Why we attract the lowest FDIs in the ASEAN region

THE PHILIPPINES was one of the most aggressive in pushing for accelerating the establishment of the ASEAN Economic Community from the original 2020 target year to 2015. But now that the start of the ASEAN integration is just around the corner, the Philippines would now appear to be least attractive investment destination in the ASEAN region. What a pity!

By end-2015 and beyond, foreign investors will vote with their feet. They will choose to invest in countries with a good governance record, a favorable tax regime, and superior public infrastructure.

If a foreign investor were to invest in one of the fastest growing region in the world, where would it invest? A strong candidate is the ASEAN-6 region consisting of Indonesia, Malaysia, the Philippines, Thailand, Singapore and Vietnam. With ASEAN integration, a foreign firm investing in any of these countries, or even in other emerging ASEAN countries (Laos, Cambodia and Myanmar), would have access to a huge consumer market of 620 million and a regional economy that is estimated to grow to $3.8 trillion by 2017.

But among the ASEAN-6 countries, which will be the foreign investors’ most preferred country of destination? Sadly, based on the tax system and the state of public infrastructure, the Philippines will be the least preferred destination.

Among ASEAN-5 economies, the Philippines has the highest total tax rate as percent of commercial profits: 44.5%, as opposed to Singapore’s 27.1%, Thailand’s 29.8%, Indonesia’s 32.2% and Malaysia’s 36.3%. Yet, we have one of the lowest tax-to-GDP ratio: 12.8% as opposed to Thailand’s 17.6%., Malaysia’s 16.1%, Singapore’s 13.8% and Indonesia’s 11.8%.

In fact, our statutory corporate tax rate is the highest in the region at 30%, with Singapore as the lowest at 17%. Other things equal, where do you think foreign investors invest — the Philippines or Singapore? That’s a no-brainer, of course. And if you throw in Singapore’s superior infrastructure and low cost of doing business, the choice is even more obvious.

Thailand and the Philippines started with the same high statutory corporate income tax (CIT) rate at 30%. But Thailand has responded to the need for tax harmonization by reducing its CIT rate from 30% to 26% in 2012 and to 20% in 2013. The Philippines, on the other hand, has stood firm.

How does one explain the high CIT rate and the low tax effort? First, rampant smuggling: high statutory rates do not always guarantee higher tax collection. In fact, the higher rate encourages tax evasion.

Second, the proliferation of redundant fiscal incentives renders the tax base narrow and hence less collection. Tax holidays have been estimated, conservatively, at one percent of GDP.

Third, poor tax administration. The Bureau of Internal Revenue under Commissioner Kim Henares has probably reached the limit what administrative reforms can do. The tax system is too complex for a country like the Philippines. It needs to be simplified.

Economic theory suggests that the higher the marginal tax rate, the higher the deadweight loss, that is, the excess burden of taxation. Tax policy suggests that, for a given revenue target, the best way to reduce the deadweight loss is by reducing the tax rate accompanied by broadening the tax base.

CUT CORPORATE TAX RATE, RATIONALIZE INCENTIVES

But why do tax rates have to be high if it imposes a heavy burden to society? Because the tax base is narrow. But why is the tax base narrow? Because of the proliferation of tax incentives. Simply put: the government can afford to lower CIT rates if the tax base is broader, and the tax base could be broader if there were fewer tax incentives.

Why not rationalize fiscal incentives then? It’s been tried before but without success. Several administrations — Ramos, Estrada, Arroyo, and even Aquino III — tried to streamline fiscal incentives, remove redundancies, and make incentives performance-based.

But the proposed reform to rationalize fiscal incentives has failed because of strong political lobbying by vested interests. Fiscal incentives are what I call “pork barrel on the tax side.” Tax incentives are enjoyed by select industries and are protected by some politicians. In fact, politicians love to give away fiscal incentives in return for financial support from the favored groups in future elections.

The bottom line: the CIT can be reduced to more competitive level, say at 25%, if only the corporate tax base is broadened by rationalizing fiscal incentives.

Rationalizing fiscal incentives is good economics, but poor politics. But why can’t the Aquino III administration that is committed to the “straight path,” to doing what is right, do the right thing?

CRUMBLING PUBLIC INFRASTRUCTURE

Among ASEAN-6 countries, the Philippines has the second poorest quality of public infrastructure, according to the World Economic Forum’s 2013 Global Competitiveness Report. Out of 144 countries, the Philippines ranked 98 while Vietnam ranked 119 in terms of overall quality of overall infrastructure.

In terms of the quality of port infrastructure, the Philippines ranked the poorest at 120 while Malaysia ranked 21, Thailand 56, Indonesia 104 and Vietnam 113. In terms of air transport infrastructure, we ranked the poorest at 112 while Malaysia ranked 24, Thailand 33, Indonesia 89, and Vietnam 94.

Even before the power crisis in Mindanao, the Philippines ranked second to the worst in terms of quality of electricity supply. It ranked 98 while Malaysia ranked 35, Thailand 44, Indonesia 93, and Vietnam 113.

Little has been done since the Global Competitiveness Report came out in 2013. The much-vaunted public private partnership projects are bogged down by indecisiveness at the top and bureaucratic delays.

After three years, only six PPP projects have been awarded. The first and smallest project (the Daang Hari Highway) is only one-third complete. How many more PPP projects will be awarded, started, and completed before President Aquino III steps down from office, remain a big mystery.

In the meantime, the country’s stock of physical infrastructure has suffered a huge loss as a result of a series of man-made and natural calamities — the Zamboanga civil strife, the Bohol-Cebu earthquake, and the killer typhoon Yolanda.

Investment means a change in capital stock (It=Kt-Kt-1). This means increasing investment does not only mean new capital spending. It also means making up for the capital losses in 2013 due to natural and man-made calamities and natural rate of depreciation.

In the quest for better, ampler, and more reliable public infrastructure — a precondition for higher, sustained, and more inclusive growth — Mr. Aquino and his successor ought to have a vigorous, well-prepared, and well-funded catch-up plan of action.

A good plan is necessary but not sufficient. It has to be accompanied by an efficient and effective administrative machinery that will convert the plan into measureable outputs and outcomes. –Benjamin E. Diokno, Businessworld

(The author is Professor of Economics at the UP School of Economics and is former Secretary of Budget and Management.)