# **Box 1**

# **Sin Tax Reform in the Philippines**<sup>**15**</sup>

In 2012, the Philippines passed a new Sin Tax Law (STL) increasing excise taxes on tobacco and alcohol products. The previous system, even after a major reform in 1997, suffered from a number of shortcomings. Cigarette excise taxation was greatly complicated by a long‐standing ‘tier’ system under which lower price cigarettes attracted lower levels of taxation, thus reducing the cost of “entry level” cigarettes and weakening efforts to discourage smoking through increases in retail prices. A similar tier system applied to alcohol, with tier thresholds set so that domestic producers incurred lower excise rates while more expensive international brands attracted higher rates –a structure that was successfully challenged in the WTO as violating the principle of national treatment. In addition to the inherent protectionism of the tier system, in the case of cigarettes the grandfathering of rates for specific brands further protected incumbent producers and discouraged competition. Moreover, because excise taxation, already weakened by leakages arising from complex tax structures and fragmented oversight, was not adequately indexed to inflation, revenues from these taxes were eroding steadily, declining from 1.25% of GDP in 1997 to only 0.5% in 2012. In 2010, Philippine taxes on tobacco as a proportion of retail sales prices were the lowest in ASEAN with the exception of Cambodia (Box 2). Unsurprisingly, cigarette and alcohol consumption in the Philippines were higher than in most countries with similar levels of GDP per capita.

Since the government was under fiscal pressure and politically committed to increase social spending, the attraction of a reform that would increase revenues – the new STL is estimated to increase sin tax revenues by 60% once fully in effect – and reduce adverse health consequences from smoking and drinking was obvious. Moreover, such a reform would also serve to improve governance and transparency by leveling the competitive playing field and reducing the extent to which, through lobbying and regulatory capture, oligopolistic producers in both the tobacco and alcohol industries were able to shape policy. On the other hand, previous attempts at reform had failed repeatedly to overcome the combined opposition arising from producers (including regionally concentrated tobacco farmers), critics of the adverse effects of increased alcohol and tobacco taxes on the poor, and those who argued that increased smuggling and evasion was likely to offset much of the anticipated revenue gain.

To overcome such opposition, the reform was positioned as not only (1) as a way to offset increasing problems facing the existing excise taxes in terms of administration and revenue but also as (2) a measure that would both improve health outcomes by raising prices and curbing demand and also finance expanding health coverage to the poor and near‐poor. In addition, the new system was both (3) phased in gradually in order to minimize the transitional costs to producers and consumers and (4) implemented through an elaborate and transparent accountability system intended to reassure people that the incremental funds were being properly targeted and spent.<sup>16</sup> Finally, close attention was paid to designing the restructured tax system to come as close as politically possible to the ‘health’ ideal of a uniform indexed specific tax system discussed in the present paper.<sup>17</sup>

> 15 This note is based on the author’s interpretation of material in World Bank (2014). 16 Although most incremental funds are earmarked (for the first time) to health spending, the long‐standing earmarking of some cigarette tax revenue to tobacco‐producing regions persists.  Of course, it remains to be seen if  the rather complex accountability and monitoring structure envisaged in the STL can be fully and effectively implemented.

> 17  Unsurprisingly given the extensive political negotiations that inevitably accompany significant tax change, the final tax design might perhaps still be improved in some respects. In particular, the 4% annual indexing factor is at best a very rough way to maintain effective tax rates while spirits continue to have the lowest unit price of any alcohol – as has long been the case in the

23