By Arjay Mecado and Filomeno S. Sta. Ana III
With marching orders from no less than President Rodrigo Duterte himself, expect Congress to approve the Corporate Recovery and Tax Incentives for Enterprises (CREATE) bill. What the final bill or law will be is a different matter. The devil is in the details.
The ongoing discussion in the Senate, particularly the period of amendments, is critical in determining CREATE’s impact. The hope is that it will not only serve as a stimulus in the wake of the pandemic-induced recession, but arguably more important, it will serve as a long-term instrument to rationalize and modernize the rules of investment promotion and the accompanying regime of fiscal incentives.
It is important that we determine which amendments to the CREATE bill are favorable and which are harmful. We caution our legislators and the public on deal-breaking amendments that can ultimately kill the very purpose of the Act.
Let it be said that CREATE is a good piece of legislation.
Recently, in light of the concern over how businesses can weather the pandemic, the stakeholders have given more attention to the provision on the sharp reduction of the corporate income tax (CIT) from 30% to 25% in the first year of CREATE’s implementation. The immediate sharp reduction of the CIT is the stimulus component of the bill, even as the lowering of the CIT itself is a structural adjustment to address long-term tax competitiveness.
However, the bill is not just about CIT reduction. The fiscal incentive rationalization (FIR) component of the law is most essential.
Here is a recapitulation of the arguments for rationalizing fiscal incentives. Fiscal incentives are a tool to encourage new investment in strategic areas (where there is market failure), thereby spurring transformative growth and quality employment. Unfortunately, the current practice of fiscal incentives has been problematic. Often, the fiscal incentives are given arbitrarily, with the economic criteria based on rigorous cost-benefit analysis being ignored. A significant number of the incentives are redundant; that is, even without the incentives, the investments would still have happened because investors have other weightier determinants. Worse, the incentives are given in perpetuity, running counter to the principle of making incentives time-bound.
The FIR component of CREATE addresses the issues enumerated above. CREATE provides incentives to new investments that yield high social benefits — creating formal jobs, introducing cutting-edge technology, and producing positive spillovers such as in research and education. CREATE puts in place measurable performance indicators and a reasonable time horizon on the effectivity of incentives. It introduces flexibility of incentives by offering a menu that is not limited to tax incentives.
It upholds transparency, and one proposed amendment to strengthen this is to disclose the list of incentives recipients, benefits data, and compliance with performance targets in the Publication Requirement of the Fiscal Incentives Review Board (FIRB). Good governance is anchored on the FIRB, which will ensure that the goals of investment promotion and fiscal soundness are both met.
But here is disturbing news. A senator, whose record is to dilute or kill progressive tax reforms, is actively but silently campaigning to insert amendments that will undermine the fiscal incentive reforms. Some of his proposed amendments are red flags. To wit: giving the Court of Tax Appeals the power to veto decisions of the FIRB; introducing a graduated (non-unitary) tax rate for corporations; and the “grandfathering” of incentives, which will retain the benefits of existing registered enterprises.
Having another body to overrule the FIRB is a recipe for gridlock and prolonged uncertainty. Besides, the judiciary must not overreach, and its role is not about making or executing economic policy. A graduated rate burdens tax administration, and is prone to being gamed for tax evasion. Grandfathering of incentives is but protecting a few — it violates fairness and equity and destroys competition. These proposed amendments overwhelm the very objectives of legislating CREATE. They have to be thoroughly rejected.
To be sure, the current version of the bill can stand improvement, and hence amendments are most welcome. We have mentioned, for example, the need to strengthen the transparency mechanisms. In the area of CIT reduction, the concern of economists regarding its effectiveness merits a hearing.
A stimulus measure has to deliver the bang for the buck; otherwise the resources are wasted. By itself, a tax cut has limited effectiveness unless it is tied to inducing new investments and jobs or preserving jobs. The goal of a stimulus is to provide wages or income to the workers and poor households, which will be used for consumption, which in turn will boost aggregate demand. But it is also possible that the behavior of corporations gaining from the tax cut would not result in a stimulus or a huge multiplier.
Thus to strengthen the stimulus part, it is appropriate to have amendments that the sharp cut in the CIT from 30% to 25% in the first year be tied to job preservation. Specifically, the amendments include temporary restrictions (limited to two years or during the period of emergency) on paying dividends (that benefit the well-off whose propensity to consume is much lower) or purchasing equity security of the corporation. This will nudge corporate behavior to use the tax gains for job preservation or creation.
As we head towards the final stretch in the legislation of CREATE, let us remain vigilant. Encourage our legislators to support CREATE. Welcome the introduction of good amendments that will strengthen the governance of fiscal incentives and that will be responsive to jobs. And call out any legislator that will insert egregious amendments that violate the intent of the reforms.
Arjay Mercado leads the tax team of Action for Economic Reforms (AER) and Filomeno S. Sta. Ana coordinates AER.