Foreign investments

[ANALYSIS] Will Duterte’s new tax measure kill foreign investment?

The sequel to the controversial TRAIN law, called Citira, pits two key economic agencies against each other.

Citira, which stands for Corporate Income Tax and Incentive Streamlining Act, is formerly known as the Trabaho Bill, which the House already passed its third and final reading in the previous Congress, but has ran out of time in the Senate.

On September 9, the House of Representatives passed Citira second reading.

The Ministry of Finance (DOF) claims that Citira will do good for the country. Still, the Philippine Economic Zone Authority (PEZA) says this tax reform measure will scare away investors and hurt the economy as a whole.

What is Citira’s goal? Will it really hurt foreign investment and kill the goose for our economy?

Decline in foreign investment

First, note that foreign investment is falling rapidly.

Figure 1 shows that after rising steadily over the years, foreign direct investment (FDI) has started to fall since the middle of last year.

Of all the components of FDI, the largest decline can be seen in “net equity”, which is just the net inflow of outward investment. Simply put, investments are withdrawing at a faster rate than they are coming into the country.

In particular, FDI in the manufacturing sector and those from the European Union and ASEAN declined the most.

Figure 1.

Figure 2 below shows that there is also a steady decline in the number of approved Foreign investments.

Investments approved by PEZA saw the largest decline, partially offset by investments approved by the Board of Investments (BOI).

Figure 2.

‘Unli’ advantages

It is against this grim backdrop of foreign investment that the Duterte government is pushing for the Citira bill.

Citira has two main objectives which, on closer inspection, actually make a lot of economic sense.

First, Citira aims to reduce the rate of tax paid by corporations on their income.

Today, the Philippines has the highest corporate income tax (CIT) rate in ASEAN, at 30%. Reducing this rate to 20% over the next decade will go a long way to making our tax system more competitive in ASEAN and attracting more investors.

At the same time, however, Citira aims to make it harder for some investors to take advantage of the “unli” benefits that they have enjoyed — indeed, abused — for a very long time.

In 2017, our government spent P441 billion on investment incentives for just 3,150 companies. This represents 2.8% of our country’s revenue that is channeled to only 0.3% of registered companies, just to incentivize them to continue doing business in the country.

About a fifth of all companies in economic zones have also benefited from investment incentives for more than a decade already. In contrast, the investment benefits of other ASEAN countries are highly targeted, conditional on performance and expire after a certain date.

In sum, the DOF sees Citira as an opportunity to curb some of those extravagant but unnecessary investment benefits.

Kill the goose with the golden eggs?

Naturally, PEZA has a completely different view of Citira. For them, such a law will kill the legendary goose that lays the golden egg.

Currently, PEZA operates nearly 400 ecozones nationwide, hosting approximately 3,558 businesses (“location businesses”) in various sectors like manufacturing, agribusiness, and IT.

PEZA argues that the incentives its companies receive pale in comparison to the value they generate for our economy.

From 2015 to 2017, PEZA says its companies got a total of P879.1 billion in investment incentives but generated more than P7 trillion in export earnings, in addition to other expense items.

According to PEZA calculations, every peso spent on incentives yields P11.4 in economic benefits.

This figure, while seemingly impressive, can be inflated because it not only includes the value of final goods (as is often the case), but also the value of worker wages and corporate taxes.

Unsurprisingly, that number is also a far cry from the DOF’s own estimate of incentive benefits, which range from just 60 centavos to P1.23 per peso in incentives.

PEZA Director General Charito B. Plaza’s opposition to Citira was clear and clear.

In one of PEZA’s presentations before the Congress, a slide showed in capital letters: “PEZA IS NOT BROKEN. PLEASE DO NOT FIX IT. At the very least, Plaza hopes PEZA will be spared Citira once it passes.

Because of this adamant stance against Citira, some assume that Plaza is the female economic manager that President Duterte wants out due to alleged underperformance.

Caught in the crossfire

Amid the ongoing debates and wrangling over Citira between DOF and PEZA, one thing is certain: investors are caught in the crossfire.

Some analysts even attribute the recent drop in foreign investment to the cloud of uncertainty created by Citira.

Recently, the DOF trumpeted a 112% increase in foreign investments approved in the first half of 2019. For them, this contradicts the assertion of “vocal naysayers” that investors are scared off by Citira.

While the figure is correct, it masks the overall downward trends in foreign investment seen in Figures 1 and 2.

At present, potential investors would delay their expansion into the Philippines or consider investing in other ASEAN countries like Vietnam. This is completely understandable: investors won’t invest until they know exactly what taxes and benefits they will end up paying and receiving.

Tax competition within ASEAN is indeed intensifying and Vietnam is now proving to be the fastest growing investment hub in the region.

For example, most of Samsung’s smartphones are now made in Vietnam, and Samsung plans to further expand alongside other tech giants such as Intel and Microsoft.

Many Chinese companies affected by the ongoing trade war between the United States and China are also seeking refuge in Vietnam. Thus, Vietnam is widely expected turn the escalation of trade tensions to its advantage.

A recent study by the Asian Development Bank also found that the Philippines could also benefit from the US-China trade war – but only if we can attract enough investors our way.

Until Citira is installed soon, however, we cannot expect foreign investors to flock to our country in droves just yet.

The worst problems

As far as we know, investors can bluff.

Even if Citira succeeds, many investors will likely choose to come in and stay because of the other redeeming factors in our economy, such as our young, educated workforce and our investment ratings.

Yet our government must also ensure that the country’s investment climate remains sufficiently attractive, even without an overabundance of tax incentives.

Worryingly, red flags are beginning to appear in our economy. In the last quarter, GDP growth continued to fall below target, private investment declined, agriculture remained sluggish and construction of infrastructure projects failed.

In other words, many other things could make or break our country’s appeal to investors. Citira’s stricter investment incentives are perhaps the least of our worries. –

The author is a PhD student at the UP School of Economics. Its opinions are independent of the opinions of its affiliations. Thanks to Jérôme Abesamis for his valuable advice and comments. Follow JC on Twitter (@jcpunongbayan) and Usapang Econ (