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Revisiting Tax Incentives

(Article published in the Aug 4, 2010 issue of Manila Standard Today)   

 Ayala Land Inc. chief fiance office, Jaime Ysmael, was quoted last Thursday by one of the daily morning broad sheets as saying, with respect to the much-awaited and in the opinion on some “long-delayed,” Bureau of Internal Revenue Regulations on the Real Estate Investment Trust Law (R.A. No. 9856):

 “I guess the concern is the immediate revenue loses that they foresee.  They are worried about the budget deficit but we hope they will see the bigger picture, which is really the overall effect on the economy.  New money will be invested, which means new employment and new compensation and there will be VAT [value-added tax] on the materials that we will use.  All these, if we add up, will have a huge impact.”

 At noon of the same day, my former student and now BIR Commissioner, Kim Jacinto (actually “Kim Henares”; but somehow I cannot get over the practice of calling them by their name in class) was, at the General Membership Meeting of the Tax Management Association of the Philippines, Inc. held at the Mandarin Oriental Hotel, Makati City. Kim was asked, in the open forum after her extempore talk, what precisely were her objections to the REIT law.

 The good Commissioner, with neither notes nor previously prepared spiel, candidly responded and mentioned at least two of her concerns, one of which was her serious doubt on whether the REIT, by itself, would actually deliver, by way of compensation for the revenue loss resulting from the law’s many tax incentives, on its promised benefits to our economy.

 The good Commissioner in questioning the effectivity of tax incentives in attracting investments, has a point. 
  










     

The grant of tax incentives is premised on the proposition that they will induce domestic and foreign investors to put their money in the tax favored economic activities which they would not otherwise undertake, or increase their investment, if they are already in.  It is assumed that the amount that the government collects in taxes is a major determinant in the decision of investors to put their money at risk in a country or not. Two reasons are given:  first, because lower taxes shorten the period within which the investor recover his capital and increase the pool of profits that can be reinvested, and second, it is supposed that the publication of generous tax benefits constitute good advertising for the country that will inevitably result in investors taking the bait and risking their money in the economy.

 The literature on tax incentives, I am sad to play the kill-joy has long debunked that idea.  As early as 1973, authorities on tax and economic policy Romualdez, Yoingco and Casem, in their Philippine Public Finance, espoused the view that “the particular role of taxation (in the investment decision) is highly indeterminate.”  They pointed out that “investment decisions are subject to a wide range of rational and irrational factors which vary over time.  Among the factors that bear upon the prospective investment are the investor’s judgments about the present and potential market, the adequacy of credit, raw materials, labor, power, transportation, distribution facilities, skilled technicians and managerial personnel, and the general status of the political and monetary system.”

 Stressing the difficulty of pinpointing the salutary impact of tax incentives, the authors explain: “The existence of high taxes does not necessarily indicate that profits will be low.  Similarly, low taxes do not by any means assure that profits will be high.  Where the level of of education, health, transportation and market facilities and power and water supplies are adequate, investors may be able to realize far greater profits despite high taxes than were tax burdens are low and these facilities are lacking or insufficient.”

 Thus, they conclude, “the best incentive laws cannot be effective if, for one reason or another, there is unwillingness on the part of the prospective investors to commit their resources for a considerable period of time.  Similarly, tax incentives fail to attract investments in a situation where the economic policy of the country is considered to be unsound or inefficiently implemented.”

 Romualdez et al’s observations are supported by international experts on tax incentives.  Indeed, instead of merely considering them “indeterminate”, foreign experts are more unequivocal.  Jack Keller and Kenneth M. Kauffman, in their Tax Incentives for Industry in Less Developed Countries, published by the Law School of Harvard University, maintain that “for many economically less developed countries the tax system is relatively unimportant, compared to the other factors impeding investment.  The more important obstacles to investment in most of these countries are characteristically either the underdeveloped state of the economy itself or a fundamental lack of resources, or both.”

 This does not mean that the overall tax system itself is unimportant to investors.  Said experts admit that “any prediction as to the general efficacy of tax incentives in a particular country must, at a minimum quite apart from appraising the many other factors bearing on investment behavior, be based on an appraisal of the existing tax system that the tax incentives are designed to modify...”

 They submit that in such countries where the tax system is thoroughly flawed, “a reform of the basic tax system to increase revenues either by higher rates or by adequate enforcement, or by both, might well serve as a better incentive to industrialization by providing revenues for the substructure of governmental services needed in an industrialized economy, and by eliminating tax preferences to activities of questionable developmental value.”

 I am thus elated and encouraged by the off-the-cuff response of Kim to the question from the floor of the TMAP meeting that ever so politely pointed out that the country has long been waiting for the regulations on the REIT.  There is the bigger picture to consider, as suggested by Mr. Ysmael of Ayala.

 But that bigger picture, if this columnist from Tondo may suggest, goes beyond the uncritical acceptance of tax incentives’ ability to woo investors and extends deep into the capability of the tax system, as a whole, to convince that what are paid in taxes go back to society a hundred fold in terms of government services.

     

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