How Local Governments Raise Money

LGUs collect taxes and fees to add to their internal revenue allotment. KEITH BACONGCO

A WELL-FUNCTIONING COMMUNITY IS ONE where residents can avail themselves of free and high-quality education, health, police, infrastructure, and emergency services.

It used to be that the national government takes charge of the delivery of these services. But after concluding that local government units (LGUs) are in a better position to do the job given their proximity to their respective constituents, the national government devolved these responsibilities to barangay, municipal, city, and provincial governments in 1991.

This is the reason why LGUs are now on the frontline as far as delivery of basic government services is concerned.

Operation of public schools and hospitals, infrastructure development, and management of peace and order situation entail obvious costs. As such, LGUs need money to finance the services they are expected to deliver.

Thus, under the Local Government Code of 1991, LGUs are entitled to a significant share in revenues of the national government. Moreover, they are allowed to raise their own funds – primarily through local taxes, fees, and charges.       

Internal Revenue Allotment

One of the basic means by which an LGU gets money to support its operations is through internal revenue allotment (IRA) from the state. The national government, as dictated by the Local Government Code, is obliged to earmark 40 percent of its entire internal revenue collection for a given year for IRA intended for barangay, city, municipal, and provincial governments.

For 2013, the national government expects to generate PhP 1.25 trillion in tax revenues collected by the Bureau of Internal Revenue. Consistent with the mandated 40-percent IRA, some PhP 500 billion should be distributed to LGUs.

The amount of money to be distributed to LGUs in a given year is based on the national government’s internal revenue collection three years before. This means that the IRA for 2013 is 40 percent of the internal revenues generated by the national government in 2010.

Moreover, the specific amount to be received by an LGU depends on several factors, namely, its population, land area, and type—whether it is barangay, municipal, city, or provincial.

Out of the total IRA for a given year, 23 percent goes to all provinces, another 23 percent goes to all cities, 34 percent goes to all municipalities, and 20 percent goes to all barangay.

Furthermore, the specific amount to be received by an LGU is based on a formula that observes the following weights: 50 percent for population, 25 percent for land area, and 25 percent for equal sharing. This means that LGUs with bigger populations and with wider land areas are supposed to enjoy higher IRAs.

Given the premium placed on delivery of basic services, the Code mandates automatic appropriation for the IRA from the national government’s annual budget. This means the setting aside of money for LGUs, as well as the amount to be given to them, do not need deliberations by nor approval of Congress.

“The share of each local government unit shall be released, without need of any further action, directly to the provincial, city, municipal or barangay treasurer, as the case may be, on a quarterly basis within five (5) days after the end of each quarter, and which shall not be subject to any lien or holdback that may be imposed by the national government for whatever purpose,” the Code states.

Share in other national government revenues

Besides a share in the national government’s internal revenues, some LGUs are also entitled to shares in other forms of income of the national government. Specifically, this means a portion of the income derived by the national government or by a government-owned and -controlled corporation from the imposition of taxes on businesses involved in the use of national wealth, such as natural resources, is mandated by law to be distributed to concerned LGUs.

The rationale behind this is that LGUs are expected to spend on projects and programs that will help ensure environmental sustainability despite use of natural resources or other wealth of the nation.  

The Code specifically states that concerned LGUs shall have a 40-percent share in the gross revenues earned by the national government from mining taxes, royalties, forestry and fishery charges, and other related charges.

Real property tax

Anchored on the assumption that the IRA is not enough, LGUs are allowed by law to raise money on their own to augment their resources. They do so primarily by imposing and collecting taxes. The tax on real properties is one of the biggest revenue earners for many LGUs.

“LGUs are highly encouraged to be financially independent. Thus, they are allowed to impose taxes to support their operations,” Ma. Lourdes Recente, assistant secretary at the Department of Finance (DOF), said in an interview with the Citizen Action Network for LGU Accountability and Performance (CANA).

Recente said the Local Government Code prescribes maximum tax rates that LGUs may use as guides in setting their own tax schedules.

She said LGUs are encouraged to maximize their taxing power, particularly by charging the highest rate allowed by law, especially if they want to raise more revenues for the purpose of delivering more services.

Under the Code, the major “types” of real properties are land and buildings.

Moreover, the major “classifications” of real properties are residential, agricultural, commercial, industrial, mineral, and timberland.  

An LGU outside Metro Manila may impose a maximum real property tax of 1 percent of the “assessed value” of a property, while an LGU within Metro Manila may set the tax at 2 percent or less.

The “assessed value” of a property is a certain percentage of the property’s fair market value, and varies depending on the property’s type and classification.

According to the Code, local governments outside Metro Manila may set the real property tax at a maximum rate of 1 percent of the “assessed” value of the property.

Land. For land falling under the classification of residential or timberland, the “assessed value” of a property is computed as 20 percent of its “fair market value.”

For example, for a piece of land located outside Metro Manila and with a fair market value of PhP 100,000, the “assessed value” would be PhP 20,000. The maximum real property tax liability would be PhP 200, which is 1 percent of the assessed value of PhP 20,000.

For land classified as agricultural, the assessed value is set at 40 percent of its fair market value.

For land classified as commercial, industrial, or mineral, the assessed value is 50 percent of its fair market value.

Buildings. For buildings that are classified as residential, the assessed values range from 10 to 60 percent of their market values.

Residential buildings with fair market values between PhP 175,000 and PhP 300,000 are assigned the lowest assessed value of 10 percent, while residential buildings with fair market values of over P10 million are assigned the highest assessed value of 60 percent.

For buildings classified as agricultural, the assessed values range from 25 percent to 50 percent of fair market values.

Agricultural buildings with fair market values of PhP 300,000 or less are assigned the lowest assessed value of 25 percent, while agricultural buildings with fair market values of over PhP 2 million are assigned the highest assessed value of 50 percent.

For buildings classified under commercial/industrial, the assessed values range from 30 percent to 80 percent of fair market values.

Commercial or industrial buildings with fair market values of PhP 300,000 and below are assigned the lowest assessed value of 30 percent, while commercial or industrial buildings with fair market values of over PhP 10 million are assigned the highest assessed value of 80 percent.

For buildings classified under timberland, the assessed values range from 45 percent to 70 percent.

Timberland buildings with fair market values of PhP 300,000 and below are assigned the lowest assessed value of 45 percent, while timberland buildings with fair market values of over PhP 2 million are assigned the highest assessed value of 70 percent.  

Business tax

Tax imposed on businesses operating within a local government’s jurisdiction is another major source of revenues. The rate of business tax, which is imposed on gross earnings, varies depending on the nature of business of an enterprise.

Manufacturers, assemblers, re-packers, processors, brewers, distillers, rectifiers, and compounders of liquor, distilled spirits, and wines are slapped a business tax of 0.375 percent of their gross earnings if said earnings hit at least PhP 65 million. Enterprises in the same nature of businesses but earn less than PhP 65 million a year are charged lower tax rates. 

Wholesalers, distributors, and dealers of any article of commerce earning at least PhP 2 million in gross revenues a year are imposed a business tax of 0.5 percent. Those that earn less than PhP 2 million are charged lower tax rates.

Retailers with gross revenues of PhP 400,000 or less are imposed a business tax of 2 percent, while those earning more than PhP 400,000 are slapped a tax of 1 percent.

Exporters, manufacturers, millers, producers, wholesalers, distributors, retailers of food and agricultural products, namely, rice, corn, wheat, cooking oil, cooking gas, laundry soap, detergents, medicine, agricultural inputs, poultry, and animal feeds may be imposed a business tax at a rate not exceeding 50 percent of the rates charged to abovementioned businesses.

The same goes for businesses that export, manufacture, mill, produce, distribute and sell school supplies and cement.

Other taxes, and fees and charges

LGUs, through passage of local government ordinances, also may generate revenues from the imposition of other minor taxes, including but not limited to amusement tax, community tax, and franchise tax.

Moreover, it also may generate revenues from fees and charges to support its operations. Some of the common fees and charges are those imposed in the issuance of business and other types of permits, and those collected from renting out local government properties.     

According to the Code, LGUs “may impose and collect such reasonable fees and charges on business and occupation…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 of such profession or calling.”

Heavy dependence on IRA

Unlike the national government, which has been posting deficits in its annual budget since 1998, LGUs have favorable fiscal positions. Latest data from the DOF showed that in 2011, LGUs registered combined budget surpluses of PhP 34.7 billion. These followed the combined surpluses of PhP 34.1 billion recorded in 2010.

However, for many LGUs, their ability to post surpluses is credited largely to the IRA granted to them by the deficit-ridden national government. Moreover, many LGUs do not bother improving or increasing their services as they ensure all their expenditures can be fully or almost entirely be covered by the IRA.

Thus, heavy reliance on the IRA is one of the major issues confronting LGUs.

There are about 120 cities, about 80 provinces, about 1,500 municipalities, and about 42,000 <i> barangays </i> in the country. Based on estimates, more than half of all LGUs in the country rely almost entirely on IRA for their operations.  

According to DOF’s Recente, this is not an ideal situation. Heavy dependence on the IRA means LGUs are not taking advantage of the opportunity to generate more income by exercising their taxing authority. She said LGUs could expand the coverage of their services to constituents if they maximize means to generate revenues.

Although the IRA has a noble objective of supporting operations of <i> barangay,</i> municipal, city, and provincial governments, sadly it has led to complacency for many LGUs, Recente said.

“What the DOF wants is for LGUs to become financially independent. Ideally, the IRA should serve only as a financial support to their overall revenues, which should be composed largely of taxes, and fees and charges they collect,” Recente said.

UP Economics Professor Benjamin Diokno echoed the same tune. He said the IRA has caused many LGUs to become lazy in thinking of ways and in implementing measures to raise their own revenues. The adverse consequence of this, he said, is that many LGUs are not able to enhance the quality or expand their services.  

“Local government units have become lazy in collecting their own taxes. More so, their delivery of services has not improved, their governance, too,” Diokno was quoted as saying in news reports.

Diokno said that on average, IRA accounted for 78.6 percent of total funds of municipalities in 2010, up from 76.5 percent in 2008.

Moreover, IRA accounted for 74.5 percent of revenues of provinces, up from 73.6 percent share in 2008.

 Diokno, therefore, suggested implementing a policy which will change the system of revenue generation for LGUs or that will push them into developing their own sources of incomes.

Most LGUs highly dependent on IRA are those outside Metro Manila. What the national government, through the DOF, wants is for these LGUs to be more aggressive in exercising their taxing authority and in inviting investors so that they can collect more taxes.

 The national government also wants dependent LGUs to observe practices by financially independent cities in generating and boosting their own revenues.

The case of Mandaluyong City

One of the LGUs recognized for being financially independent is Mandaluyong City in Metro Manila.

In his latest State of the City Address delivered in February 2013 at the city government’s gymnasium, Mayor Benhur Abalos said that although the IRA that Mandaluyong receives is getting smaller and smaller every year, the city’s operations are not adversely affected because of its growing income.

“Unlike other cities, Mandaluyong is not dependent on the internal revenue allotment, which means that our own revenue-generating resources are just enough to make us entirely independent,” Abalos said in the address, a copy of which was given to CANA.

Because more and more municipalities are converting into cities, the share of each city in the IRA is dwindling. In the case of Mandaluyong City, its IRA dropped from about PhP 496 million in 2011 to nearly PhP 431 million in 2012.

This did not bother the city government because its main source of revenues is its own tax collection system. In fact, IRA accounted for only about 18 percent of the city’s total revenues in 2012.  

Based on documents which CANA obtained, the local government of Mandaluyong City collected PhP 1.74 billion in local taxes last year. Of this amount, PhP 1.16 billion were accounted for by business tax and the balance was accounted for real property tax and other local taxes.

Abalos said that because of its capacity to generate significant revenues, the city government of Mandaluyong was able to accommodate higher expenses resulting from the application of the salary standardization law to LGUs as well as the mandatory increase in the personnel economic relief allowance (PERA) to employees.

He also said the city government was able to improve its services.

“Together, we have done so many things. We have re-engineered roads… we have elevated the level of our basic services,” Abalos said.

Aggressive tax collection

Juliet Ereso, assistant city assessor at the city government of Mandaluyong, said one of the strategies it employs to generate sufficient revenues is constant communication with the taxpayers.  

“Here in Mandaluyong you can see billboards reminding taxpayers of the schedule of tax payments,” Ereso said.

Ereso said concerned employees of the city government also constantly communicate with taxpayers to remind them of their obligations and to run after delinquents.

She said the city government likewise offers compromise settlements of overdue tax obligations, but only for people who are proven to suffer from financial difficulty. This is so they would be encouraged to pay at compromise rates rather than hide from local authorities.

Luis Canonizado Jr., head of the Mandaluyong City government’s business inspection division, said in a separate interview with CANA that inspectors regularly conduct site visits to check on tax compliance of businesses operating within the city.

Canonizado said strict enforcement of penalties encourages compliance.

“When businesses know that tax enforcement is not that strict, they tend to be lax. But if the implementation is strict, such as if the grace period for paying overdue taxes is reduced, then they become more compliant,” Canonizado said.

Because of its efforts to raise revenues on its own, Mandaluyong is considered one of the country’s most financially independent and affluent cities.

Local government bonds

The national government likewise encourages LGUs to become more financially savvy, particularly by considering issuance of their own bonds as a means to raise funds.

Bonds are investment instruments that an entity may sell to investors, who are given the promise of being able to get their money back and gain interest at a specified date in the future.

There have been a few cases of local government issuance of bonds, but the national government said LGUs could tap more this revenue-raising measure especially if they have growing expenditure requirements.

Selling of bonds, however, is like obtaining a loan from investors. As such, an LGU issuing bonds must be mindful of the obligation to pay back the loan and the corresponding interest to keep an image of creditworthiness.

Finance experts believe bond issuance by LGUs would help deepen the country’s capital markets. They said the more LGUs issue bonds, the more vibrant the capital markets could become. This is because more LGUs issuing bonds mean availability of more investment instruments for yield-seeking investors.    

Investments mean revenues 

For Mayor Abalos, implementation of measures which encourage investments is a key reason behind the ability of Mandaluyong City to generate sufficient revenues. This is because without businesses to collect taxes from, an LGU will not have much means to generate its own money.

In the case of Mandaluyong, the business tax it collects is more than double the IRA it gets from the national government.  

Abalos said these measures to encourage investments include efforts to ease business registration systems and to build trust among taxpayers.

Streamlining of business registration procedures is said to be enticing to investors as this shortens the time it takes for them to start operating and earn money. In return, an LGU benefits as well because of the taxes it can collect.  

Mandaluyong City government’s Ereso said transparency helps in building trust among taxpayers. She claimed that in the case of Mandaluyong City, the local government makes its income statements available to the public, such as through its website.

Abalos said that from 2010 to 2012 alone, the city attracted PhP 111.45 billion worth of investments from large corporations, including land developers and call centers.

“The influx of investors is in the city is a testament to the effective leadership and systematic business registration system in the city,” he said in his speech.

The mayor also said that the significant revenues generated have allowed it to spend more on road development projects, improvement of public school facilities, and enhancement of health and security services.

“We have re-engineered roads, we have introduced reforms and changed the landscape of the city and we have elevated the level of our basic services,” Abalos said.

Amendment of the Local Government Code 

Complementary to suggestions for LGUs to raise more revenues on their own is the proposal to amend the Local Government Code.

Recente said the finance department has been pushing for the amendment of the over 20-year old law so that the tax rates would be updated.

Moreover, she said, the list of businesses must be expanded so that LGUs have a clearer mandate to impose taxes on enterprises that are into businesses that were not yet common in 1991, when the Local Government Code took effect.

Recente also said the formula for computing the IRA also needs to be updated.

Because more and more municipalities are developing into cities, the 23-percent share of cities in the IRA is being divided among an increasing number of recipients. Given this backdrop, the share of each municipality in the IRA has been on a decline over the past few years.

Recente also said there is an old proposal, which legislators may find worthy of studying, for the formula for the distribution of IRA to be amended in such a way that will incentivize LGUs that are active in raising their own revenues.

In particular, she said, the proposal states that besides land area and population, an LGU’s revenue-generating capacity should be included among the weights used to determine one’s IRA.

She said such a proposal could encourage LGUs to be more aggressive in raising their own revenues and avoid relying heavily on funds automatically given by the national government.  

“Under the old proposal, the ability of an LGU to provide counterpart funding [vis-à-vis the IRA] would be considered and would positively affect one’s allocation from the national government,” Recente said.

“The Local Government Code is already an old law. To be more effective, it needs to be amended,” she said.

The task at hand

Given their responsibility of delivering basic government services to their respective constituents, LGUs play a crucial role in determining the quality of living in local communities and, therefore, the quality of life of residents.

Since the efficiency of the delivery of the basic services, as well as their quality, hinge on the resources of LGUs, it pays for them to maximize opportunities to raise revenues.

But since LGUs are confronted with issues of financial dependency and an outdated Local Government Code, implementation of administrative and legislative measures that will help them maximize their revenue-generating capacity is a task at hand. Citizen Action Network for LGU Accountability and Performance