Review of Corporate Income Tax Policy in the Philippines

Review of Corporate Income Tax Policy in the Philippines:

Do investments respond to taxation and incentives? Evidence from the Philippines

SA. Quimbo*

(with X. Javier, M. Reganon. L. Gallevo, R. Quimbo**)

15 June 2016

U N I V E R S I T Y O F T H E P H I L I P P I N E S

S C H O O L O F E C O N O M I C S

*UP President Edgardo J. Angara Fellow (2015/16); Professor (on leave), UP School of Economics; Commissioner, Philippine Competition Commission (The opinions expressed in this presentation and paper are the author’s own and do not necessarily represent the views of the Philippine Competition Commission.) **Ways and Means Committee Chair, House of Representatives, 16th Congress



Capital formation and economic growth: tightly linked (Robinson 1971, Mankiw et al. 1992, Khan and Kumar 1997, Bond et al 2007, Karras 2010 )



Barriers to capital formation: Taxation included

Source: World Economic Forum (2015). The Global Competitiveness Report 2015-2016.



Low Gross Capital Formation in the Philippines (% of GDP)

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Philippines Low Income Countries Lower Middle Income Countries

Upper Middle Income Countries High Income Countries



Are high tax rates and low FDI related?

Country Corporate

Tax Rate

Singapore 17%

Cambodia 20%

Vietnam 22%

Indonesia 25%

Thailand 23%

PHILIPPINES 30%

15

20 22 23

25

29

0

5

10

15

20

25

30

35

0

2

4

6

8

10

12

14

16

18

20 Effe

ctiv

e C

orp

ora

te Ta

x R

ate

(%)

Ne

t FD

I a

s %

of G

DP



Corporate Tax Rates and Gross Capital Formation: Philippines (1946-2014), Indonesia (1984-2014), Thailand (1990-2014), and Vietnam (1986-2014)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00 45.00

Co

rpo

rate

Tax

Rat

es

Capital Formation as % of GDP

Legend:

Philippines

Vietnam

Thailand

Indonesia



Research Questions

Should corporate income taxes be lowered?

• Will investments increase with lower corporate income tax rates?

• Will investments increase with more fiscal incentives?



Tax Reforms in the Philippines

1986 1997 2005 2009

The introduction of a uniform, consumption-based VAT; the consolidation of corporate tax rates into a single rate; and the provision of tax incentives to encourage foreign direct investments.

The Comprehensive Tax Reform Program gradually reduced the CIT rate from 35 to 32%; the Minimum Corporate Income Tax was imposed; tax on dividends restored.

The VAT rate increased from 10% to 12%, and the corporate income tax rate increased from 32% to 35%.

The corporate income tax rate was lowered to 30%.



Senate Bill (SB) 2163 (Angara), SB 2974 (Recto), House Bill (HB)

4099 (Gunigundo), HB 4829 (Quimbo), HB 4925 (Noel), HB 4941

(Yap) and HB 4996 (Aggabao).

Recent Tax Reforms in the Philippines



An important consideration: What is the impact of lower taxes on tax effort?



An important consideration: What is the impact of lower taxes on tax effort?



Taxes paid by firms

Corporate income tax

Final (withholding) tax

Value-added tax

Excise taxes

Customs duties

Other taxes include: fringe benefits tax, documentary stamps tax, and percentage tax

Local taxes



Subsidies: tax incentives (1)

Omnibus Investments Code of 1987 (EO 226)

Bases Conversion and Development Act of 1992 or

BCDA (RA 7227), amended by RA 9400 in 2006

(including Clark Development Corporation, Poro Point

Management Corporation, and Subic Bay Metropolitan

Authority)

Special Economic Zone of 1995 (RA 7916) amended

by RA 8748 in 1999



Subsidies: tax incentives (2)

Cagayan Special Economic Zone Act of 1995 (RA

7922)

Freeport Area of Bataan Act of 2009 (RA 9728)

Regional or Area Headquarters, Regional Operating

Headquarters and Regional Warehouses Act (RA

8756)



Fiscal Tax Incentives

Income tax holiday for 4-6 years for selected

industries

5% preferential gross income tax rate

Tax and duty exemption on imported capital

equipment

Total incentives amounted to 146.8B in 2013, 1.3% of

GDP (Source: DBM, 2015)



Internal Revenue Collections, 2009-2014



Accelerator Model of Investments

Assume:

(i) The firm is a profit maximizer.

(ii) Output is concave in capital stock.

(iii) The firm is a price taker.

(iv) Firms' investments at time t are proportional to

desired capital stock, which is a function of

expected output levels, Qt

(v) Firms are also assumed to expect future output to

be a linear function of current output levels.



Accelerator Model of Investments

Where

ΔQ refers to the change in output over the previous period

It-1 refers to lagged investments

Π refers to profits

Τ refers to tax rates

X refers to other firm or industry characteristics

It= I (∆Qt, It-1, πt, t, Xt)



Data

Annual Survey of Philippine Business and Industry

(ASPBI)

The 2010 ASPBI sample consists of 29,298 firms

(about 20% of the total number of firms in the sampling

frame) in 942 industry sub-classes.

2009 ASPBI used for lagged variables

ASPBI data merged with roster of firms (n=3,593)

receiving PEZA incentives



Estimation Methods

Unit of analysis: industry sub-class

• use of firm-level data is regulated

• Firm level data are aggregated (either sum or average) at

the industry sub-class level (5 digit Philippine Standard

Industry Code)

Ordinary Least Squares

• 5 sets of models (one for each alternative measure of

investment)



Dependent Variables

Four alternative measures of capital formation:

• Capital expenditures

• Value of new tangible assets

• Research and development expenditures

• Number of new firms



Main Regressors: Potential Major Tax Payments and Subsidies

Potential major tax payments: defined as the sum of four

main tax liabilities of a firm:

corporate income taxes, value-added taxes, the final withholding tax payable, and excise taxes.

the tax variable is defined as potential tax payments as a proportion of total revenues

Subsidies only include PEZA incentives; no firm-level data

available for other types of incentives



Potential Major Tax Payments, Incentives, and Subsidies



Potential Major Tax Payments, by industry

A measure of

corporate tax

collection efficiency:

Actual BIR collections/

Potential collections

= 67 percent

(after incentives)



Estimated Fiscal Incentives, by industry



Other Regressors

Revenues in 2009 and 2010

Lagged values of the investment measures (LHS)

Profit rate

A measure of employment

Interaction terms to account for possible non-

linearities



Other Regressors

Concentration Ratio – market share of top 4 firms

Does market structure predict innovation and investment

behavior?

Research and Development?



Descriptive Statistics



A QUICK LOOK AT THE REGRESSION RESULTS

4 sets of regression results :

1 per investment measure

Per set , 6 models



OLS Results – Total Capital Expenditures (LHS) (1)









OLS Results – New Tangible Assets (LHS) (1)









OLS Results – R and D Expenditures (LHS) (1)









OLS Results – New Entrants (LHS) (1)









Findings (1)

Investments seem to be better explained by a flexible,

rather than a simple accelerator model

• Current and previous output levels explain investments

• Higher previous investments predict more current

investments



TOTAL MARGINAL EFFECTS OF TAX RATE

Findings (2)

Investments are negatively related with tax rates • The prediction reduction in investments is substantial:

for every percentage point increase in tax rates, the reduction

in investments is 6-8 percent.



Findings (3)

Investment expenditures are positively related with

subsidies

• A 1000 peso increase in PEZA incentives in industry groups is

associated with a 434-865 peso increase in investments

• Selected sectors with PEZA incentives have greater increases in

investment activity:

• Manufacturing (66 to 649 increase in investments per

1000 peso increase in PEZA)

• Information & communication industries (22,000 increase

in investments per 1000 peso increase in PEZA).



TOTAL MARGINAL EFFECTS OF FISCAL INCENTIVES on INVESTMENTS

By specific industries:



Findings (4)

Higher tax rates (subsidies) predict lower (higher) R and D

expenditures

A 1 percentage point increase in tax rates will reduce R and D

expenditures by 1.9 percent for a given level of lagged R and D

expenditures



Findings (5)

Tax rates do not predict changes in the market structure

(change in number of firms).

Selected industries with PEZA incentives have grown in

size (more establishments) from 2009 to 2010

Notable finding, given that the general trend in 2009 to

2010 is that industries have fewer firms, on the average



Findings (6)

Older firms have higher level of R&D expenditures

of firms.

Concentration ratios predict larger investment

expenditures (Models D)



Supplemental Results from Time Series Analysis

Marginal effects of a 1 ppt increase in tax rate on

investment rates • A 1 ppt increase in the statutory corporate tax rate predicts a

P22 Billion decrease in GCF a year after

• Equivalent to 1% of average GDP and 3% of average GCF

in constant 2000 prices.

Can we show comparability with cross section results? • Yes.

Revenue Implications of a 5 ppt reduction in taxes

A CONSERVATIVE ESTIMATE: Does not yet include revenue gains from increased FDI.



Concluding Remarks (1)

Tax payments are burdensome to firms.

Tax rates matter to investments in all industries; they

matter more for industries that already have investments.

Our results suggest that tax rates in the range of 25

percent (as proposed by some) could help achieve

investment rates (GCF) of Indonesia, Vietnam and

Thailand.




On the whole, fiscal incentives could be productive

(investment-promoting)

Yet, there are indications that there is scope for rationalization

(e.g., choose sectors to support)

Important for government to keep collecting firm and

industry level data so that debates on taxation can be

evidence-based

Further research: can simplifying the tax regulations

increase tax effort via increased compliance and business

expansions? (now feasible with TIMTA)




On tax reform:

Consider lowering CIT to 25 percent

Conservative assessment on revenues: better than neutral; should

increase if increase in FDI is considered

Rationalize fiscal incentives

Lowering of CIT should be accompanied by other measures such

as simplifying complex tax regulations



THANK YOU

Documents

Review of Corporate Income Tax Policy in the Philippines