Trust and TRAIN 2

We had a very interesting and frank discussion of the controversial package 2 of the administration’s tax reform program at a meeting of the Foundation for Economic Freedom (FEF). This group of economists supported the first package, but there are pockets of dissent on the second.

The second package is about rationalizing our system of granting investment incentives. Apparently, because of the penchant of Congress to grant some incentive or another to supposedly promote investments, there are now 123 special laws on investment tax incentives. In 2015, government lost P301 billion due to various forms of tax incentives.

The rational thing to do, as proposed by Finance Secretary Carlos Dominguez is to repeal all those laws and consolidate them into a single omnibus incentives law. Among many reform measures, DOF wants to stop double registration for incentives.

Additionally, only new investment or activities shall be granted tax incentives. Expansions are signs of profitability, the DOF presentation observed, and need not be given incentives. Expansions can avail only of exemption from customs duty of capital equipment.

The definition of what constitutes an exporter was also tightened. Only those with 90 percent of sales actually shipped out to a foreign country will be considered an exporter entitled to benefits.

 Other items in the reform criteria: domestic firms included in the investments priority plan; one year relocation incentive for firms moving out of Metro Manila, and superior incentives for those locating or moving to lagging regions, conflict, and calamity-stricken regions.

One controversial proposal, which I cited last Friday, is to replace the five percent gross income tax, in lieu of all taxes, with a reduced income tax, rate of 15 percent based on net taxable income. There is fear this will open investors to harassment and corruption by the BIR. They prefer the gross income tax regime as it isolates them from contact with corrupt revenue examiners.

The thing is... the five percent gross income tax benefit is now enjoyed by the investor in perpetuity. None of the other ASEAN countries is as generous. This subject generated the most discussion last Wednesday evening.

Many FEF members told Usec Karl Chua they generally are in favor of reforms for so long as those reforms are not dependent on an assumption of an honest and competent bureaucracy. We cannot add the problem of exposure to BIR corruption on top of the list of negatives that an investor must consider before risking capital here.

Indeed, there was the suggestion to keep the optional standard deduction (OSD) at 40 percent rather than reducing it to 20 percent as proposed by the DOF. It was pointed out that OSD and tax on gross income are consistent with the objectives of tax reform – to simplify the code for ease of compliance.  

The OSD is a shield against harassment from the BIR. This shield is needed specially because there is no effective accountability mechanism against arbitrary and baseless deficiency assessments which are usually unsigned to evade responsibility.

The DOF also proposed that the grant of incentives would be the responsibility of a Fiscal Incentives Review Board. This will expand the authority to pass on investors applying for incentives beyond the Board of Investments that operates under the DTI. The FIRB will be co-chaired by the finance and DTI Secretaries.

Under the proposed reform, the DOF wants to grant incentives only to those who meet the following conditions:

It must be performance-based, meaning it will be granted based on actual job creation, exports, countryside development, modern technology transfer, or R and D.

It must be time-bound and no longer in perpetuity. DOF is thinking in terms of five years of income tax holiday and/or reduced rate with no extension, except for customs duty of capital equipment.

It must be targeted based on our investment priorities plan which can cover both foreign and domestic firms, and both export and domestic markets.

It must be transparent with the name of beneficiaries and estimated tax incentives to be reported by the Fiscal Incentives Review Board.

Other suggestions were made last Wednesday on how to make it work on the ground.

One suggestion is to confine the incentives to a small subset of companies or industries that are “footloose” or those that can easily move out to other countries, and to those that are highly employment intensive. This is because the country already heavily taxes employment through high rice and food prices, labor law rigidities, holidays, and payroll taxes.

But they also think incentives for this subset should be automatic and not dependent on negotiations with a bureaucracy. Outside of this small subset, incentives can still be given by a Fiscal Incentives Review Board or Economic Development Board, with representatives that will have development in mind, not just fiscal losses.

While our FDI or foreign direct investments have been growing lately, we are the lowest in ASEAN in FDI as a percentage of GDP. As a result, the DOF presentation observed, overall exports dropped as a share of GDP, reflecting lack of competitiveness.

Still, DOF pointed out that the lack of incentives is not a leading problem for doing business in the Philippines. The top three problems as of last year are inefficient government bureaucracy, inadequate infrastructure, and corruption.

Finance Secretary Dominguez should be lauded for bravely advocating a reform of our investment incentives system. But DOF must not assume their good intentions can be well implemented by a rather corrupt bureaucracy.

Opposition to some TRAIN 2 proposals is largely because of a widespread lack of trust due to corruption. This can only be corrected over time and with a serious clean up of the agencies on top of revenue collection or granting benefits.

Let’s see how Congress and the President himself will respond to the DOF initiative. The public opposition of PEZA director general Charito Plaza to the DOF proposal already means that much work is yet to be done.

Boo Chanco’s e-mail address is [email protected]. Follow him on Twitter @boochanco