annual

debt service-payment of amortization and interest cannot exceed 20% of their

regular income.

- The elimination of the so-called “big-brother” LGU, trying to reinforce the legal

personality of the alliance itself in order to reduce its dependence on a particular

member LGU (actually, the biggest one).

Borrowing and other credit financing of alliances should be subject to the approval of

the DILG and the DOF. Particularly, if the operations may endanger the overall ceiling laid

down by the national government.

2.6. Other resources including windfall revenues

All resources that had not been in the initial budgets of the alliance must be incorporated

as soon as they are known on an accrual basis. The DILG, jointly with the DBM and the DOF,

shall pass an implementing regulations on this matter28. Likewise, there must be a specific

regulation for cyclical revenues, that is, the revenues due to higher economic growth than

planned or to any other unforeseen circumstances. As a general rule, those unexpected revenues

shall be partially or totally intended to reduce the total outstanding debt of the alliance

28 Similar provisions shall apply to windfall expenditures.

25

(including amounts due to suppliers). This measure shall be designed to be complementary to

a separated endowment of a “rainy day fund”, or stabilization fund, within the common pool

of the alliance.

3. Provisions on Budget, Accounting, Audit, and Personnel

Specific accounting and auditing standards, consistent with the existing ones applied to

the LGUs, must be adopted for the alliances. The NRA and the DILG shall conduct a regular

monitoring and evaluation of projects and activities being implemented by the alliances,

especially those that are financed by national grants and funds, as well as those alliances and/or

LGUs that are highly-indebted. Monitoring by the NRA should include submission of annual

reports indicating operational and financial performance towards achievement of detailed

goals. Failure to comply with this provision means delisting from the NRA.

As the proposed Section 33 provides, the COA shall have the new alliances under its

jurisdiction, rules and regulations and the new alliances shall be subject to the Civil Service

Commission and the DBM provisions, according to their specific stipulations. As a minimum

requirement, it is recommended that the COA may audit the new alliances on an annual basis,

“according to the respective constitutional and legal provisions”. This financial and regularity

auditing shall examine financial condition, LGUs contributions, the remaining public and

private resources, the results and use of resources, and the expenditures after budget execution.

The alliances shall be audited using the three main types of public-sector audit (Figure 6).

Figure 6. Three Main Types of Public-Sector Audit Financial audit Performance audit Compliance audit

Financial audit focuses on determining

whether an entity’s financial

information is presented in accordance

with the applicable financial reporting

and regulatory framework. This is

accomplished by obtaining sufficient

and appropriate audit evidence to

enable the auditor to express an

opinion as to whether the financial

information is free from material

misstatement due to fraud or error.

Performance audit focuses on whether

interventions, programs and institutions

are performing in accordance with the

principles of economy, efficiency and

effectiveness and whether there is room

for improvement. Performance is

examined against suitable criteria, and

the causes of deviations from those

criteria or other problems are analyzed.

The aim is to answer key audit questions

and to provide recommendations for

improvement.

Compliance audit focuses on

whether a particular subject

matter is in compliance with

authorities identified as criteria.

Compliance auditing is

performed by assessing whether

activities, financial transactions

and information are, in all

material respects, in compliance

with the authorities which

govern the audited entity. These

authorities may include rules,

laws and regulations, budgetary

resolutions, policy, established

codes, agreed terms or the

general principles governing

sound public-sector financial

management and the conduct of

public officials. Source: ISSAI 100: “Fundamental principles of public-sector auditing”.

It is likewise recommended that any public fund, transfer grant, or even the

authorization for created indebtedness, must be conditional on the accurate rendition of

accounts within the time limits and in the correct form, following accounting and auditing rules.

The COA shall certify compliance with said procedures on a yearly basis.

V. CONCLUSION AND FINAL REMARKS

For the first time since its enactment in 1991, the LGC is undergoing a government-led,

comprehensive review designed to boost revenues streams for the provision of better basic

services, and to assist local economic development and job creation. The ADB and the DILG

26

are working together in order to improve transparency and accountability in local governance,

and enhance efficiency on service delivery. Within the general review of fiscal provisions of

the LGC, this paper is aimed at reinforcing ILC through the new legal figure of alliances. The

proposals are partial, feasible, and intended to look for the highest probability of success.

This paper made several proposals, particularly, in trying to expand the provision of

Section 33 of the LGC, where ILC is regulated. Moreover, this paper contains an initial guide

for the DILG in their task of drafting an expounded guidelines and implementing regulations,

but not to be treated as a closed text of articles. Furthermore, some other proposals have been

made for sections closely linked to Section 33. In all of these, the powers and functions of the

DILG –and the DOF, when appropriate- are considerably reinforced. The following list of

proposals reflects the major changes in the LGC:

- The term “alliance” should be legally preserved for a new public corporation, based

on formal and voluntary ILC, which shall have its own legal personality, under

several provisions.

- The legal personality implies indefinite duration, auto organization for the alliance

and also capacity to finance itself. The alliances must ensure financial sustainability.

- The administrative procedure for formal registration of the new alliances goes

through the newly created NRA under the DILG.

- The duration of the alliance shall be indefinite and the linkages between the

constituent LGUs and the common entity are reinforced.

- The new alliances shall be able to levy fees and charges and have access to national

funds and grants and likewise, able to borrow by itself.

- The internal Statute, instead of the traditional and non-binding MOA, shall lay down

the detailed provisions for each new alliance, which must be consistent with the

LGC and the DILG guidelines.

It must be noted that some risks remain hidden in this set of proposals. Firstly, because

of political interference. For instance, if national grants for alliance formation are reduced.

Secondly, may be caused by the lack of good existing ‘informal’ ILC experiences, as well as

some interesting public-private associations. But this potential problem is not a real threat since

the three schemes are different, complementary and compatible.

The third latent risk may be due to the cost of the new bureaucratic procedure. In order

to minimize this risk, the LGUs must perceive the benefits derived from the new alliance to be

high enough. On a more encouraging point of view, it can be said that the time-consuming

procedure for official registration is a warranty for durability and strength of alliances.

Fourthly, there may be a potential loss of democratic control over the activities of the

alliance, compared to LGUs acting separately, because the governing bodies of the alliance are

designed or appointed in an indirect manner. Again, this is not true because the Sanggunian

concerned retains their competences and functions, which includes fundamental decision

powers over the alliance.

Finally, there may be cases of “jealous” stakeholders that may harm alliance formation.

For instance, the smallest LGUs with respect to the biggest ones, or vice versa. Hence,

promoters and executives of the projected alliances in the Philippines have to persuade these

stakeholders. In the long run, efficient and sustainable alliances may be a ‘substitute’ for the

27

provinces in providing service delivery. Nevertheless, it must be noted that the abovementioned

conjectures are personal speculations of the author only.

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29

ANNEX A. LEGAL BASIS OF NEW ALLIANCES

SECTION 3. OPERATIVE PRINCIPLES OF DECENTRALIZATION

Present Provision in the LGC Proposal for Reform

(f) Local government units may group themselves,

consolidate or coordinate their efforts, services, and

resources for purposes commonly beneficial to them;

(f) Local government units may group themselves,

cluster, consolidate or coordinate their efforts, services,

policies and resources for purposes commonly beneficial

to them; inter-local cooperation may be formalized as

an alliance, according to the provisions of this Code and

the guidelines and implementing regulations previously

passed by the Department of the Interior and Local

Government;

(k) The realization of local autonomy shall be facilitated

through improved coordination of national government

policies and programs and extension of adequate

technical and material assistance to less developed and

deserving local government units;

(k) The realization of local autonomy, as well as efficient

inter-local cooperation and the formalization of

sustainable alliances, shall be facilitated through

improved coordination of national government policies,

national specific grants and programs, and extension of

adequate technical and material assistance to less

developed and deserving local government units;

SECTION 33. COOPERATIVE UNDERTAKINGS AMONG LOCAL GOVERNMENT UNITS

Present Provision in the LGC Proposal for Reform

Local government units may,

through appropriate ordinances,

group themselves, consolidate, or

coordinate their efforts, services,

and resources for purposes

commonly beneficial to them. In

support of such undertakings, the

local government units involved

may, upon approval by the

Sanggunian concerned after a

public hearing conducted for the

purpose, contribute funds, real

estate, equipment, and other kinds

of property and appoint or assign

personnel under such terms and

conditions as may be agreed upon

by the participating local units

through Memoranda of

Agreement.

(a) Local government units may, through appropriate ordinances, group

themselves, cluster, consolidate, or coordinate their efforts, services, policies

and resources for purposes commonly beneficial to them.

(b) Two or more local governments units may build an alliance based on the

provisions of this Code and the guidelines and implementing regulations of the

Department of the Interior and Local Government.

(c) The local government units involved may, upon approval by the Sanggunian

concerned after a public hearing conducted for the purpose, contribute funds,

real estate, equipment, and other kinds of property and appoint or assign

personnel to the projected alliance. The duration of the projected alliance must

be open-ended and it must ensure its financial sustainability.

(d) Once the formation of the alliance is endorsed by the Sanggunian, the local

chief executives of the participating local government units shall covenant

their respective local government units through the articles of cooperation of

the projected alliance which shall include, at least, the founding local

government units, object, projected powers, functions, responsibilities and

powers to assume, board of directors, initial resources and any other relevant

information for these purposes.

(e) The articles of cooperation as well as the strategic plan and the long-term

financial provisions must be submitted to the Department of the Interior and

Local Government in order to verify that the provisions of this Code and the

guidelines and requirements are properly fulfilled. The long-term financial

provisions must be also submitted to the Department of Finance which shall

express its opinion on the initial financial condition and the long-term

sustainability of the projected alliance.

(f) Upon written application addressed to the National Registry of Alliances,

the projected alliance shall be officially registered if, and only if, the

requirements are properly fulfilled and supported by sufficient evidence, and

the opinion of the Department of Finance over the long-term financial

provisions is fully positive. The official registration shall only take effect after

the completion of its publication either in the Official Gazette or in a

newspaper of general circulation in the Philippines. From that moment

onwards, the new alliance shall have its own legal personality and full

juridical entity as a public corporation, different from the constituent local

government units. The new alliance by itself as well as their resources,

expenditures and policies shall be under the jurisdiction of the Commission on

Audit according to the respective constitutional and legal provisions. The

constituent local government units shall be indefinitely engaged with the new

alliance in terms of the provisions of this Code, the guidelines and

implementing regulations of the Department of the Interior and Local

Government, and the internal Statute and by-laws of the alliance.

30

(g) If the projected alliance was not finally registered in the National Registry

of Alliances, it shall be maintained as a private association or even shall be

refused by the Department of the Interior and Local Government based on

national criteria. This does however not apply in the absence of any reply from

the Department of the Interior and Local Government, the Department of

Finance or the National Registry of Alliances to a request for registration of a

projected alliance, within one (1) month from its petition. Should this be the

case, it shall be equivalent to an acceptance of the projected alliance for

official registration.

(h) Any other specific provision, including dynamic conditions for alliances,

directives for the National Registry of Alliances, common specifications for the

articles of cooperation, the strategic plan and the long-term financial

provisions of the projected alliances, as well as any clarification of this

Section, shall be regulated by the Department of the Interior and Local

Government.

SECTION 33. COOPERATIVE UNDERTAKINGS AMONG LOCAL GOVERNMENT UNITS—SHORT

VERSION

Provision in the LGC Proposal for Reform

Local government units may, through appropriate

ordinances, group themselves, consolidate, or coordinate

their efforts, services, and resources for purposes

commonly beneficial to them. In support of such

undertakings, the local government units involved may,

upon approval by the Sanggunian concerned after a

public hearing conducted for the purpose, contribute

funds, real estate, equipment, and other kinds of property

and appoint or assign personnel under such terms and

conditions as may be agreed upon by the participating

local units through Memoranda of Agreement.

(a) Local government units may, through appropriate

ordinances, group themselves, cluster, consolidate, or

coordinate their efforts, services, policies and resources

for purposes commonly beneficial to them.

(b) Local governments units may voluntarily build an

alliance based on the provisions of this Code, the

guidelines and implementing regulations of the

Department of the Interior and Local Government, and

the internal Statute and by-laws of the alliance. In any

case, the administrative procedure for official

registration of the alliance must incorporate the

approval by the Sanggunian concerned, the opinion of

the Department of Finance over the long-term financial

provisions, and the role and functions of the National

Registry of Alliances.

(c) The duration of the alliance must be open-ended and

it must ensure its financial sustainability at all times.

The constituent local government units shall be

indefinitely engaged with it.

(d) Once the alliance is officially registered, it shall have

its own legal personality, as a public corporation, under

the jurisdiction of the Commission on Audit according to

the respective constitutional and legal provisions.

(e) Specific provisions and clarifications of this Section

shall be passed by the Department of the Interior and

Local Government.

31

ANNEX B. DESIGN OF NEW ALLIANCES

SECTION 128. SCOPE


The provisions herein shall govern the exercise by

provinces, cities, municipalities, and barangays of their

taxing and other revenue-raising powers.

(a) The provisions herein shall govern the exercise by

provinces, cities, municipalities, and barangays of their

taxing and other revenue-raising powers.

(b) The common provisions for all the LGUs shall also

apply to alliances based on the Section 33 of this Code,

which shall have their own resources, apart from the

contributions from the constituent local government units,

and including the creation of indebtedness and other forms

of credit financing. The internal Statute of the alliance

shall govern the exercise by these public corporations of

their revenue-raising powers. The provisions herein as

well as general national regulations for the local

government units shall be applied in the vacuums.

ARTICLE IV BIS (“ALLIANCES’) SECTION 152 BIS IN CHAPTER II, TITLE I, BOOK II OF THE LGC

“Scope of taxing powers. The alliances based on Section 33 of this Code may levy fees and charges, respecting the

specific provisions of this Chapter over the taxing and other revenue-raising powers of the constituent local government

units. The internal Statute of the alliance shall lay down concrete rules according to the functions and competences of the

alliance itself as well as the powers of the constituent local governments units”.

SECTION 284 BIS IN CHAPTER I, TITLE III, BOOK II OF THE LGC

“Alliances. The alliances based on Section 33 of this Code shall have an indirect share in the national internal revenue

taxes, which shall be chargeable against the share of the constituent local government units, according to the provisions of

this Chapter and the internal Statute of the alliance. The alliances cannot be entitled to a direct share in the internal

revenue allotment. No additional amount, apart from the total sum devoted to the local government units, shall be

assigned to the alliances”.

SECTION 289 BIS IN CHAPTER II, TITLE III, BOOK II OF THE LGC

“Alliances. The alliances based on Section 33 of this Code shall have an indirect share in the proceeds derived from the

utilization and development of the national wealth within their respective areas, which shall be chargeable against the

share of the constituent local government units, according to the provisions of this Chapter and the internal Statute of the

alliance. The alliances cannot be entitled to a direct share in the national wealth. No additional amount, apart from the

total sum devoted to the local government units, shall be assigned to the alliances”.

SECTION 295. SCOPE


This Title shall govern the power of local government units

to create indebtedness and to enter into credit and other

financial transactions.

This Title shall govern the power of local government

units, as well as alliances based on Section 33 of this

Code, to create indebtedness and to enter into credit and

other financial transactions. The specific provisions for

alliances shall be detailed in the internal Statute and shall

be consistent with national limitations on local deficit and

debt.

SECTION 347. RENDITION OF ACCOUNTS


Local treasurers, accountants and other local accountable

officers shall render their accounts within such time, in

such form, style, and content and under such as the

Commission on Audit may prescribe. Provincial, city, and

municipal auditors shall certify the balances arising in the

accounts settled by them to the Chairman of the

Commission on Audit and to the local treasurer,

accountant, and other accountable officers. Copies of the

certification shall be prepared and furnished other local

officers who may be held jointly and severally liable for

Local treasurers, accountants and other local accountable

officers shall render their accounts within such time, in

such form, style, and content and under such regulations

as the Commission on Audit may prescribe. Provincial,

city, and municipal auditors shall certify the balances

arising in the accounts settled by them to the Chairman of

the Commission on Audit and to the local treasurer,

accountant, and other accountable officers. Copies of the

certification shall be prepared and furnished other local

officers who may be held jointly and severally liable for

32

any loss or illegal, improper or unauthorized use or

misappropriation of local funds or property.

any loss or illegal, improper or unauthorized use or

misappropriation of local funds or property. All these

provisions shall also apply to alliances based on Section

33 of this Code.

SECTION 354. ADMINISTRATIVE ISSUANCES: BUDGET OPERATIONS MANUAL


The Secretary of Budget and Management jointly with the

Chairman of the Commission on Audit shall, within one (1)

year from the effectivity of this Code, promulgate a Budget

Operations Manual for local government units to improve

and systematize methods, techniques, and procedures

employed in budget preparation, authorization, execution,

and accountability.

The Secretary of Budget and Management jointly with the

Chairman of the Commission on Audit shall, within one (1)

year from the effectivity of this Code, promulgate a Budget

Operations Manual for local government units to improve

and systematize methods, techniques, and procedures

employed in budget preparation, authorization, execution,

and accountability. The Budget Operations Manual shall

be amended to include specific provisions for the alliances

based on Section 33 of this Code.

33

ANNEX C. STRENGTHENING THE INSTITUTIONALIZATION OF ILC

1.1. Role of the LGU Sanggunian

- Initial approval of the procedure to build a new alliance, incorporation into an existing

one, and exit from an existing one.

- The decision over contribution of funds, real estate, equipment, and other kinds of

property, as well as the appointment or assignment of staff, executives, representatives

and personnel to the alliance. Reciprocally, the decision over provisions for liquidation

of the alliance.

- Designation or appointment of LGU representatives in the governing bodies of the

alliance.

- Authorization to the local chief executive in order to sign agreements and documents

in the name of the LGU.

1.2.Governing Bodies of the Alliance

The following general rules shall organize the interim governing bodies of the alliance:

- The provisional board of directors of the alliance shall be composed of one (1)

representative from each constituent LGUs, who will be appointed by the respective

Sanggunian. The person can be the LCE or any other person with appropriate technical

qualifications. The initial set of officers should be indicated in the by-laws and indicated

in the application for registration.

- At the constituent meeting, the provisional board of directors shall elect an Acting Chair

and a Deputy Acting Chair, from among its members, by plurality rule. The Deputy

Acting Chair shall serve as Chairperson in the absence of the Acting Chair and also as

the Acting Secretary. In the event of continued absence of agreement for the election,

the representative of a constituent barangay, municipality, city or province, strictly

following this order, shall be designated as the Acting Chair. If there is more than one

LGU of the same type, the representative of the smallest one, in terms of population,

shall be designated as the Acting Chair. Should be the case, the Deputy Acting Chair

shall be directly appointed by the Acting Chair among the members of the board of

directors.

- The provisional board of directors shall pass the internal statute of the alliance as

prescribed below.

1.3. Articles of cooperation, strategic plan and long-term financial provisions

The articles of cooperation must include the following information as a minimum

requirement:

34

- A formal declaration expressing the concurrence of wills in order to constitute the new

alliance, under the provisions of the Section 33 of the LGC. The LGUs should state the

reasons for establishing an open-ended alliance.

- The official name, registered office and basic organizational structure of the projected

alliance.

- The breakdown of functions and powers of the LGUs that the projected alliance is going

to assume. This can cover a broad set of functions and public services within the open

general welfare clause (Section 16) and the basic services and facilities clause (Section

17) of the LGC.

- A comprehensive inventory of the initial contributions of each constituent LGU,

including quantitative and qualitative descriptions over monetary and in-kind articles

as well as the allotment of each LGU in the initial common pool of the alliance.

1.5. Guidelines on the internal Statute and other by-laws

The sequential procedure for the approval of the internal Statute of alliances shall be the

following:

- The provisional board of directors of the alliance shall prepare a preliminary draft of

the internal Statute, which will reflect all the above-mentioned requirements.

- The preliminary draft shall be submitted to the Sanggunian concerned and the DILG.

The DILG must submit the preliminary draft to the COA.

- The DILG and the COA shall give and publish, within two (2) months from the formal

reception, their non-binding opinions to the preliminary draft of the internal Statute. If

at least one of these two opinions is not fully positive, the board of directors of the

alliance can modify the draft or, on the contrary, it must provide a detailed justification

for its original criterion.

- The final draft version of the internal Statute must be endorsed by all the Sanggunian

concerned. Plurality rule shall apply for this decision.

- Finally, the provisional board of directors of the alliance shall pass the internal Statute,

which shall have the force of law within the alliance.

- The procedure for any amendment shall be the same as the one established earlier.

- Any amendment or modification to the internal Statute shall follow the same procedures

established for its approval in these rules and regulations.

The compulsory elements of an internal Statute that shall be discussed in as much detail as

possible are as follows:

- So-called “whereas” clauses.

- Official and distinctive name of the alliance and the territorial scope.

- Name of the constituent LGUs and the role definition based on the comparative

advantages of each one.

- Registered office.

- Mandate of the alliance, which shall always be indefinite. Only in case of dissolution

of the alliance –that must be motivated- the own personnel and staff shall automatically

become part of the constituent LGU according to the specific regulations. In that

35

eventuality, the member LGUs shall be subrogated to all the rights and obligations of

the alliance.

- General mission, functions and prerogatives of the alliance, as an open stipulation. In

the absence of specific provisions in the internal Statute, the alliance can assume all the

powers and prerogatives which the LGC confers to the LGUs.

- A clear distinction between investment projects and basic social services delivery, as

well as the handling to perform jointly specific local works and services.

- Name, structure, rules and operations of the governing bodies, which shall be

representative of the constituent LGUs. The provisions shall include a clear assignment

of functions and responsibilities, authorities, quorum requirements and voting rules.

- Number of personnel and technical staff, as well as descriptive information on job posts

with particular functions.

- Initial amount of common resources, equities and liabilities, in particular, LGUs

contributions, and real estate and equipment. Also, the requirements in order to pledge

the fulfilment of individual settlements.

- An ‘opening’ clause defining the specific requisites for new LGUs in order to qualify

for membership. A petition by the interested LGU is always required. Also, the opinion

of the member LGUs, the DILG and the COA must be warranted at any time.

- An ‘exit’ clause for the member LGUs and the resolution of their duties and

contributions. No exit of a member LGU shall be authorized if the financial

sustainability of the alliance is jeopardized.

- Events of default and specific provisions for dispute resolution and liquidation of the

alliance.

- Any other relevant information relative to the alliance.

1.6. Individual default, dispute resolution and liquidation of the alliance

The board of directors of the alliance, excluding the defaulting LGU, shall act on default

payments in the following sequential manner:

- They shall address a payment order procedure to the local chief executive of the

defaulting LGU, within thirty (30) days from the observation of non-compliance.

- If the above-mentioned formal claim is attended within the next fifteen (15) days, or if

the defaulting LGU seeks force majeure relief, the procedure shall end without penalty.

In the later event, the board of directors of the alliance, excluding the executives from

the defaulting LGU, shall decide over the outstanding debt.

- If the above-mentioned claim is not fulfilled or no formal explanation is provided, the

board of directors of the alliance, excluding the officers of the defaulting LGU, may

decide by plurality rule to expel the guilty LGU from the alliance. Upon such expulsion,

all obligations, monetary, financial or otherwise, that would have been due and

demandable for the entire term hereof shall immediately due and demandable. In

addition, the Chair of the alliance, acting on behalf of all the member LGUs and the

alliance itself, will have the faculty to take legal actions for damages, or to seek another

form of juridical compensation, to the former member of the alliance, and also without

prejudice to any administrative or criminal penalties that may ensue.

IMPROVING LOCAL FISCAL ADMINISTRATION

Antonio A. Avila Jr.

ADB Consultant

FEBRUARY 2014

i

TABLE OF CONTENTS

Page

List of Table ....................................................................................................................... ii

List of Annexes .................................................................................................................. ii

EXECUTIVE SUMMARY………………………………………………………..……iii

I. INTRODUCTION.................................................................................................... 1

1. LGU PFM Reform Roadmap .......................................................................... 1

II. PROMOTE FINANCIAL VIABILITY AND FISCAL DISCIPLINE IN

ESTABLISHMENT AND OPERATION OF LOCAL ECONOMIC

ENTERPRISES ........................................................................................................ 3

1. LGC Provisions on Local Economic Enterprises (LEEs) ............................... 3

2. Issue/Problems in the Establishment and Operation of LEEs ......................... 4

3. Proposed Amendments to the Local Government Code ................................. 7

III. ESTABLISHING INTERNAL AUDIT IN LGUS ................................................ 8

1. Current Laws and Issuances on Internal Audit ............................................... 8

2. Issues and Problems in the Establishment and Maintenance of Internal Audit

System ......................................................................................................... 9

3. Proposed Amendments to the Local Government Code ............................... 10

IV. REVISITING THE LGU INCOME CLASSIFICATION SYSTEM ................ 12

1. Laws and Issuances on LGU Income Classification ..................................... 12

2. Issues on LGU Income Classification ........................................................... 14

3. Proposed Amendments to the Local Government Code ............................... 15

V. ENHANCING MEASURES ON FISCAL TRANSPARENCY ......................... 17

1. LGC Provision on Fiscal Transparency ........................................................ 17

2. Proposed Amendments to the LGC ............................................................... 17

References:....................................................................................................................... 19

ii

List of Table

Table 1. Results of Operations of LEEs, 2006-2007 .......................................................... 6

Table 2. Comparative Matrix of the Provisions of EO 249 and the Proposed Bil ............ 15

List of Annexes

Annex A. Legislations and Regulations Internal Audit .................................................... 20

Annex B. Draft Income Classification Bill of BLGF ....................................................... 22

iii

EXECUTIVE SUMMARY

Following the comprehensive assessment of the Philippine Public Fiscal Management system

using the Public Expenditure and Financial Accountability PFM Measurement Framework in

2007, the oversight agencies led by the Department of Budget and Management, with the

assistance of the EU project "Support to the Local Government Units for More Effective and

Accountable Public Financial Management”, developed a “localized” PEFA called Public

Financial Management Assessment Tool for LGUs. The PFMAT is created to assess the

elements of the PFM system which include revenue generation, budgeting, accounting,

auditing, cash management, debt management, and public sector reporting on financial

operations.

Based on the outcome of the assessment, an LGU PFM Roadmap was developed. It envisions

"an LGU service delivery system that lowers the cost of doing business, stimulates private

investments, generates employment and income opportunities, improves welfare level for LGU

constituents and accelerates local economic growth” and aims to possess “an open and

transparent LGU PFM System that is stable and sustainable, renders financial compliance,

underpins efficient and effective delivery of services, ensures the highest level of accountability

and provides genuine citizens participation."

To achieve the vision and goal of the LGU Roadmap, its strategy matrix is grouped into four

(4) clusters that collectively intend to: (i) enhance policy and financial discipline; (ii) make

performance count; (iii) ensure availability of relevant and timely financial information to

improve decision-making and increase accountability; and (iv) manage the change process to

sustain reforms. The reform sequence focuses more on technical developments that influence

(support, encourage, discipline, demand) decisions and continuous improvement in LGU PFM.

In addition to the LGU PFM, this paper discusses issues/problems of fiscal administration in

the local level, specifically, on the establishment and operation of local economic enterprises;

establishment and maintenance of internal audit system; income classification system; and,

fiscal transparency.

In sum, this paper recommends to: (i) promote financial viability and fiscal discipline in

establishment of LEEs by defining the nature of LEEs and by having a clear policy guideline

on the operation of economic enterprises and public utilities that would arrest the continuing

losses of LGUs; (ii) establish internal audits in LGUs by excluding internal audit function of

the accountants in the LGC and by creating an internal audit service as a mandatory office

under the local chief executive; (iii) revisit the income classification system and further

harmonize the provisions of EO 249 and the Local Government Code as well as to strengthen

the importance of the LGU income classification system in promoting greater LGU fiscal

responsibility and accountability; and (iv) enhance measure on fiscal transparency.

1

IMPROVING FISCAL ADMINISTRATION

I. INTRODUCTION

In 2007, the government undertook comprehensive assessment of the Philippine PFM system

using the Public Expenditure and Financial Accountability (PEFA) PFM Measurement

Framework to identify the weaknesses, gaps and issues of the present system. Based on the

outcome of the assessment, a National PFM Reforms Roadmap was formulated outlining the

national government's strategies to address the identified problems and strengthen the national

PFM. With adoption by the Commission on Audit (COA), Department of Budget and

Management (DBM), and Department of Finance (DOF) of National PFM Reforms Roadmap,

it was imperative that a similar initiative be undertaken at the LGU level.

With the assistance of the EU project entitled "Support to the Local Government Units (LGUs)

for More Effective and Accountable Public Financial Management”, oversight agencies led by

the Department of Budget and Management developed a “localized” PEFA called Public

Financial Management Assessment Tool (PFMAT) for LGUs to assess the elements of the

PFM system: Revenue Generation, Budgeting, Accounting, Auditing, Cash Management, Debt

Management and Public Sector Reporting on Financial Operations. Based on the assessment

of the current state of the LGU PFM using the PFMAT and validated by LGUs and regional

offices of oversight agencies, a LGU PFM Roadmap was developed containing the vision, goal,

and the proposed reform measures/strategies to address the identified issues and problems.

1. LGU PFM Reform Roadmap1

The vision of the LGU PFM Roadmap is "An LGU service delivery system that lowers the cost

of doing business, stimulates private investments, generates employment and income

opportunities, improves welfare level for LGU constituents and accelerates local economic

growth.” The goal is “An open and transparent LGU PFM System that is stable and sustainable,

renders financial compliance, underpins efficient and effective delivery of services, ensures the

highest level of accountability and provides genuine citizens participation."

To achieve the above-stated goal and vision, the roadmap strategy matrix is grouped into four

(4) clusters that collectively intend to: (a) enhance policy and financial discipline; (b) make

performance count; (c) ensure availability of relevant and timely financial information to

improve decision-making and increase accountability; and (d) manage the change process to

sustain reforms. The reform sequence focuses more on technical developments that influence

(support, encourage, discipline, demand) decisions and continuous improvement in LGU PFM

Cluster 1. Linking Policy Priorities to Budget Planning

The policy agenda under Cluster 1 recognize that the focus of reform must go beyond

the technical aspects of operations, and deal with the difficult issues of mismatch

between policy and resource realities. The mismatch which leads to lack of fiscal

discipline, and consequently, poor service delivery is due to planning being largely

1 Source: Department of Budget and Management, “The Local Government Unit Public Finance Management (LGU PFM)

Reform Roadmap”, Report prepared under the Support to the Local Government Units for More Effective and Accountable

Public Financial Management (lGU PFM 2 Project) funded by the European Union and implemented by the Government of

the Philippines.

2

separated from policy making. Based on feedback from stakeholders, both

policymaking and planning are also weakly linked to budgeting including

implementation.

This reduces budget effectiveness as the use of resources does not fully address

development priorities. If poverty inclusive growth obtained more quickly in line with

Government policy, then more attention has to be paid to objectives to available

resources through improved planning. This requires the introduction of a new planning

paradigm, which is largely based on the identification of develop improved interface

between provincial, city and municipal planning.

To better support the reforms taking place on the ground, OA inter agency teams will

be mobilized to ensure better coordination between OAs and LGUs, and among OAs

and LGUs, and among OAs themselves. The OA regional inter-agency teams will also

ensure consistency in the cascading and rolling out policies, which include guidance

on development of financially self-reliant LEEs and PUs in the LGUs.

The use of the PFMAT and PFMIP will be institutionalized to ensure the LGUs will

continue implementing PFM improvement measures and OAs will obtain information

needed for policy formulation. Implementation of the policy agenda under Cluster 1

will lead to better resource allocation, including revenue and borrowing instruments,

linked to government policy goals.

Cluster 2. Developing Reliable and Predictable Budget

The policy agenda under cluster 2 recognize the inter-relationship of strategic planning

and fiscal policy to operational performance.

Predictability of funding, which depends on the stability of revenue forecast and

collections, and the realism of policy priorities predictability in funding are, however,

diluted when there are no accompanying efforts to improve the efficiency of resource

use, particularly in procurement. Central to the accomplishment of the Cluster 2 policy

agenda is therefore improved revenue generation and expenditure management, which

shall be achieved through a mix of better tools and improved competences of LGUs

officers.

Enhancing procurement compliance through strengthening of capabilities will enable

better use of existing resource, as will the reform in cash management practices.

Increasing the flow budget information will promote further transparency and enable

conditons for stronger accountability of LGUs to their constituents.

The implementation of this policy agenda will achieve the Cluster 2 outcome of

aggregate fiscal discipline.

Cluster 3. Integrating Transparency and Accountability into Financial and

Performance Management

The policy agenda of Cluster 3 recognizes the importance of enabling genuine

participation of civil society in the budget process. This has created demands for

performance monitoring and evaluation and opening up government to citizens through

3

increased civil society involvement and service delivery surveys. This does not mean

that government stops governing, but that is governs in a different way. LGUs do not

give up their power, legal rights and duties to make policy and take decisions. Instead

LGUs introduce new ways to exercise their power in partnership with CSOs. This

brings closer to the government and develops a stronger sense of community that

facilitates more balanced development.

The foregoing requires a new performance paradigm that focuses on citizens, and not

exclusively on internal measures, particularly departmental performance. Crucial,

therefore, to the achievement of Cluster 3 is the harmonization of policies and issuances

on accreditation. This is essential in order to send a clear policy message, and to ensure

that CSOs wishing to participate are legitimate and credible organizations. Increased

advocacy with LGUs on the importance of CSO participation in the budget process is

a key feature of the policy agenda as not all LGUs fully accept the value of citizen’s

participation.

In addition, CSO involvement is often held back by a lack of understanding on how

LGU PFM works. Inviting CSOs to participate is more apparent than real if efforts are

not made to enable genuine participation. The issue is addressed through capacity

building support that may take the form of guidance to CSOs and orientations on LGU

PFM operations.

The implementation of this policy agenda will achieve the Cluster 3 outcome of

integrating transparency and accountability into financial and performance

management

Cluster 4: Holding Managers to Account

The policy agenda of Cluster 4 recognizes the importance of developing financial

management systems to improve the flow of timely and reliable financial data, coupled

with team building efforts to ensure better management of the change process.

Equally importance is the establishment of effective internal controls and internal

audit service. These are essential if the risks of mismanagement or misuse of public

funds, fraud or error or unsatisfactory accounting records are to be minimized. An

efficient IAS should be able to prevent and take action against irregularities, and

recover any amount lost as a result. While no system of controls can be absolute

guarantee against incompetence and wrongdoing, the aim is to provide reasonable

assurance that improprieties will not occur. And if they do, they will be revealed and

appropriate action taken.

II. PROMOTE FINANCIAL VIABILITY AND FISCAL DISCIPLINE IN

ESTABLISHMENT AND OPERATION OF LOCAL ECONOMIC

ENTERPRISES

1. LGC Provisions on Local Economic Enterprises (LEEs)

Under PD 231, otherwise known as the Local Tax Code for Provinces, Cities, Municipalities

and Barrios, issued on June 28, 1973, LGUs were authorized to impose market fees, slaughter

fees, public utilities charges, tuition fees, toll fees, and service fees. Specifically, Sec. 32 of

4

PD 231 provided LGUs the power to collect charges for services rendered in connection with

the operation of public utilities owned, operated, and maintained by them, at the rates to be

fixed by the local board or council concerned. The maximum annual net profit that may be

derived therefrom shall not be in excess of ten per cent of the capital invested in the public

utility. In addition, the yearly financial statements covering the utility shall be audited by the

provincial or city auditor concerned and should the amount of net profit of the public utility be

found to be in excess of the percentage herein fixed, the charges thereof shall be accordingly

adjusted and the excess shall be spent only for the improvement of the public utility.

These common revenue-raising powers of LGUs were carried substantially in the Local

Government Code of 1991 but stated in more general terms as can be observed in Sec. 153 on

service fees and charges, Sec. 154 on public utility charges and Sec. 155 on toll fees and

charges. It is to be emphasized that these powers of LGUs are different from the proprietary

power of LGUs as “municipal corporations.” Sec. 15 of the LGC states that LGU can exercise

powers as a political subdivision of the national government and as a corporate entity

representing the inhabitants of its territory. Moreover, Sec. 18 provided LGUs the power to

generate and apply resources, such as among others, to acquire, develop, lease, encumber,

alienate, or otherwise dispose of real or personal property held by them in their proprietary

capacity and to apply their resources and assets for productive, developmental, or welfare

purposes, in the exercise or furtherance of their governmental or proprietary powers and

functions and thereby ensure their development into self-reliant communities and active

participants in the attainment of national goals. Sec. 22(c) of the LGC and Art. 47(b) of its

IRR state that LGUs shall enjoy full autonomy in the exercise of their proprietary functions

and in the management of their economic enterprises, subject to the limitations provided in the

Code and other applicable laws.

Under Sec. 313 local government units are mandated to maintain special accounts in the general

fund for public utilities and other economic enterprises. In addition, Sec. 313(c) provides that

profits or income derived from the operation of public utilities and other economic enterprises,

after deduction for the cost of improvement, repair and other related expenses of the public

utility or economic enterprise concerned, shall first be applied for the return of the advances or

loans made therefor. Any excess shall form part of the general fund of the local government

unit concerned. Lastly, Sec. 325(a) states that the appropriations for salaries, wages,

representation and transportation allowances of officials and employees of the public utilities

and economic enterprises owned, operated, and maintained by the local government unit

concerned shall not be included in the annual budget or in the computation of the maximum

amount for personal services. The appropriations for the personal services of such economic

enterprises shall be charged to their respective budgets;

2. Issue/Problems in the Establishment and Operation of LEEs

Economic enterprises are businesses owned by local governments that provide services and

typically generate revenue for local communities. Local governments have long operated

public utilities and public facilities such as ports, parking lots, waterworks, etc. Many are now

entering fields traditionally dominated by private companies. This is motivated in part by

political resistance to tax increases and the need to raise revenues, as well as public pressure to

create jobs as the economy has faltered.

Need to Define the Nature of Local Economic Enterprise (LEE). The Local Government Code

of 1991 and its implementing rules and regulations do not provide specifically a definition of

5

local economic enterprise. But the terms “public utility” and “economic enterprise” can be

found in several provisions of the LGC and its IRR. Moreover, the NGAS Manual implicitly

defines the term by way of enumerating the various types of public utilities and economic

enterprises that LGUs operate and assigning each one a sub-code number (Section 108). The

Updated Budget Operations Manual or UBOM (DBM 2005) provides an explicit, if still

ambiguous, definition of the term “economic enterprise.” The UBOM says economic

enterprises are “income-generating establishments created for the purpose of improving

production & delivery of basic goods and services for a specified market or client group” while

public utilities are “revenue-raising undertakings created for the purpose of providing a basic

need or service to the general public which otherwise cannot be provided adequately by the

private sector” (p. 188, FAQS-A).

Several studies (e.g., Pardo and Zipagan 2008) identified the following as local economic

enterprises (LEEs): public markets, slaughterhouses, hospitals, public cemeteries, parking

areas, sports, recreational and cultural facilities, public utilities such as water and power supply

and distribution and telecommunications, garbage collection and disposal, and public transport

and terminal services, among others. The traditional economic enterprises that can be found

ubiquitously in almost all cities and municipalities nationwide are public markets and

slaughterhouses. On the other hand, waterworks, power supply distribution and

telecommunications are considered as public utilities. The other economic enterprises are

considered as public utilities. As can be deduced from the enumeration, all the enterprises

mentioned have two common characteristics i.e. delivery of basic goods or services and

revenue raising entities which are in line with the definition of economic enterprise/public

utility in the UBOM.

As pointed in the study of Manasan and Castel (2010), there is a need to have an unambiguous

definition of the term “economic enterprise” which is central to the formulation of a clear policy

framework for the continued operation of these entities. The study suggested to adopt the

definition of Jones (1982) and the World Bank (1995) as follows: LEEs are local government

owned economic entities that generate the bulk of their revenues from selling goods and

services. While this definition equivocably describes such economic entities, it is still

important to distinguish economic enterprise from public utilities.

A public utility is an organization that maintains the infrastructure for a public service. Public

utilities are subject to forms of public control because they often considered as government

monopolies.2 Other economic enterprises, on the other hand, are market-oriented. A classic

comparison is the public market and shopping mall wherein the latter is driven by market

forces. It can also be argued that public utilities take the form of governmental function while

economic enterprise is the exercise of the proprietary function or corporate power of LGUs.

The implication of distinction is that a policy framework for economic enterprises and another

for public utilities should therefore be formulated separately.

In the formulation of policy framework, it is recommended that the following definitions be

adopted:

a. Local economic enterprise is a local government owned economic entity that generates

the bulk of its revenues from selling goods and services.

2 Source: http://encyclopedia.thefreedictionary.com/Public+Utilities

http://encyclopedia.thefreedictionary.com/Public+Utilities

6

b. Public utility is a local government entity that provides basic public service to the

public.

Continuing losses of LEEs mean higher subsidies. Earlier studies (e.g., Pardo and Zipagan

2008, Manasan and Castel 2010) have pointed out that although LEEs are meant to be self-

sustaining, if not revenue-generating units, many of them actually incur losses on a continuing

basis. Manasan and Castel (2010) said that eighty-nine percent of provinces, 58% of cities and

56% of municipalities posted net losses on their aggregate LEE operations in 2006. In 2007,

the net result of aggregate LEE operations was negative in 77% of provinces, 63% of cities and

56% of municipalities. In the aggregate, the net result of operations of LEEs of all LGUs

combined was negative in 2006-2007 (Table 1).

Table 1. Results of Operations of LEEs, 2006-2007

Source: Manasan and Castel (2010)

The aggregate net loss from LEE operations was PhP 0.9 billion – PhP 1.1 billion for provinces,

PhP 9.6 billion - PhP 10.8 billion for cities and PhP 1.3 billion - PhP 1.5 billion for

municipalities in 2006-2007. The aggregate net loss for all LGUs ranges from P11.8 billion-

PhP 13.2 billion. See Table 1.

Some sectors attribute the huge losses incurred by LEEs to inefficiency in management, lack

of qualified personnel, lack of political will to apply the prevailing market rates for some

services or goods resulting to unfair competition with the private sector, unrealistic feasibility

studies, if any, substandard or poor quality of services or goods, etc.

A policy guideline on the operation of economic enterprises and public utilities would arrest

the continuing losses of LGUs and, eventually, would lead to more profitable undertakings

which will mean more resources can be channeled to finance the delivery of basic services.

3. Negative Impact of the LGC provision on personal services spending of LEEs

Table 3. Results of operation of LEEs, 2006-2008

2006 2007 2008

actual actual projected

Provinces

% of LEEs posting net loss 89 77 75

Net profit (loss) of LEEs in the aggregate (in mill pesos) (931) (1,071) (1,384)

Gross receipts as % of total expd of lossing LEEs 30 33 33

Gross receipts as % of total expd of profitable LEEs 272 113 248

Cities


Net profit (loss) of LEEs in the aggregate (in mill pesos) (9,582) (10,881) (13,068)



Municipalities


Net profit (loss) of LEEs in the aggregate (in mill pesos) (1,265) (1,482) (1,380)



Source of basic data: LEE survey

7

Sec. 325(a) of the LGC also provides that the allowances of officials and employees of public

utilities and economic enterprises owned, operated and maintained by the local government

unit shall not be included in the annual budget or in the computation of the maximum amount

for personal services. The appropriations for the personal services of such economic

enterprises shall be charged to their respective budgets.

The exemption of personal services expenditures of LEEs computation of the PS cap has given

rise to perverse incentives. Manasan and Castel (2010) observed that economic enterprises

were oftentimes used as the vehicle for charging casual employees who are utilized elsewhere

in the LGU system so as to circumvent the 45%-55% limitations on personal services (PS)

expenditures of LGUs. On the other hand, part of the cost of LEE operation and management

is sometimes charged under other offices in the LGU. Overall, the less than business-like

approach to local enterprise management has resulted in large arrearages and low collection

efficiency.

To resolve this perverse effect, it is recommended that the favorable treatment given to the

personal services spending of LEEs as provided under Section 325 (a) be retained but that its

application be limited to LEEs which are created by ordinance with articulated policy on cost

recovery and strict adherence in the accounting of revenues and expenditures.

4. Proposed Amendments to the Local Government Code

1. Insert in Sec. 131 (Definition of Terms), Chapter 1, Article One, Book II of the

LGC the following definition:

a. Local economic enterprise is a local government owned economic entity

that generates the bulk of its revenues from selling goods and services.

b. Public utility is a local government entity that provides basic public service

to the public.

2. Amend Sec. 325(a) by stating the public utilities and economic enterprises have

been created by ordinance with articulated policy on cost recovery and strict

adherence in the accounting of revenues and expenditures in accordance and the

guidelines to be issued by the Department Of Budget And Management (DBM);

viz:

“SEC. 325. General Limitations. - The use of the provincial, city, and municipal

funds shall be subject to the following limitations:

(a) The total appropriations, whether annual or supplemental, for personal services

of a local government unit for one (1) fiscal year shall not exceed forty-five percent

(45%) in the case of first to third class provinces, cities, and municipalities, and

fifty-five percent (55%) in the case of fourth class or lower, of the total annual

income from regular sources realized in the next preceding fiscal year. The

appropriations for salaries, wages, representation and transportation allowances of

officials and employees of the public utilities and economic enterprises owned,

operated, and maintained by the local government unit concerned shall not be

included in the annual budget or in the computation of the maximum amount for

personal services, PROVIDED, HOWEVER THE SAID PUBLIC UTILITIES

8

AND ECONOMIC ENTERPRISES HAVE BEEN CREATED BY ORDINANCE

WITH ARTICULATED POLICY ON COST RECOVERY AND STRICT

ADHERENCE IN THE ACCOUNTING OF RENUES AND EXPENDITURES.

The appropriations for the personal services of such economic enterprises shall be

charged to their respective budgets IN ACCORDANCE WITH THE GUIDELINES

TO BE ISSUED BY THE DEPARTMENT OF BUDGET AND MANAGEMENT

(DBM);”

III. ESTABLISHING INTERNAL AUDIT IN LGUS

With the assistance of the EU project entitled "Support to the Local Government Units (LGUs)

for More Effective and Accountable Public Financial Management”, the Department of Budget

and Management assessed the elements of the PFM system: Revenue Generation, Budgeting,

Accounting, Auditing, Cash Management, Debt Management and Public Sector Reporting on

Financial Operations using the “localized” PEFA called Public Financial Management

Assessment Tool (PFMAT). The results of the showed that internal and external audit received

the lowest rating. The very low score of 0.54 in Internal Audit is due to the fact that most LGUs

have not created their Internal Audit Service (IAS) Units. Consequently, there are no internal

audit reports for management to act upon to improve the operations of the LGU. According to

stakeholders, IAS not established or not operational due to budget (PS) limitations, and lack of

uniform policy and localized IAS Manual.

1. Current Laws and Issuances on Internal Audit

A number of legislative and executive issuances have been made to mainstream both internal

controls and internal audit in the public sector in the Philippines.3 The Department of Budget

and Management (DBM) issued in its Letter Circular No. 2008-8, dated October 23, 2008, the

National Guidelines on Internal Control Systems (NGICS) compelling every government

agency, including the local government units (LGU), to put into operation the National

Guidelines for Internal Control Systems (NGICS). The said circular letter underscores that the

direct responsibility for installing, implementing, and monitoring a sound system of internal

control rests with the chief or head of each government agency or instrumentality

This is the DBM’s compliance to the provisions of Administrative Order (AO) No. 119 dated

March 29, 1989 and Memorandum Order (MO) No. 277 dated January 19, 1990 for it to

promulgate the necessary rules, regulations or circulars for the strengthening of the internal

control system (ICS) of government agencies.

AO No. 278 (April 28, 1992) mandates the head of government agencies to organize the

internal audit services as an integral part of the organization. It defines the scope of internal

audit service in the government as follows:

Ascertaining the reliability and integrity of financial and operational information

and means used to identify measures, classify, and report such information;

Ascertaining the extent of compliance and reviewing the system established to

ensure compliance with government policies, plans and procedures, laws and

regulations which could have a significant impact on operations;

3 See Annex A for the list of legislations and regulations on internal audit.

9

Ascertaining the extent to which the assets and other resources of the institutions

are accounted for and safeguarded from losses of all kinds;

Reviewing and evaluating the soundness, adequacy and application of accounting,

financial and other operating controls and promoting the most effective control at

reasonable cost;

Reviewing operations or programs to ascertain whether or not results are consistent

with established objectives and goals and whether or not such programs are being

carried out as planned;

Evaluating the quality of performance of groups/individuals in carrying out their

assigned responsibilities; and

Recommending corrective actions on operational deficiencies observed.

For the LGUs, the Local Government Code of 1991 (Republic Act No. 7160) serves as the

primary legal basis in ensuring that ICS is in place. One of the fundamental principles in local

fiscal administration as provided under Sec. 305(l) of the said Code states that the fiscal

responsibility shall be shared by all those exercising authority over the financial affairs,

transactions, and operations of the local government units. Sec. 474(b)(1), Article Four, Title

Five, Book III of the LGC mandates the accountant to install and maintain an internal audit

system in the local government unit concerned.

2. Issues and Problems in the Establishment and Maintenance of Internal Audit

System

An inventory and analysis of the legal framework on ICS conducted by Mendoza (2009) reveal

following issues on ICS and internal audit:

1. Lack of guidelines in the organization and staffing for both internal control and internal

audit in the LGUs.

DBM Circular Letter No. 2008-5, issued to provide guidelines for national government

agencies and corporations only. While the national government agencies and government

corporations have this circular letter as guideline, there is none of similar coverage and subject

matter that pertains to LGUs. Thus, it is necessary that a guideline similar to DBM Circular

Letter No. 2008-5 be issued for the purpose of LGUs. Such issuance should consider the

provisions of the NGICS.

2. Absence of operational guidelines for the conduct of internal audit.

The NGICS emphasizes internal audit as an important component of internal control.

However, there is no document to serve as reference in the conduct of the same, more

particularly in the LGUs. Such guidelines should detail the standards to be adopted and

followed, the internal audit approach, and other audit methodologies.

3. Undefined Linkage of ICS with other Government Systems

10

The NGICS clarifies that ICS is not a system in isolation. However, its linkage with other

systems or schemes in the government is not well-defined. This disjoint can create a constraint

in the overall implementation of the NGICS.

4. Conflict of NGICS Provisions with the Local Government Code

The organizational requirements of the NGICS specifically pertain to internal control

monitoring and internal audit. If the LGU has to establish these organizational units, exceeding

the limitation on personal services is always a possibility. Thus, it is possible that the funding

requirements may not be adequately satisfied despite the rationality and acceptability of the

organizational requirements.

In addition, the creation of a separate internal audit unit is contrary to the provision of the Local

Government Code, specifically Sec. 474(b)(1), Article Four, Title Five, Book III of the LGC

mandating the accountant to install and maintain an internal audit system in the local

government unit concerned


1. Delete the internal audit function of the accountant in the LGC as follows:

“Article Four. - The Accountant

SEC. 474. Qualifications, Powers and Duties. - (a) No person shall be appointed

accountant unless he is a citizen of the Philippines, a resident of the local government

unit concerned, of good moral character, and a certified public accountant. He must

have acquired experience in the treasury or accounting service for at least five (5) years

in the case of the provincial or city accountant, and three (3) years in the case of the

municipal accountant. The appointment of an accountant is mandatory for the

provincial, city and municipal governments.

(b) The accountant shall take charge of [both] the accounting [and internal audit]

services of the local government unit concerned and shall:

[(1) Install and maintain an internal audit system in the local government unit

concerned;]

[(2)] (1) Prepare and submit financial statements to the governor or mayor, as the case

may be, and to the sanggunian concerned;

[(3)] (2) Apprise the sanggunian and other local government officials on the financial

condition and operations of the local government unit concerned;

[(4)] (3) Certify to the availability of budgetary allotment to which expenditures and

obligations may be properly charged;

[(5)] (4) Review supporting documents before preparation of vouchers to determine

completeness of requirements;

11

[(6)] (5) Prepare statements of cash advances, liquidation, salaries, allowances,

reimbursements and remittances pertaining to the local government unit;

[(7)] (6) Prepare statements of journal vouchers and liquidation of the same and other

adjustments related thereto;

[(8)] (7) Post individual disbursements to the subsidiary ledger and index cards;

[(9)] (8) Maintain individual ledgers for officials and employees of the local

government unit pertaining to payrolls and deductions;

[(10)] (9) Record and post in index cards details of purchased furniture, fixtures, and

equipment, including disposal thereof, if any;

[(11)] (10) Account for all issued requests for obligations and maintain and keep all

records and reports related thereto;

[(12)] (11) Prepare journals and the analysis of obligations and maintain and keep all

records and reports related thereto; and

[(13)] (12) Exercise such other powers and perform such other duties and functions as

may be provided by law or ordinance.

2. Based on the internal audit functions enumerated in DBM Circular Letter 2008-5,

April 14, 2008 with slight modifications, amend the LGC by inserting in Article

Four, Title Five, Book III, the qualifications, powers and functions of internal

auditor as follows:

“Article Twenty One – Internal Auditor

Sec. ____. Qualifications, Powers and Functions. - - (a) No person shall be appointed

internal auditor unless he is a citizen of the Philippines, of good moral character, a

holder of a college degree preferably in accounting, economics, public administration

or any related course from a recognized college or university, and a first grade civil

service eligible or its equivalent. He must have acquired experience in government or

private internal auditing or in any related field for at least five (5) years in the case of

the provincial or city internal auditor, and at least three (3) years in the case of the

municipal internal auditor. The appointment of an internal auditor shall be mandatory

for the provincial, city, and first class municipal governments.

(b) The internal auditor shall take charge of the internal audit services and shall:

i. Establish an internal audit system based on the National Guidelines on Internal

Control Systems (NGICS), similar issuances and guidelines to be issued by the

Department of Budget and Management;

ii. Advise the Local Chief Executive (LCE) on all matters relating to management

control and operations audits;

12

iii. Conduct management and operations performance audit of the LGU’s

functions, projects, activities with outputs, and determine the degree of

compliance with their mandate, policies, government regulations, established

objectives, systems and procedures/processes, and contractual obligations

including the review of operations or programs to ascertain whether results are

consistent with established objectives and goals and whether the operations or

programs are being carried out as planned;

iv. Review and appraise systems and procedures, organizational structures, asset

management practices, financial and management records, reports and performance

standards of the LGU departments/offices/units covered;

v. Analyze and evaluate management deficiencies and assist the LCE by

recommending realistic courses of action; and

vi. Perform such other related duties and responsibilities as may be assigned or

delegated by the LCE or as may be prescribed by law.

4. In the guidelines to be issued by the Department of Budget and Management, the

internal auditor shall be detached from all functions of routine operating

character, such as the following:

i. Pre-audit of vouchers and counter-signature of checks;

ii. Inspection of deliveries, although the internal auditor may, as part of his

examination observe inspection;

iii. Preparation of treasury and bank reconciliation statements;

iv. Development and installation of systems and procedures, however, in

exceptional cases, the internal auditor may assist by giving suggestions

preferably during the development stage;

v. Taking physical inventories, however, the internal auditor may review the plans

in advance and observe and test-check the accuracy of counting, costing, and

summarizing;

vi. Maintaining property records; and

vii. All other activities related to operations

IV. REVISITING THE LGU INCOME CLASSIFICATION SYSTEM

1. Laws and Issuances on LGU Income Classification

Republic Act (RA) No. 4477 entitled “An Act Providing For New Classification Of Provinces

And Cities And Fixing The Rates Of Salaries Of The Officials Thereof And For Other

Purposes” divided provinces and cities into seven classes according to their average income

during the last four fiscal years. The Secretary of Finance was authorized to classify all

municipalities every four fiscal years pursuant to Section 4 of Republic Act No. 2368 and

subclassify all first class municipalities under Section 2 of Republic Act No. 4358. Salaries of

provincial, city and municipal officials were pegged depending on their income classification.

These laws also provided for a general limitation that could be spent for salaries and wages.

Lower income class local governments were allowed to spend a higher proportion of their

regular income for salaries and wages.

13

Presidential Decree (PD) 465, issued on July 1, 1974, amended the above-cited laws to provide

for a more equitable system of classifying provinces, cities and municipalities commensurate

with their respective revenue-raising capacities. PD 465 retained the provisions pegging the

salaries of LGU officials and the limitation on the amount that could be spend for personal

services to the income classification of the LGU. In addition, tax ceilings or the maximum

rates of taxes that LGUs can impose were determined based on their income classification.

Executive Order 249, issued on July 25, 1987, revised the basis for and use of the income

classification of LGUs. Under Sections 1 and 2 of EO 249, provinces, cities and municipalities

except Manila and Quezon City which shall remain as special class cities, were divided into

six (6) main classes according to the average annual income that they actually realized during

the last four calendar years immediately preceding the general classification. The term “annual

income” shall refer to revenues and receipts realized by provinces, cities and municipalities

from regular sources of the local general and infrastructure funds including the internal revenue

and specific tax allotments provided for in PDs 144 and 436, both as amended, but exclusive

of non-recurring receipts, such as other national aids, grants, financial assistance, loan

proceeds, sales of fixed assets, and similar others [Sec. 4(a)].

Under Sec. 9 EO 249, the Secretary of Finance is given the “authority to review the income

ranges at least once every 4 years” after the implementation of the EO, and to “recommend

such appropriate changes or revisions to the proper authority in order that the income

classification of local government units may continue to conform with the prevailing

economic conditions and the overall financial status of the local governments.”

Sec. 5 of EO 249 provides that the income classification of provinces, cities and municipalities

shall, among other purposes, serve as basis for:

a. The fixing of the maximum tax ceilings imposable by the local governments;

b. The determination of administrative and statutory aids, financial grants, and other

forms of assistance to local governments;

c. The establishment of the salary scales and rates of allowances, per diems, and other

emoluments that local government officials and personnel may be entitled to;

d. The implementation of personnel policies on promotions, transfers, details or

secondment, and related matters at the local government levels;

e. The formulation and execution of local government budget policies; and

f. The determination of the financial capability of local government units to undertake

developmental programs and priority projects.

In addition, EO 249 provided that the total annual appropriations for salaries and wages of

provincial, city and municipal officials and employees for one calendar year shall not exceed

forty-five per cent (45%), in the case of all first and second class provinces, cities and

municipalities, and fifty-five (55%), in the case of those lower than second class, of the total

annual income actually realized from regular sources during the next preceding calendar year.

The landmark Local Government Code of 19971, however, did not specifically repeal EO 249

which was considered as law because it was issued by the President by virtue of her powers

under the revolutionary government. Only certain sections of EO 249 were deemed amended

or modified accordingly. Because the administrative authority of the Secretary of Finance to

issue rules and regulations fixing the new classifications of provinces, cities and municipalities

was not repealed or modified by RA 7160, DOF issued Department Order No. 24-97 on March

26, 1997 prescribing new income brackets for the reclassification of provinces, cities and

14

municipalities. Then, Department Order No. No. 32-01, dated November 20, 2001,

Department Order No. 20-05, dated July 29, 2005, and Department Order No. 23-08, dated

July 29, 2008 further revised the income brackets for purposes of classifying the income class

of LGUs. The revised income brackets on the average were adjusted upward to net out the

impact of IRA increases on the income of LGUs for the past four (4) years after every

reclassification. In effect, the changes in income bracket were anchored on the own-sourced

revenue efforts of LGUs, thus, promoting greater local fiscal sustainability.

2. Issues on LGU Income Classification

The main issue is the need to harmonize in unambiguous terms the provisions of EO 249 and

the Local Government Code as well as to strengthen the importance of the LGU income

classification system in promoting greater LGU fiscal responsibility and accountability.

1. Need to Clarify the Administrative Authority of the Secretary of Finance to Revise

Income Ranges

Sec. 9 of EO 249 authorized the Secretary of Finance to review the income ranges provided in

Sections 1 and 2 once every four years and recommend such appropriate changes or

revisions to the proper authority in order that the income classification of local government

units may continue to conform with prevailing economic conditions and the overall financial

status of the local governments. This provision clearly provides that the action of the Secretary

of Finance in revising the income brackets is merely recommendatory subject to the approval

of the “proper authority” which presumably is the President of the Philippines. It appears,

therefore, that the four (4) revisions of the income brackets pursuant to DOF Department Order

Nos. 24-97, 32-01, 20-05, and 23-08 can be considered as not valid since the Secretary of

Finance has no authority to mandate such changes. After the 2008 general income

reclassification of LGUs, the next schedule of revision is supposed to happen in 2012. It seems,

however, that the Department of Finance is now reluctant to issue revisions on income ranges

because of the unclear provision of EO 249.

2. Provisions of EO 249 Deemed Amended/Repealed by the LGC

The following provisions of EO 249 were deemed amended, modified or repealed accordingly

by the passage of the Local Government Code of 1991 (RA 7160):

a. Sec. 5(a) on the use of income classification in fixing the maximum tax ceilings

imposable by the local governments;

b. Sec. 5(d) on the use of income classification in the implementation of personnel

policies on promotions, transfers, details or secondment, and related matters at

the local government levels;

c. Sec. 5(e) on use of income classification in the formulation and execution of

local government budget policies;

d. Sec. 6 on the maximum amount expendable for salaries and wages; and

e. Sec. 8 on maximum rates of local taxes;

There is, however, a need to expressly repeal or modify the above provisions of EO 249.

3. On the Objectives and Uses of the Income Classification System

15

According to a study prepared under ADB TA 4556, the present income classification

of provinces, cities and municipalities using average annual total revenues needs to be

strengthened to promote greater LGU fiscal responsibility and accountability. The series of

income reclassification and revision of income bracket implemented by the DOF were

anchored on the LGUs' own snuffed revenue efforts in order to promote greater local fiscal

sustainability. The intention is to provide an incentive system that gives premium to LGUs

that generate more local revenues. In addition, fiscal sustainability means the ability of LGUs

to finance basic services to their constituents. This could be indicated by a rising per capita

income from local sources in real terms. The BLGF/DOF can perhaps formulate a mechanism

how to incorporate the effect of changes in per capita income over time in the revision of the

income brackets.

One of the uses of income classification under Sec. 5(c) is the establishment of the salary scales

and rates of allowances, per diems, and other emoluments that local government officials and

personnel may be entitled to. To strengthen LGU fiscal discipline, such provision should be

linked with Republic Act No. 6758 entitled “An Act Prescribing A Revised Compensation And

Position Classification System In The Government And For Other Purposes” enacted on

August 21, 1989. Specifically, Section 10 law provides that he rates of pay in LGUs shall be

determined on the basis of the class and financial capability of each LGU:

For Provinces/Cities For Municipalities

Special Cities 100%

1st Class 100% 90%

2nd Class 95% 85%

3rd Class 90% 80%

4th Class 85% 75%

5th Class 80% 70%

6th Class 75% 65%

4. On the Frequency of General Income Reclassification

Sec. 3 of EO mandates the Secretary of Finance to undertake a general income reclassification

of provinces, cities and municipalities once in every four (4) years. However, it would be more

realistic and meaningful if the general income reclassification will be done once every three

(3) years to coincide with the 3-year term of local officials.


The Bureau of Local Government Finance (BLGF) of the Department of Finance has prepared

a draft bill to address the issues on LGU income classification (see Annex B). The table

hereunder summarizes the provisions of EO 249 and the salient features of the proposed bill

Table 2. Comparative Matrix of the Provisions of EO 249 and the Proposed Bill

FEATURE EO 249 PROPOSAL

1. Legal Environment Pre-Ra 7160- Local

Government Code 1991

* Repeal EO 249 (Sec. 5,6,7 &

8 already superseded by RA

7160

*No amendments to RA 7160

2. Authority of the Secretary

of Finance

Recommendatory to the proper

authority-Section 9

Express authority/mandate to

set income ranges and to

16

FEATURE EO 249 PROPOSAL

undertake regular LGU income

reclassification Section 5

3. Number of Income

Classes

Six (6) – Section 1 & 2 Section(6)-Section 4;

Consistent with RA 7160

4. Coverage of Re-

classification All provinces, cities and

municipalities, excluding

special class cities (Manila &

Quezon City)

All provinces, cities and

municipalities, including

special class cities

5. Income ranges Income ceilings and floors for

each income class in each level

are set

-Section 1 and 2

Income ranges to be

determined and approved by

the Secretary of finance-

Section 5

6. Period General

Reclassification *Every 4 years-Section 3

*Years specified as a Calendar

Years

*Every 3 years; consistent with

term of local officials-Section

6

*Years specified as a Fiscal

Year per Sec.353 of Ra 7160

7. Uses of Income

Classification

Section 5 (A),(C)(D), and €

superseded by RA 7160

Adopts only Section 5 (B) and

(F) of EO 249-Section 7;

consistent with RA 7160

8. Definition of Terms ‘Annual Income’ and Average

Annual Income’

Revised EO 249’s definition of

‘Annual Regular Income to

include recurring income

accruing to the general fund

9. Data to be used COA audited report DOF-BLGF’s Statement of

Receipts and Expenditures

(SRE); per DOF Order No. 08-

2011

10. Amendment to existing

laws

PD 465 (1974) EO 249

11. Adjustments due to

changes in Income

Class

Special Provisions-Section 7 Transitory guidelines on

Personal Services Limitations,

consistent with RA 7160-

Section 11

12. IRR Secretary of Finance-Section

10

Secretary of Finance (3

months)-Section 10

The above draft bill of the BLGF is recommended with the following modifications:

1. The draft bill should incorporated as part of the Local Government Code to ensure that

the income classification system is synchronized and harmonized with other provisions

of the Code;

2. For clarity as well as to avoid confusion in interpretation, the income brackets set in

Department Order No. 23-08, dated July 29, 2008 should be updated using the increase

in IRA from 2008 to 2014 then included in the bill; and

3. The establishment of the salary scales and rates of allowances, per diems, and other

emoluments that local government officials and personnel may be entitled as one of the

uses of income classification should be indicated by inserting it in Sec. 7 of the draft

bill.

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V. ENHANCING MEASURES ON FISCAL TRANSPARENCY

Transparency is widely recognized as a core principle of good governance. And transparency

means sharing information and acting in an open manner. Transparent systems have clear

procedures for public decision-making and open channels of communication between

stakeholders and officials, and make a wide range of information available. Free access to

information plays an important role in promoting transparency. Information, however, must be

timely, relevant, accurate and complete for it to be used effectively.

1. LGC Provision on Fiscal Transparency

Sec. 352 of the LGC provides that Local treasurers, accountants, budget officers and other

accountable officers shall, within thirty (30) days from the end of each fiscal year, post in at

least three (3) publicly accessible and conspicuous places in the local government unit a

summary of all revenues collected and funds received including the appropriations and

disbursements of such funds during the preceding fiscal. Pursuant to this LGC provision as

well as that of the procurement law (RA 9184), DILG issued Memorandum Circular No. 2010-

83 directing LGUs to post the following documents and transactions in conspicuous places

1. ž Annual Budget of the current calendar year

2. ž Quarterly Statement of Cash Flows

3. ž Statement of Receipts and Expenditures of the previous calendar year

4. ž Trust Fund (PDAF) Utilization

5. ž Special Education Fund Utilization

6. ž 20% Component of the Internal revenue Allotment (IRA) Utilization

7. ž Gender and Development Fund Utilization

8. ž Statement of Debt Services

9. ž Annual Procurement Plan or Procurement list

10. ž Items to Bid

11. ž Bid Results on Civil Works, and Goods and Services

12. ž Abstract of Bids as Calculated

2. Proposed Amendments to the LGC

Consolidate HB Nos. 19 and 186 of Rep. Leni Robredo and Rep. Winnie' Castelo, respectively

by amending Sec. 352 as follows:

“Sec. 352. Posting of the Summary of Income, [and] Expenditures AND OTHER

INFORMATION. GOVERNORS, MAYORS, VICE MAYORS, [L]local treasurers,

accountants, budget officers and other accountable officers shall, within thirty (30) days from

the end of each fiscal year, post in at least three (3) publicly accessible and conspicuous places

in the local government unit, IN PRINT OR MEDIA, AND IN THEIR WEBSITE [a summary

of all revenues collected and funds received including the appropriations and disbursements of

such funds during the preceding fiscal year] THE FOLLOWING INFORMATION:

1. ANNUAL BUDGET

2. QUARTERLY STATEMENT OF CASH FLOWS

3. STATEMENT OF RECEIPTS AND EXPENDITURES

4. TRUST FUND (PDAF) UTILIZATION

18

5. SPECIAL EDUCATION FUND UTILIZATION

6. 20% COMPONENT OF THE IRA UTILIZATION

7. GENDER AND DEVELOPMENT FUND UTILIZATION

8. STATEMENT OF DEBT SERVICE

9. ANNUAL PROCUREMENT PLAN OR PROCUREMENT LIST

10. ITEMS TO BID

11. BID RESULTS ON CIVIL WORKS' GOODS AND SERVICES

12. ABSTRACT OF BIDS CALCULATED”

19

REFERENCES

Manasan, Rosario G. and Cynthia G. Castel. 2010. “Improving the Financial Management of

Local Economic Enterprises.” PIDS Discussion Paper Series 2010-25. October 2010.

Mendoza, Rufo R. 2009. “Internal Control System Roll-Out for Local Government Units:

Recommended Implementation Strategies.” Report submitted to EU Technical

Assistance to the Health Sector Policy Support Programme in the Philippines (EC-TA

HSPSP).

Pardo, Erlito and Romulo Zipagan. 2008. “Study on the Corporate Powers of Local

Government Units.” Report submitted to the Department of Interior and Local

Government and the Asian Development Bank under ADB Technical Assistance 4778

20

Annex A. Legislations and Regulations Internal Audit

Local Government Code of 1991 (RA 7160)

In the Local Government Code of 1991, Book III, Section 474, the following is stated with regard to the Provincial Accountant:

“The accountant shall take charge of both the accounting and internal audit services of the local government unit concerned and shall:

(1) Install and maintain an internal audit system in the local government unit concerned;”

General/National (also applicable to LGUs):

No. Date Title Subject

Republic Act No. 3456 16 June 1962 Internal Audit Act of 1962 States that IAS’ must be set up in all government entities; outlines the

main goal, the independence of the IAS, the rank of the IAS chief and the

responsibilities of COA circulate and enforce IA policies, rules and

regulations.

Republic Act No. 4177 26 March 1965 Act to amend Internal Audit Act of 1962 Amends the Internal Audit Act of 1962.

Presidential Decree No.

898

3 March 1976 Providing for the Restructuring of the

Commission of Audit

Instructs that a sound system of internal control must be installed,

implemented and monitored.

COA Circular 77-48 31 January 1977 Basic Guidelines on Internal Control Provides basic guidelines on the installation of an adequate internal

control system, incl. recommending the creation of an Internal Control

Unit.

Presidential Decree No.

1445

11 June 1978 Ordaining and instituting a Government

Auditing Code of the Philippines

Specifies COA’s role and responsibilities in detail, incl. (i) prescribing

the chart of accounts; (ii) issuing accounting rules and regulations

whenever reporting requirements of the Budget Commission pursuant to

a budget law affect accounting functions; (iii) regulating requirement for,

and submission of accounting reports; (iv) releasing claims in favour of

government agencies; (v) authorising funds transfers; (vi) approving

property sales; and (vii) certifying funds availability. Deals with internal

control, incl. definition, but not internal audit.

Administrative Order

No. 278

28 April 1992 Directing the Strengthening of the Internal

Control Systems

Institutionalises IAS in all government entities, clarifies the role,

specifies which activities to undertake and which not, details the issues

of independence and proficiency, for the latter incl. the role of the AGIA:

AGIA’s Code of Ethics must be observed

All IAS heads and staff must cooperate with and participate in

AGIA activities

21

No. Date Title Subject

AGIA must ensure that IA practices, methods and procedures are

improved and updated through training

AGIA must ensure that all IAS are conducted in conformity with

the standards of the IA profession

COA Circular 95-006 18 May 1995 Total lifting on pre-audit on all financial

transactions

Lifts all pre-audit of financial transactions without exception, which shall

in future be subject to COA’s post-audit. Specifies that pre-audit

activities henceforth are to be considered as part of the accounting and

fiscal control process, and that an adequate internal control system shall

be instituted.

COA Memo. 95-092 23 August 1995 AO No. 270 of the President Instructs IAS heads to monitor the compliance with AO No. 278.

Administrative Order

No. 70

14 April 2003 Strengthening of the Internal Control

Systems

Instructs the establishment of IAS’ and outlines the main goal and basis,

mentions some proficiency aspects and the role of AGIA (excl. the

earlier requirement on staff cooperation).

DBM Budget Circular

2004-4

22 March 2004 Guidelines on the Organization and Staffing

of Internal Auditing Units (IAUs)

Specifies the functions of IAUs as well as the organisation and staffing,

incl. position titles and salary grades as well as job characteristics, and

the role of DBM (for evaluation of proposals for organisation of IAUs).

Memorandum Circular

No. 89

18 August 2005 Reiterating Compliance with AO 70 … and

its Implementing Guidelines under DBM

Budget Circular No. 2004-4

Directs the creation of IAS in compliance with AO No. 70 and the

observation of the guidelines set forth in the DBM Budget Circular 2004-

4.

Association of Government Internal Auditors (AGIA)

AGIA was first organized in 1959. The Internal Auditing Act 1962 (RA 3456) introduced internal auditing requirements to the national government. A 1965 amendment

(RA 4177) extended the Act’s coverage to government owned and controlled corporations (GOCCs), and local government units (LGUs). In 1992, President Aquino

directed that government internal-control systems be strengthened (AO 278). The AGIA, among others, was instructed to ensure that internal audit practices, methods,

and procedures be improved through continuing education and be conducted in accordance with internal auditing standards. The Association represents internal auditors

in government and promotes their professional development. It had 1,177 members at January 1999.

Source: ADB (2002) – Diagnostic Study of Accounting and Auditing Practices in the Philippines, pp. 73-74.

22

Republic of the Philippines

HOUSE OF REPRESENTATIVE

Constitution Hills, Quezon City

SIXTEENTH CONGRESS

________ Regular Session

HOUSE BILL NO. _________

AN ACT INSTITUTIONALIZING THE INCOME CLASSIFICATION OF PROVINCES,

CITIES AND MUNICIPALITIES, AND FOR OTHER PURPOSES

EXPLANATORY NOTE

From the time local governments had been established in the Philippines, they had

always been classified, based on income, for certain purposes, among which are the

determination of their financial capability, the establishment of the salary scales of local

government officials and personnel and the determination of the number of Sanggunian or local

council members.

The most recent legislation providing for the income classification of local government

units (LGUs) is Executive Order No. 249 issued on July 25, 1987 by then President Corazon

Aquino exercising legislative powers after the EDSA revolution. Subsequent LGU income

reclassifications had been carried out through the promulgation of Department of Finance

(DOF) Orders, the most recent of which is DOF Order No. 23-08 (issued on July 29, 2008.)

Through time, however, the income reclassifications of local governments have

evolved in such a way that an LGU’s income class is not truly reflective of its financial

capability particularly in generating locally sourced revenues because of the heavy reliance on

the Internal revenue Allotment (IRA) in setting the income ranges for the different classes.

With the phased doubling of the IRA under the Local Government Code, it has become the

biggest component of the annual regular income, which is the basis for classifying the income

class of LGUs. As a result, LGUs at every level have tended to cluster in the higher classes

while very few are classified in the lower classes. In addition, the wide disparities in the taxing

capacities of LGUs and given further that this factor has a limited effect on the LGUs current

classification, the present system does not truly reflect the LGUs financial capabilities and their

relationship to each other within the same level.

In order to address these issues, it is imperative to give the Secretary of Finance a clear

and unambiguous mandate and authority to determine the income brackets and to undertake

the regular income reclassification of provinces, cities and municipalities, so that LGUs can be

better aligned with national government financial and fiscal policies.

For the reasons cited above, the early passage of this bill is earnestly requested.

Annex B. Draft Income Classification Bill of BLGF

23

Republic of the Philippines

HOUSE OF REPRESENTATIVE

Constitution Hills, Quezon City

SIXTEENTH CONGRESS

________ Regular Session

HOUSE BILL NO. _________

___________________________________________________________________________

______________

INTRODUCED BY _____________________

AN ACT INSTITUTIONALIZING THE INCOME CLASSIFICATION OF

PROVINCES, CITIES AND MUNICIPALITIES, AND FOR OTHER PURPOSES

Be it enacted by the Senate and House of Representatives of the Philippines in the

Congress assembled:

SEC 1. Short Title – This Act shall be known as the ‘THE LOCAL GOVERNMENT

UNIT’S INCOME CLASSIFICATION ACT.’

SEC.2 Declaration of Policy – It is the policy of the State to provide an equitable and

rational system of regular income classification of provinces, cities and municipalities that will

reflect realistically their respective financial positions.

SEC. Definition of terms. – As used in this Act, the following terms shall mean:

(a) Annual Regular Income refers to revenues, including fees and receipts actually

realized which are reported yearly on cash basis by provinces, cities and

municipalities from regular sources, including the internal Revenue Allotment

(IRA) and other shares provided for in Sections 284, 290 and 291 of republic Act

No. 7160, but exclusive of non-recurring receipts, such as national aids, grants,

financial assistance, loan proceeds, sales of assets, miscellaneous income/receipts

and similar others. For the purpose of this Act, shares from national wealth, excise

tax on tobacco, incremental collection from value added tax (VAT) under R.A No.

7643, and the gross income tax paid by businesses and enterprises in Special

Economic Zones (ECOZONES) Under R.A 7916, as amended, and such other

shares as may be granted by law to the province, city, municipality, shall be

considered as part of the annual regular income. The annual regular income shall

be computed from the Statement of Receipts and Expenditures (SRE) maintained

by the Bureau of Local Government Finance of the Department of Finance.

(b) Average Annual Regular Income refers to the sum of the ‘annual regular income’,

as herein defined, actually obtained by a province, city or municipality during the

required number of fiscal years preceding the year of general income

24

reclassification of local units. Divided by such number of fiscal years as provided

in Section 4 hereof.

(c) Local Government Units refer to the political subdivisions of the State, namely,

province, city or municipality.

SEC 4. Income Classification of Provinces, Cities and Municipalities. – All provinces,

cities and municipalities shall be classified into six (6) income classes according to

income ranges and based on the average annual regular income for three (3) fiscal years

preceding the general income reclassification.

SEC. 5. Administrative Authority of the Secretary of Finance - The Secretary of Finance

shall have the authority to set the income ranges and undertake the regular income

reclassification of all provinces, cities and municipalities once every three (3) fiscals

years, in order that the income classification of local government units conforms with

the prevailing economic conditions and the overall financial status of the local

governments.

SEC. 6. Period of Income reclassification - a) The Secretary of Finance shall undertake

the first general income reclassification of all provinces, cities and municipalities within

six (6) months after the effectivity of this Act, and every three (3) years thereafter. In

cases of diminishing revenues, the Secretary of Finance may order the re-computation

and revision of the income classification of provinces, cities and municipalities to

reflect the actual financial situation of the local government units.

b) However, a province, city or municipality, which has been in existence for a period

of less than three (3) fiscal years immediately preceding the general income

reclassification of local government units, as herein provided, shall be classified on the

basis of its average annual regular income during such lesser number of fiscal years.

c) If a province or municipality is created before the year of general reclassification of

local government units, it shall be classified on the basis of the aggregate net share of

income from regular sources actually realized from its components cities and

municipalities in the case of a province, or its component barangays in the case of a

municipality, plus the corresponding estimated Internal Revenue Allotment (IRA) of

the newly created province or municipality pursuant to Section 285 of republic Act. No.

7160, during the fiscal year immediately preceding its creation.

d) The rule prescribed under the immediately preceding paragraph shall likewise apply

to a municipality that is converted into a city, or a city that is created out of existing

municipalities and/or barangays.

SEC. 7 Uses of Income Classification – The income classification of provinces, cities

and municipalities shall, among other purposes, serve as basis for:

a) The determination of administrative and statutory aids, financial grants, and other

forms of assistance to local governments;

b) The determination of the financial capability of local government units to undertake

developmental programs and priority projects; and

c) Such other purposes as provided under existing laws and regulations

25

SEC 8. Guidelines in Cases Where a Fourth or Lower Income Class Province, City or

Municipality Receives a Third or Higher Income Class Designation as a Result of the

General Income Reclassification.- A fourth or lower income class province, city or

municipality which gets either a First, Second or Third income class designation from

the general reclassification provided herein shall cease to provide for additional

personal services and maintain its existing personnel complement prior to the

reclassification, pursuant to civil service rules and regulations; Provided, further, that

in case of personnel transfers, resignations or deaths, the local government shall not

cause the filling up of the vacant position nor provide for its funding until the

succeeding general reclassification; and Provided, finally, that in case the local

government shall still exceed the limitations and provided in Section 325 of the LGC

despite the maintenance of the status quo after it first received a First, Second or Third

income class designation as provided herein, this shall not be considered in violation of

Section 325 of the LGC.

SEC. 9 Effectivity of the Income Reclassification – All income reclassification of

provinces, cities and municipalities pursuant to this Act shall be effective on January

1st of the immediate succeeding year.

SEC. 10 Implementing Rules and Regulations (IRR) – The Secretary of Finance shall

promulgate rules and regulations within three (3) months after the effectivity of this

Act, and may continue to issue guidelines to carry out the provisions of this Act.

SEC. 11. Saving Clause- All existing income classifications of provinces, cities and

municipalities shall continue to be force and effect until superseded by the issuance of

a new income classification by the Secretary of finance pursuant to this Act.

Sec.12. Suppletory Application of Existing Laws - The provinces of Republic Act

No. 7160, otherwise known as the Local Government Code of 1991, and other laws

consistent with this Act shall have suppletory effect.

SEC 13. Repealing Clause. Executive Order No. 249, dated July 25, 1987 is hereby

repealed. All laws, presidential decrees, executive orders, presidential proclamations,

rules and regulations or parts thereof contrary to or inconsistent with this Act are hereby

repealed, superseded or modified accordingly.

SEC. 14 Separability Clause - Any portion or provision of this Act that may be declared

unconstitutional or invalid shall not have the effect of nullifying other portions or

provisions hereof, as long as such remaining portions or provisions can still subsist and

be given effect in their entirety.

SEC. 15. Effectivity. – This Act shall take effect fifteen (15) days after its complete

publication in the official Gazette or in at least two (2) newspaper of general circulation.

Approved

POSITION PAPERS

u1ll01t 0t I0GA1 AUIH0BIilIS 0t IHE plililpptltrsUnit 2803 Summit One Tower 530 Shaw Boulevard, Mandaluyong City

Tel. nos.: 7t8-t8t2,7L7-L8t0,534-6787 Telefax: 534-6789 Email: [email protected]: www.ulap.net.ph Facebook: www.facebook.com/ulap.org.ph

RESOLUTION NO. 20\5-02

POSITION OF UIAP ON RA 7160 OR LQCAL GOVERNEMNT REFORMS AND AMENDMENTSWITH REGARD TO THE INTERNAL REVENUE ATLOTMENT AND INTERGOVERNMENTAL

FISCAT TRANSFERS

Whereas, there are legislations (house bills) submitted to the House of the Representatives and the Senatefor the past congresses on the amendment of Republic Act 7160 or the Local Government Code (LGC) of1991,;

Whereas, there are subsequent efforts from the Department of Interior and Local Government (DILG), inpartnership with the Asian Development Bank (ADB), to amend RA 7160 or the LGC by conductingnational consultations with the local government units (LGUs) and forward possible suggestions on theamendments to the Philippine Congress;

Whereas, for the 16th Congress, Senator Aquilino "Koko" L. Pimentel III submitted Senate Bill 2987 or anAct Amending Section 284 of RA 7160 or the LGC;

Whereas, the following provisions are stipulated in the Senate Bill298T:

National Taxes; and,

collected by the Bureau of Internal Revenue (BIR), Bureau of Customs (BOC), Philippine PortsAuthority (PPA), Department of Environment and Natural Resources (DENR), Department ofForeign Affairs (DFA) and such other government agencies deputized by the BIR to collectnational taxes.

Whereas, based on the consultations conducted by ADB and DILG, some of the proposed reforms are toincrease share of IRA from 40% to 50/", and clarify the term national internal revenue taxes to includeVAT and excise tax collections of BOC. This is in concurrence with the Senate Bill 2987 of SenatorPimentel;

Whereas, additional proposed reforms by ADB and DILG in relation to intergovernmental fiscal transfersinclude:

of LGUs in line with their expenditure needs (equalization grant); and.

performance indicators (especially with regard to delegated functions).

Page 1 of2

U]IIll]I ll[ IllGA[ AUIII||RIIITS OT IHT PHIIIPPilISre,nos:,''}i."""T;llill31:l:#;'i::[x:,:?:",[Jix?iiilHr.:i3g,.ir.o,

Website: www.ulap.net.ph Facebook: www.facebook.com/ulap.org.ph

Whereas, on motion made and duly seconded among the ULAP NATIONAL EXECUTIVE BOARD, ONBEHALF OF ITS MEMBER LEAGUES, LOCAL GOVERNMENT UNITS AND ELECTIVE OFFICIALS,BE IT RESOLVED, AS IT HEREBY RESOLVED:

't. THAT ULAP DEEMED THE SENATE BItt 2987 OF SENATOR AQUTLINO.KOKO.PIMENTET III IS THE BEST SCENARIO FOR THE IGUS WITH REGARD TOREFORMS IN THE INTERNAL REVENUE ALLOTMENT IN RA 7160 OR THE LGC;

2. THAT ULAP SUPPORTS THE ADDITIONAL PROPOSED REFORMS OF ADB ANDDILG ON INTERGOVERNMENTAL FISCAL TRANSFERS;

3. THAT ULAP WILL SUPPORT OTHER BILLS INTENDED TO INCREASE IRASHARES OF THE LGUS.

Approved this 22.a day of January, 2015, in the City of San Juan, philippines.

CERTIFIED BY:

BOARD M MBER ATTY. EDMUND ABESAMISULAP Sec tary General

MALI, JR.

Page2 of2

ECCP Position Paper on the Proposed Amendments to the Local Government Code of

1991

The European Chamber of Commerce of the Philippines (ECCP) welcomes the initiative by DILG to carry out consultations with the business sector as part of the process to amend the Local Government Code of 1991 (LGC), as LGUs are a key part of national policy making and implementation. Therefore, strong and mutually beneficial cooperation between the private sector and LGUs is crucial to further strengthening inclusive economic growth at a national level. A clear legislative framework, through the necessary amendments to the LGC, which sets the competencies, obligations and also boundaries to the authority of LGUs is necessary to ensure such cooperation. More specifically, the creation of PEZA is an initiative which has been key to attracting an increasing number of international investors into the country, and effectively fuelling national economic growth and much needed employment generation. However, a number of cases have come to the attention of ECCP, in which LGUs are requiring taxes, fees and additional permits from PEZA investors, which are not in line with the fiscal and non-fiscal incentives provided to PEZA companies. This is despite RA 8748, which amended RA 7916, including the exemption from all national and local taxes for companies registered under PEZA. More specifically, Section 24 of RA 7916 provides that “Except for real property taxes on land owned by developers, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE”. Effectively, the added costs being imposed by LGUs are leading to additional operation and financial costs for investors and present a significant bottleneck for investors. Furthermore, they reduce the competitiveness of the Philippines as an investment destination. Therefore, it is strongly recommended that amendments to the LGC include a section clearly clarifying that LGUs cannot overrule national policies, including fiscal and non-fiscal incentives provided by PEZA. This section should also set out a clear framework of the mechanism, structure and procedures to ensure that revenues from PEZAs mutually benefit PEZA and LGUs and effectively end the friction that exists between PEZA and the LGUs due to the perception by LGUs that they are not receiving sufficient revenues from PEZA investors in their area. Additionally, ECCP opposes the proposed amendment of Section 143 of the Local Government Code of 1991 to introduce a single tax rate, with a maximum rate of 1.5% of gross sales of the preceding year for cities and 1% for municipalities. The implementation of a single tax rather than a number of disparate taxes is supported, however the rate for

Rosario Manasan

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both cities and municipalities is deemed too high, not least because it is gross sales and not profit which is being taxed. Therefore it is recommended that a single tax rate is introduced, but at a lower tax rate. The proposed amendment to Section 195 of the LGC on protest of assessment and Section 196 on claims for a refund of tax credit to provide an administrative mechanism for appeal of the assessment of taxes decided by the local treasurer to the DoF or Bureau of Local Government Finance is strongly supported by European business. These amendments will facilitate a more efficient and less costly procedure for businesses and will therefore increase the ease of doing business for companies. In addition to the above recommendations and with the opportunity of the current amendment procedure to the LGC, it is also recommended that amendments are made to ensure:

- The definition of clear taxation rules between national and local government; and, - A framework for the harmonization of the proposed LGU Investment Promotion

Units with national government investment promotion policies. More generally, the amended LGC should reflect the need to facilitate the further development of industry sectors with potential and a positive effect on job generation and inclusive growth more specifically:

1. Agribusiness. LGUs in key agricultural areas should strengthen their agricultural extension and training services for farmers and improve farm-to-market roads. (Immediate action DTI, DA, LGUs, and private sector)

2. IT/BPO/KPO. LGUs should respect the status of investor operations established in PEZA/IT zones. At the same time, guidelines should be developed and followed on which fees for local services (e.g. garbage collection) are acceptable. (Immediate action ICTO, DTI, DILG, LGUs, and private sector)

3. Creative Industries. LGUs should fully support the development of the creative industries in their locality and encourage them to export their products/services. (Immediate action DTI, LGUs, and private sector)

4. Infrastructure. LGUs should strongly support rapid implementation of priority infrastructure projects, including PPP projects, that will develop their regions, e.g. for tourism. (Immediate action DTI, DILG, various departments, and LGUs)

5. Manufacturing and Logistics. LGUs should fully support manufacturing, and logistics, which provide local jobs, procurement, and LGU revenue, and prioritize reducing and minimizing business costs. Investments are long-term, done on the basis of existing rules and based on established zoning regulations. It is essential that LGUs maintain the rules long-term too and that LGUs avoid rezoning developed industrial zones. (Medium-term action DTI, DILG, DOTC, LGUs, and private sector)

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6. Mining. LGUs should help develop local community support for national government policy to develop mining projects that observe social and environmental regulations. (Immediate action DTI, DENR, LGUs and private sector)

7. Tourism, Medical Travel, and Retirement. LGUs can help mobilize local communities to make the local tourism experience better through a clean and safe environment, more efficient transportation, and the like. LGUs will have a greater role under the Tourism Act, becoming involved in master planning, tourism zone site selection, implementation of standards, putting one-stop shops in place, upgrading local infrastructure, and the like. (Medium-term action DTI, DOT, LGUs, and private sector)

The benefits of continuing economic growth and increasing FDI are far-reaching; while the development and revenue potential for LGUs through investment is significant. However, to ensure that economic growth is inclusive and sustainable, it is crucial that an attractive investment environment is provided to companies. Therefore, amendments to the LGC which will guarantee that this requirement is met are key to fostering such growth.


DEPARTMENT OF THE INTERIOR AND LOCAL GOVERNMENT DILG NAPOLCOM Center, EDSA corner Quezon Avenue, Quezon City

BUSINESS SECTOR COMMENTS AND POSITIONS ON PROPOSED

FISCAL AMENDMENTS IN THE LOCAL GOVERNMENT CODE

The DILG-ADB Local Government Code review team held two (2) consultations with

representatives from the business sector:

Nov. 21, 2014 at Microtel Inn & Suites, Libis, Quezon City

Dec. 4, 2014 at Holiday Inn and Suites, Makati City

The following business groups participated during the consultations:

a. Philippine Chamber of Commerce and Industry (PCCI)

b. Bankers Association of the Philippines (BAP)

c. Management Association of the Philippines (MAP)

d. Philippine Exporters Confederation (Philexport)

e. Tax Management of the Philippines (TMAP)

f. Federation of Philippine-Chinese Chambers of Commerce (FFCCCI)

g. Australia-New Zealand Chamber of Commerce of the Philippines (ANZCHAM)

h. European Chamber of Commerce of the Philippines (ECCP)

i. Information Technology and Business Process Outsourcing Association of the

Philippines (IT-BPAP)

j. Makati Business Club (MBC)

Also in attendance was the national government’s Philippine Economic Zone Authority (PEZA).

Participants were briefed about the fiscal aspects in the Local Government Code and the

proposed amendments that have a bearing on the private sector. The following is a summary of

the business sector’s comments and positions articulated during the consultation sessions and

through position papers that were subsequently submitted.

1. Participants who included members of the international business community welcomed

the DILG initiative to consult the sector as part of the process to amend the Local

Government Code of 1991 (LGC). Both half-day consultations reflected a common

sentiment of the sector to ensure that Philippine laws and policies continue to promote a

transparent, predictable, standardized and corruption-free business environment,

specifically through the following:

a. A clear legislative framework, through the necessary amendments to the LGC, which

sets the competencies, obligations as well as boundaries to the authority of LGUs

necessary to ensure such a mutually beneficial cooperation with the private sector.

b. Clearly defined taxation rules between the national and local government.

c. Harmonization of LGU and national government policies on local investment.

d. “No changing of the rules in mid-game.” The business sector cautions that it will send

wrong signals anew to investors. It also says the added costs being imposed by some

LGUs are leading to higher operation and financial costs for investors that reduce the

competitiveness of the Philippines as an investment destination.

2. On proposed amendment to the Code assigning the approval of the schedule of market

values of real properties to DoF rather than through enactment of a local ordinance,

but retain LGUs’ autonomy in setting real property tax assessment rates. Issues:

outdated schedule of fair market value of real property in many provinces and cities; and



the need to strengthen real property valuation standards to promote integrity and

fairness in the RPT system.

a. The business sector generally agrees with the proposal, a priority measure of the

Department of Finance which has been championed by several legislators in

Congress. Additionally, the sector seeks clear guidelines to govern the power that

LGUs will have in setting RPT assessment levels.

b. PCCI wants to address inconsistencies in the Code vs. its IRR pertaining to the

definition of “machinery” to be taxed and the granting of tax incentives.

c. Foreign chambers support the SMV proposal as a way of standardizing rules of doing

business towards improving service delivery

3. On proposed amendment to the Code amending Section 143 by simplifying the

graduated business tax applicable to various types of businesses to a single tax rate

not exceeding 1.5% of the gross sales/receipts of the preceding year for both cities

and municipalities. Issues: Different graduated local business tax rate schedules for

different types of business complicate local tax administration; structure is regressive,

imposing higher effective tax rates on smaller businesses relative to larger ones; and the

disparities in effective tax rates with respect to size and type of business tend to provide a

venue for tax evasion.

a. Many participants favor a uniform or flat business tax rate but almost all participants

believe 1.5% is too high and could hurt some industries and start-up companies e.g.

electronics industry profit margins are about 3%. The sector is worried that LGUs

might naturally peg the business tax at the highest possible rate of 1.5%. Business

seems open to a compromise rate of about 1%.

b. ECCP supports the implementation of a single tax rather than a number of disparate

taxes but finds the proposed rate too high, not the least because tax computation is

based on the gross sales and not on profits.

c. The sector asserts that LGUs should respect the status of investor operations

established in PEZA/IT zones. At the same time, guidelines should be developed and

followed regarding which fees for local services (e.g. garbage collection) are

acceptable.

d. Foreign chambers and PEZA cite many cases where LGUs require taxes, fees and

additional permits from PEZA investors which are not in line with the fiscal and non-

fiscal incentives provided to PEZA-registered companies under RA 8748, including

exemption from all national and local taxes. More specifically, Section 24 of RA

7916 provides that “Except for real property taxes on land owned by developers, no

taxes, local and national, shall be imposed on business establishments operating

within the ecozone”.

e. Therefore, the sector strongly recommended amendments to the LGC include clearly

stating that LGUs cannot overrule national policies, including fiscal and non-fiscal

incentives provided by PEZA. It also proposes a section to set out a clear framework

of the mechanism, structure and procedures to ensure that revenues from PEZAs

mutually benefit PEZA and LGUs and effectively end the friction that exists between

PEZA and the LGUs due to the perception by LGUs that they are not receiving

sufficient revenues from PEZA investors in their area.

4. On proposed amendment to the Code inserting paragraph in Sec. 191: “In case of

fixed taxes prescribed in this Code, the maximum allowable rate may be adjusted

not more than once every 3 years based on the average annual inflation rate based

on CPI as certified by the Philippine Statistics Authority.” Issue: revenue from local



taxes with peso-denominated tax rate (set at a maximum of PhP 300 for professional tax

and PhP 500 for delivery vans in 1991) eroded by inflation over time.

On indexing of peso-denominated tax rates to inflation, the sector agrees but it opposes

the tax on delivery vans for increasing the cost of doing business.

5. On proposed amendment to the Code imposing a local business tax on plantations and

sugar centrals of business enterprises operating integrated production systems

based on the value of production. Issue: Host LGUs of plantations of business

enterprises with integrated production systems are not able to receive a share in local

business taxes.

In relation to “situs of taxation” issues that includes the above, many participants do not

agree and see the proposal as tantamount to double taxation.

6. On proposed amendment to the Code amending Sec. 157 of the LGC to:

increase the community tax (to be renamed residence tax) from P1 to P10 for

every P1,000 income for individuals;

remove the cap of P5,000 on tax due;

transfer the collection of the same to the BIR; and


Issues: LGUs (particularly provinces) need more revenue productive taxes; proposed

amendment to community tax becomes more relevant if/when proposals to reduce

personal income tax rate succeeds to offset resulting reduction in IRA; and community

tax may be low but its revenue yield is not insignificant to LGUs

a. The sector does not favor a new residence tax (in lieu of community tax), even as the

proposal exempts business entities, because the tax is deemed unnecessary and in fact

not needed anymore when filing income tax returns.

b. A few groups prefer the proposal to “piggyback” on the marginal income tax rate but

think a 1% add-on tax on income (or 1,000% increase on the community tax) is too

high. The sector also worries whether BIR can collect such a tax efficiently.

7. On proposed amendment to the Code amending Sec. 195 of the LGC on protest of

assessment and Sec. 196 on claim for refund of tax credit to provide an

administrative mechanism for appeal of the assessment of taxes decided by the local

treasurer to the Department of Finance/Bureau of Local Government Finance.

Issues: Lack of administrative recourse for taxpayers in cases of disputes on local taxes;

current situation expensive for taxpayers because they have to go to court immediately.

a. Participants want to see first the specific provisions of the appeals process. Private

sector tax experts are willing to contribute ideas and assistance in devising an appeals

mechanism.

b. The proposed new mechanism for protesting tax assessments and claiming tax credit

refunds is also strongly supported by ECCP for it will facilitate a more efficient and

less costly procedure for businesses.

c. Additionally, TMAP and PEZA representatives propose that:

i. If payment is required even under protest, it should be equivalent only to the

amount not being contested by the taxpayer; otherwise it will be just another layer

of bureaucracy.

ii. If payment is not required while under protest, then most if not all businesses may

protest simply to delay payment especially if there is no surcharge.

iii. If there is a surcharge for the delay in payment due to the protest, then the base

amount of the surcharge must be limited to the contested amount.



8. On the proposal to insert the following paragraph at the end of Sec. 147. “The

Department of Interior and Local Government (DILG) and the Department of

Finance (DOF) shall jointly issue guidelines to determine the amount of reasonable

fees LGUs can impose (based on the cost of regulation, inspection and licensing

using the cost accounting framework). Issue: complaints of too many or “exorbitant”

local fees and charges;

And the proposed amendment to Sec. 193 to read: Authority to local tax exemption

privileges - Local governments units may, through ordinances duly approved, grant

tax exemptions, incentives, or reliefs FOR THE PURPOSE OF PROMOTING OR

ENCOURAGING INVESTMENTS IN THEIR JURISDICTIONS, under such

terms and conditions as they may deem necessary, PROVIDED THAT THE

DURATION OF SUCH INCENTIVES SHALL NOT EXCEED 5 YEARS FROM

THE DATE OF REGISTRATION; PROVIDED FURTHER THAT SUCH

INCENTIVE SHALL BE AVAILED ONLY ONCE.

On the proposed formulation of DILG/DOF/BLGF guidelines on fees, charges and grant

of local incentives, all participants fully agree. ANZCHAM suggests further measures to

standardize and harmonize local with national incentives.

9. On the proposal to remove in the Code the preferential treatment extended to GFIs

as depository banks:

PCCI suggested for the amendment to explicitly state that the Local Government Code

allow LGUs to deposit funds with private banks as long as these banks will give them

better terms especially for borrowings.

10. On the proposal to allow LGU borrowing for capital investment only as well as limit

borrowing of last-termer officials:

The business sector understands the burden upon the next elected officials who might

inherit an LGU without any borrowing capacity left. However it believes that the primary

criterion for lending to LGUs is still “capacity to pay” which can also be a problem

among many. PCCI is not convinced that a mandatory public hearing or publication of

the proposed loan amount and purpose could truly prevent unsound borrowing practices.

11. Other proposals from business sector:

a. PCCI suggests having a clear provision in the Code to clarify whether income derived

from LGU-operated economic enterprises should be taxed or not.

b. As investments are long-term and made on the basis of existing rules and on

established zoning regulations, ECCP believes it is essential that LGUs maintain

long-term rules of doing business as well and avoid any rezoning of developed

industrial zones.

c. ECCP suggests that the Code reflect the need to facilitate the further development of

industry sectors with a potential positive effect on local job generation and inclusive

growth, specifically: agribusiness; IT/BPO/knowledge outsourcing; creative

industries; infrastructure including PPP projects that will develop the regions outside

Manila, e.g. for tourism; manufacturing and logistics; mining projects that observe

social and environmental regulations; tourism, medical travel, and retirement markets

where LGUs can help mobilize local communities to make the local tourism

experience better through a clean and safe environment, more efficient transportation,

and the like. ###