Incentives for the rich harm the poor

Our latest report deals with how tax incentives amounting to billions of pesos are being given to big companies that have no need for them. It cites the P13-billion in incentives given by the Board of Investments to telecommunications companies putting up 3G operations, even if these companies have decided to carry out the projects — with or without incentives.

Tax incentives are meant to attract and encourage investments. Yet they are being given mostly to for high-return projects being undertaken by big, profitable companies that practically own the entire domestic market for their product or service. These firms have no need for incentives to encourage them to invest.

And yet, as this report by business journalist Roel Landingin shows, such incentives are routinely being provided to mobile-phone providers, power plants, water services and other business activities that cater to domestic customers as well as to “resource-seeking” projects such as mining and call centers.

This report is timely as it is being released just as the Senate is set to begin deliberations on a bill that seeks to overhaul the country’s system of tax incentives. Authored by Senator Ralph Recto, Senate Bill No. 2411 wants to do away with tax and duty exemptions for companies serving the domestic market, except those located in the country’s poorest 30 provinces. Tax and duty breaks will continue to be granted to exporters although the type of incentives and the way they are administered will also be changed.

IT TAKES the tax bureau’s southern Makati district office, housed at the Atrium building along Makati Avenue, about a year to collect P13 billion in taxes. Just a few blocks away, another government agency, the Board of Investments (BOI), took just 14 working days to decide to grant the same amount in tax exemptions to two of the country’s most profitable companies — Globe Telecom Inc. and Smart Communications Inc.

The BOI accepted Globe’s application for a four-year income tax holiday for its P5.5- billion 3G (3rd generation) mobile wireless communication project last April 27. Nine working days later, on May 10, the agency approved P2.87-billion worth of tax exemptions for the project, which is expected to earn an average 22-percent return on investment and 37-percent return on equity in its first five years of operation.

Less than a week after, Smart filed a similar application for its P33.2-billion 3G project, which is expected to post an eight-percent return on investment and 14-percent return on equity over the five-year start-up period. Though Smart’s P7.96-billion tax exemption is nearly thrice that of Globe, the BOI approved the application in almost half the time.

A timely objection from the Department of Finance prompted the BOI to freeze the approval of fiscal incentives for Globe and Smart’s 3G investments. The finance department, which is struggling to boost tax collection to fund higher spending for infrastructure and social services while cutting the budget deficit, wants to review if the tax exemptions are still necessary for the 3G investments to push through.

Fiscal incentives, after all, are meant to attract and encourage investments. Yet the two phone companies have pretty much decided to carry out the projects — with or without incentives. Some of their officials say they asked for the tax perks to hasten the pace of investment in 3G wireless technology.

Manuel Pangilinan, chairman of the Philippine Long Distance Telephone Co. (PLDT), parent firm of Smart Communications, says the company needs the incentives “so we can accelerate the period of losses from x years down to y years. We make money and we pay taxes sooner than later.”

He does not understand what the fuss is all about: “In the first three years of 3G, people won’t be making money anyway. We’re not gonna pay taxes.”

But the furor over Globe and Smart’s aborted tax exemptions has raised important questions about the need for giving incentives to what are expected to be high-return projects being undertaken by big, profitable companies that practically own the entire domestic market for their product or service.

The controversy also comes just as the Senate is set to begin deliberations on a bill that seeks to overhaul the country’s system of fiscal incentives. Authored by Senator Ralph Recto, Senate Bill No. 2411 wants to do away with tax and duty exemptions for companies serving the domestic market, except those located in the country’s poorest 30 provinces. Tax and duty breaks will continue to be granted to exporters although the type of incentives and the way they are administered will also be changed.

Citing international studies, Prof. Renato Reside Jr. of the UP School of Economics explains that fiscal incentives have varying degrees of effect on the decision to invest or not, depending on the motivation that is driving the investment. He says incentives matter most for so-called efficiency-seeking investments such as electronics and semiconductor exporters who locate in the country primarily to reduce per-unit production costs.

But incentives have little or no effect on two other types of investments: a) market-seeking ventures such as mobile phones, power plants, water services and other business activities that cater to domestic customers; and b) resource-seeking projects such as mining and call centers.

Unfortunately for the Philippines, a sizeable proportion of investments granted tax and duty exemptions are either market-seeking and resource-seeking, according to Reside who closely examined investments registered with the BOI, Philippine Economic Zone Authority (PEZA), Subic and Clark.

He estimates that up to 90 percent of the tax and duty exemptions granted by the BOI are “redundant” as these went to companies selling goods and services to domestic customers rather than the export market. At PEZA, which has overtaken BOI as the biggest giver of incentives, redundant incentives account for 10 percent of all tax exemptions; at the Clark Special Economic Zone, the comparative figure is 36 percent and at Subic Bay Metropolitan Authority (SBMA), 17.5 percent.

Companies availing themselves of incentives for the biggest projects with the BOI are also some of the country’s largest and most profitable, and belong to its wealthiest and powerful families, according to a ranking by PCIJ of all BOI-registered projects from 1969 to the first half of 2006.

Of the 10 companies that registered the biggest projects, seven are owned, controlled or run by some of the Philippines’ best-known family-based conglomerates such as the Lopezes, Ayalas, Gokongweis and Cojuangcos. Maynilad Water Services Inc., the joint venture set up by the Lopezes with the French engineering group Suez, topped the list. The Ayalas’ Manila Water Co., a joint venture with United Utilities of UK, was No. 3 while the family’s telecommunications unit, Globe Telecoms Inc., was No. 8. The Gokongweis also had two companies in the top 10 list-Digitel Telecommunications Inc. and JG Summit Petrochemicals Inc. The family of Antonio Cojuangco Jr. owned PLDT and Pilipino Telephone Co. before these were sold to First Pacific of Hong Kong in 1998.

Only one of the 10, GN Power Ltd., is completely foreign-owned. The government put up the remaining two, PNOC Petrochemical Development Corp. and Petron Corp., though the latter is now controlled by a Saudi Aramco unit.

The top 10 companies accounted for only 30 projects or 0.4 percent of the more than 7,500 ventures registered with the BOI over the last three and a half decades. But their P720-billion combined project cost made up about 36 percent of the total, which stood at P1,994 billion as of end-June 2006. This suggests they also got a sizeable proportion of the total incentives granted by the agency.

None of the top 10 is mainly an exporter. All cater to domestic customers in highly regulated or oligopolistic markets dominated by just a few players. Maynilad and Manila Water are monopolies in their respective water zones in Metro Manila. Petron, which has the fifth biggest project in the list, accounts for 40 percent of the domestic petroleum market. Similarly, PLDT, including subsidiary Piltel, and Globe are the country’s No. 1 and 2 telecommunications groups, while Digitel is a far third. PNOC Petrochem and JG Summit Petrochem are among the country’s biggest petrochemical makers.

In a paper on fiscal incentives, former economic planning secretary Felipe Medalla writes, “It is not surprising that much of BOI’s tax incentives are redundant since those who lobbied for incentives were really much less concerned with correcting market failure than with raising the rate of return to capital invested by domestic capitalists hurt by trade liberalization.”

Interestingly, five of the companies with the next 10 biggest projects are all independent power producers that made billions of pesos in profits out of what many consider to be onerous power purchase agreements with either the state-owned National Power Corp. or Manila Electric Co. These include GN Power, San Roque Power Corp., Mirant Sual Corp., Kepco Ilijan Corp., First Gas Power Corp, and Quezon Power (Philippines) Ltd. For some years, these companies were among the country’s most profitable.

According to Reside, the projects granted incentives were expected to earn an average return on investment of 15 percent or higher.

Manila Water, the joint venture of the Ayala Corp. and UK’s United Utilities, in fact made money on its second year of operations and, last year, launched the country’s biggest initial public offering since 1997, when a financial crisis began in Asia.

Documents seen by the PCIJ also show that the return on investment in Globe’s 3G project is expected to reach 15 percent in the second year and will rise to 40 percent in the fifth year. Similarly, Smart’s 3G investment is projected to yield a return of six percent in the third year of operations, rising to 19 percent in the fifth year.

BOI managing head Elmer Hernandez, however, says the agency granted income-tax holidays to Globe and Smart because these were included in the Investment Priorities Plan (IPP), a list of preferred economic activities that is drawn up by several government agencies and approved by the president and the entire Cabinet. Criticisms thrown at the BOI for approving the incentives are misplaced, he says, adding that critics inside and outside government should have participated in the IPP process to exclude telecommunications from the list. “They are barking up the wrong tree,” he says.

Some companies that have enjoyed tax holidays also say they share their benefits with their customers. For example, Manila Water’s chief finance officer Sherisa Nuesa says, the tax perk the firm got from BOI helped reduce its borrowing requirement by boosting cash flows in the initial years of the 25-year concession agreement. Thus, she says, “we were able to begin expansion projects in the Rizal towns of Antipolo, Taytay, Cainta, San Mateo and others ahead of schedule.” And because Manila Water is a regulated firm, benefits from lower borrowings were passed on to its customers, she adds.

Then again, Manila Water didn’t need the tax holiday in the first place because income taxes are reimbursable expenses under its concession agreement. In other words, the company is allowed to avoid the tax by passing them on to customers, making an income-tax holiday superfluous. “The tax holiday has no effect on Manila Water’s decision to invest,” says Medalla, who also consults with the government’s Metropolitan Waterworks and Sewerage System.

But one implication of fiscal incentives going to the country’s biggest and most profitable companies is that it contributes to the worsening disparity between the rich and the poor. Says Reside: “Across classes, it is mostly capitalists who have mostly benefited from fiscal incentives, the poor and middleclass taxpayers have borne the brunt of the fiscal cost of incentives.”

Medalla says that because the cost of collecting taxes is high, a peso gained by wealthy beneficiaries of tax incentives could be equivalent to as much as two pesos worth of foregone spending for infrastructure and social services for the poor. He told a forum on fiscal incentives in June, “The people who benefit from the subsidy would probably use the money on luxury whereas people who are deprived of the money — it’s a question of whether they will eat for the day or not.”

As it is, the Philippines stands close to the bottom in many global competitive rankings, especially in relation to the indicators of the quality of infrastructures and human capital, such as road density, public spending on education and student-teacher ratio.

Reside says that cutting redundant incentives can go a long way in improving the country’s infrastructure and human capital. Every peso spent for education, for instance, raises functional literacy by 0.04 percent while each peso for road construction increases the length of paved roads by 0.14 kilometers.

“Ultimately,” he says, “the country’s competitiveness as a destination for both foreign and domestic investment lies not in fiscal incentives, but in expanding access to input markets, reasonably priced skilled labor and managerial ability (a particular strength of our country); access to ports (infrastructure); and access to vibrant markets, both foreign and domestic.”

But Hernandez insists that when judiciously applied, incentives can be a crucial government policy tool for economic development. He says incentives can draw investments to certain industries critical for the country’s rapid growth, help compensate for a weak or unattractive investment climate, and support local industries amid trade liberalization and globalization.

He also says incentives can level the playing field between local goods and imported goods that enjoy subsidies from the exporting country. “Thai patis (fish sauce) has overtaken our own patis even though the Thais just copied it from us because the Thai food processing industry enjoys enormous incentives from the Thai government,” he points out.

With the fierce competition for foreign direct investments in Southeast Asia, the Philippines cannot afford to do away with incentives especially when countries like Thailand and Malaysia are offering much more generous incentives while having better infrastructure and educational systems, Hernandez argues.

PLDT’s Pangilinan also says a drastic policy change on incentives may rattle investors. “What are you signaling to investors both domestic and foreign?” he asks. “That you can change it? Sure you can change it. But if you do that, why will I invest here?”

“Thailand does not change its tax laws,” he says. “And Indonesia and Singapore when they say that’s it, that’s it. You can operate long-term on the basis of that environment.”

In the weeks and months ahead, beneficiaries of tax incentives are expected to flex their power and influence once more as the Senate holds plenary debates on Recto’s fiscal incentives rationalization bill.

In January 2005, the House of Representatives passed a counterpart bill with little fuss as it merely rationalized the system for giving incentives. But Recto’s bill not only seeks to eliminate incentives for most domestic-oriented investors, it also plans to create a tax expenditure fund, a more transparent and explicit way of administering fiscal incentives by treating these as expense items. As such, they are subject to budgeting and accounting.

Exporters, meanwhile, can expect tightened control and monitoring of their tax and duty breaks. For example, income tax holidays or exemptions will be replaced with lower taxes (either a 15-percent tax on net income or five-percent tax on gross income) and rules that will help lower income tax liabilities such as longer periods for carrying losses in the initial years of operations, and shorter periods for depreciating fixed assets.

Imports of capital equipment and raw materials will continue to be duty-free for exporters. But value-added taxes must be paid on such imports, and refunded later after the goods made with the imported raw materials and equipment are shipped abroad. The tough measure aims to prevent producers and traders selling to the domestic market from availing themselves of an incentive meant only for exporters.

Already, domestic-oriented investors are objecting to the bill. But even exporters are apprehensive. They are horrified by the prospect of having to seek value-added-tax (VAT) refunds from the government considering that the Bureau of Internal Revenue and Bureau of Customs (BOC) takes almost a year on average to approve claims.

The bill addresses this worry by requiring the BIR and BOC to decide within 30 days of receiving the applications. It also creates a trust liability account, where the exporters’ VAT payments will be deposited, to facilitate refunds.

But it is likely that the Recto bill will have a tough fight ahead. Medalla’s scorecard says it all. At a recent public forum, he began his speech by saying that his record in fighting for limiting tax and duty exemptions — starting from 1986 when he was helping former Economic Planning Secretary Solita Monsod, to 1999 when he worked with Senator Juan Ponce Enrile — was 3-0: three losses and no wins.

ERRATUM

GN Power was mistaken included in an enumeration of independent power producers that made money out of what many consider as onerous power purchase agrements with either the National Power Corporation or Manila Electric Co. GN Power has yet to start commercial operation and has no power purchase contract with either Napocor or Meralco. Besides, the enumeration referred to companies that ranked somehere between 11th and 20th in a list of companies with the biggest projects registered with the Board of Investments. GN Power was No. 2 in that list, and should have not been included in the enumeration. PCIJ regrets the error.