Information about Asia and the Pacific Asia y el Pacífico
Journal Issue

Philippines: Selected Issues

International Monetary Fund. Asia and Pacific Dept
Published Date:
November 2017
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Information about Asia and the Pacific Asia y el Pacífico
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Does Taxation Stifle Corporate Investments1

This paper conducts a firm-level analysis of the effect of taxes on capital spending in member states of the Association of Southeast Asian Nations (ASEAN). Using panel data on nonfinancial firms over the period 1990–2014 and controlling for firm characteristics and country-level differences, it is found that taxation facilitates private investment (possibly by enabling public investment in infrastructure and human capital and proper functioning of institutions), but as the tax burden increases, its effect turns negative and stifles fixed investment growth. This adverse effect of higher tax burden is particularly pronounced in in the Philippines and Thailand, which may partly reflect the differences in the efficiency and quality of government spending funded by tax revenues.

A. Introduction

1. The interaction between taxation and economic activity persists as an important issue at the core of public policy. The global economy is on a recovery path, but maintaining the momentum will require sustained investment growth. In Asia, while gross capital formation remains high—increasing from the post-Asian financial crisis low of 29 percent of GDP in 1999 to 33 percent during the period 2011–15, there is considerable variation across countries in private fixed investments (Figure 1). It is critical to macroeconomic performance to understand the dynamics of corporate investment, which constitutes the lion's share of private investment. Empirical studies suggest that profitability and leverage are important in shaping investment behavior at the firm level, while macroeconomic, financial and institutional factors determine the overall conduciveness of the business climate. Accordingly, the effect of corporate income tax (CIT) on private fixed investments in ASEAN countries is investigated using firm-level balance sheet data on a large sample of nonfinancial firms over the period 1990–2014.2

Figure 1.Fixed Investment Trends

2. There is an extensive literature on the potential determinants of business investment dynamics, but the impact of taxation remains elusive. One strand of the literature uses firm-level data and, consistent with standard models of factor demand, focuses on output and the cost of capital (Hall and Jorgenson, 1967; Auerbach, 1983; King and Fullerton, 1984; Auerbach and Hassett, 1992). In particular, according the neoclassical model of investment, capital formation is a function of expected future profitability, leverage, and financing constraints (Summers, 1981; Hayashi, 1982; Hubbard, 1998; Kalemli-Ozcan, Laeven, and Moreno, 2015). While there are many empirical studies in this area of the literature, results differ substantially, especially with regard to the strength of influence of the tax component of the user cost of capital on capital formation in the private sector (Chirinko, Fazzari, and Meyer, 1999; Schaller, 2006; Gilchrist and Zakrajsek, 2007). On the one hand, taxation is expected to lower firms’ capital investment (and total factor productivity) by raising the user cost of capital, distorting factor prices, and reducing after-tax return on investment. On the other hand, taxation provides resources for public infrastructure investments and proper functioning of government institutions that are key to firms’ performance and hence appetite for new investment projects. As shown by Barro (1990) and, more recently, Aghion and others (2016), the overall impact of taxation on firm performance depends on the relative weight of these two effects, which can vary depending on the size of the government and the composition and efficiency of spending and taxation.

3. Tax policy and administrative reforms can unlock a virtuous circle of efficient governance and private investment. Empirical evidence indicates that excessive tax burden reduces incentives for capital spending by raising the user cost of capital and distorting resource allocations. A fair and efficient tax system is therefore key to promoting private investment and concurrently raising revenues for public investment in physical and human capital. To this end, a simpler CIT code can encourage entrepreneurial activity by new and existing firms and reduce compliance costs across all segments of the corporate sector. While there is room to reduce the statutory CIT rate in some countries, an alternative reform option is to limit the CIT on “excess returns” on equity to reduce tax-induced investment distortions and promote long-term growth. However, given that ASEAN countries have relatively low tax revenue-to-GDP ratios, it is necessary to develop a far-reaching strategy for corporate tax reform aiming to strengthen tax compliance and broaden the tax base, while reducing tax burden on the corporate sector.

B. Data and Methodology

4. The dataset used in this study consists of annual observations on a total of 826,739 listed and unlisted companies in five ASEAN countries. The analysis focuses on nonfinancial firms across 11 sectors3 in five ASEAN countries based on detailed and harmonized firm-level financial data from the Orbis database compiled by Bureau van Dijk Electronic Publishing.4 In total, the complete sample consists of an unbalanced panel of 826,739 unique enterprises with 3,283,494 firm-year observations over the period 1990–2014. Similar to any other large-scale micro dataset, however, the Orbis data require careful management to ensure consistency and comparability across firms and countries and over time. Following the data cleaning principles suggested by Kalemli-Ozcan and others (2015), observations with negative values of investment, assets, sales, and debt are filtered out. To minimize the effect of extreme outliers, 1 percent of observations on both tails of the distribution of firm-level regression variables is excluded from the analysis. Accordingly, the estimations are based on an unbalanced panel of 799,321 firms in five ASEAN countries with 2,087,133 firm-year observations during the period spanning from 1990 to 2014.

5. The sample of nonfinancial firms—drawn from the Orbis database—is unevenly distributed across countries and sectors. The dataset has 714 firms in Indonesia; 260,879 in Malaysia; 31,079 in the Philippines; 499,257 in Thailand; and 7,392 in Vietnam. Accordingly, the great majority is concentrated in Thailand and Malaysia, accounting for 95 percent of 799,321 firms covered in our sample.5 It is important to note that the number of firms covered in the Orbis database varies from one year to another, increasing considerably after 2000. In terms of sectoral coverage, the dataset covers 11 nonfinancial sectors excluding public services. Excluding the “others” category, most of the firms in our sample belong to the manufacturing sector and account for 30.8 percent of observations over the sample period, followed by trade sector with 30.3 percent of observations and administrative services with 13.6 percent of observations.

6. Capital formation at the disaggregated level is investigated in a large panel of nonfinancial firms with 3,283,494 firm-year observations. The dependent variable is the ratio of net fixed investment to total assets and the main variable of interest is a firm-specific measure of corporate tax burden as gauged by the ratio of corporate income tax (CIT) expense to sales.6 To obtain consistent estimates, the empirical model incorporates firm characteristics (such as size, sales, profitability and the leverage ratio) and controls for macroeconomic and structural differences among ASEAN countries during the period 1990–2014. We also include the square values of explanatory variables (and the lagged dependent variable in dynamic models) to capture nonlinear behavior (and persistency) in corporate investment decisions. Employing alternative methods, we estimate both static and dynamic models of firm-level investment in physical capital in order to address the heterogeneity of firms and to control for country-specific and time effects. Static specifications of the model are estimated using the fixed-effect model, while dynamic specifications are estimated employing the system generalized method of moments (GMM) approach proposed by Arellano and Bover (1995) and Blundell and Bond (1998), which is better in dealing with various econometric issues including potential endogeneity of the explanatory variables.

C. Empirical Results

7. The granular empirical analysis reveals nonlinear patterns of behavior in firms’ fixed investment decisions. Controlling for firm characteristics and macro-structural factors across countries, the dynamic estimation results, presented in Table 1, indicate significant persistence in capital spending over time. With regards to firm size, large companies are found to undertake significantly less investment than others, but this is not a linear connection as very large firms invest more than others. Similar nonlinear behavior is observed with the impact of sales on investment, with a negative coefficient on its square term. This may reflect the fact that firms tend to experience higher operating costs with increasing sales, which in turn dampens investment appetite. On the other hand, the opposite dynamics are observed with profitability, as higher profitability leads to more fixed investment. This could also reflect the fact that more profitable firms are able to carry the tax burden and at the same time allocate more resources to fixed investment. The results show an intricate pattern of nonlinear behavior with regards to leverage, as greater levels of indebtedness become increasingly detrimental to capital spending by nonfinancial firms. Finally, for the main variable of interest, the nonlinear estimations indicate that taxation facilitates business investment by enabling public investment in infrastructure and human capital and proper functioning of government institutions. However, as the tax burden increases, its effect turns negative and stifles fixed investment growth in ASEAN countries.7

Table 1.Cross-Country and Country-Specific Dynamic Estimations
Dependent variable: Investment-Asset Ratio
Firm characteristics
Investment-Asset Ratio, lag0.135***0.111***0.191***0.191***0.252***
Investment-Asset Ratio^2, lag−0.029***−0.025***−0.064*−0.050***−0.100**
Total Assets, lag−0.102***−0.172***−0.067***−0.004−0.066
Total Assets^2, lag0.003***0.005***0.002**−0.0000.002
Sales, lag0.036***0.044***0.0180.029***−0.103**
Sales^2, lag−0.001***−0.001***−0.000−0.001***0.003**
Debt-Asset Ratio, lag0.025***0.1050.063−0.009*0.070
Debt-Asset Ratio^2, lag−0.003***−0.221−0.0810.001*−0.102
Profit-Asset Ratio, lag−0.0020.0200.046−0.017**0.071
Profit-Asset Ratio^2, lag0.0050.012*−0.1830.0030.015
Tax-Sales Ratio0.269***0.239***0.440*0.384***0.341
Tax-Sales Ratio^2−0.527*−0.493−3.553**−2.024*1.854
Macroeconomic and institutional controls
Real GDP per Capita, lag0.015***−0.059−0.838***−0.180***−0.684**
Real GDP Growth, lag−0.003***0.001*0.007**0.000−0.051
Credit to Private Sector, lag−0.028*−0.229***1.688***0.065***0.204
Trade Openness, lag−0.025***−0.098***−0.312**−0.085***0.350
Public Investment, lag0.0010.040***−0.0230.008−0.018
Rule of Law, lag0.028***0.025***−0.008−0.016**0.003
Corruption, lag0.015***0.028**0.023−0.0051.514***
# of observations160,67698,8986,49351,9503,297
# of firms90,08756,5364,18627,2802,053
AR1 p-val.00000.001
AR2 p-val.0.1290.2980.8870.2690.765
# of instruments40047445041
Note: Robust standard errors clustered at a firm level are displayed in brackets. *** p<0.01, ** p<0.05, * p<0.1. A constant is included in all regressions, but not shown in the table. Source: IMF staff estimates.
Note: Robust standard errors clustered at a firm level are displayed in brackets. *** p<0.01, ** p<0.05, * p<0.1. A constant is included in all regressions, but not shown in the table. Source: IMF staff estimates.

8. Country-specific estimations, albeit with limited number of observations, are broadly consistent with cross-country panel estimations. Since the estimated parameters based on a panel of ASEAN firms represent an “average” effect of various firm characteristics and macro-structural factors, the dynamic model of business capital formation is also estimated using the panel of firms in each ASEAN country in the sample. Even though this exercise reduces the number of observations (especially in countries with limited coverage in the Orbis dataset), it provides a more granular analysis of the nonlinear dynamics of corporate fixed investment at a disaggregated level for each country.8 These results are broadly consistent with our cross-country panel estimations, but do show variations among the four ASEAN countries included in the country-specific regression analysis. In particular, with regards to the main variable of interest, we find that a moderate level of corporate taxation has a significant positive effect on business fixed investment in all countries except Vietnam, where it appears to be insignificant but still positive.

9. The Philippines stands out with greater adverse effect of higher tax burden on corporate investment spending. Similar to cross-country estimations, a nonlinear pattern is observed with the square term of the tax burden having a significant negative impact on firm-level capital spending. This adverse effect of higher tax burden is particularly pronounced in in the Philippines and Thailand, which may partly reflect the differences in the efficiency and quality of government spending funded by tax revenues. For example, in 2016, the Philippines was ranked 20thfor macroeconomic environment, but 95th for infrastructure and 81st for health and education out of138 countries by the World Economic Forum’s Competitiveness Index.

D. Conclusion

10. Fair and efficient taxation is pivotal in funding public investment in infrastructure and human capital and thereby stimulating private investment. Taken together, the empirical findings provide supportive evidence that tax policy and administration can do more to promote capital formation in the private sector and concurrently raise additional revenue for much-needed government spending on physical and human capital. In particular, corporate taxes need to be integrated into a coherent tax structure designed to encourage entrepreneurial activity by new and existing firms and tax compliance across all segments of the business sector. For example, Dabla-Norris and others (2017) find that tax compliance costs tend to be disproportionately higher for small and young businesses and thereby tax administration reforms aimed at lowering compliance costs reduce the productivity gap of small and new firms relative to larger and older firms.

11. A simpler CIT code can create a level playing field and reduce compliance costs, especially for smaller firms. This would in turn promote fixed investment by existing and new firms and attract foreign direct investment. Size-dependent and sector-specific preferential tax treatments through exemptions, incentives and other relief measures—a prevalent feature of tax regimes across all countries—distribute the burden of taxation disproportionately, reduce administrative and economic efficiency, and result in below-potential tax revenue generation.9

12. The Philippines has room to modernize the CIT regime in a revenue-neutral way by lowering the statutory rate and eliminating distortionary exemptions. The empirical results show that an excessive level of taxation reduces incentives for private investment by raising the user cost of capital and distorting resource allocations. The Philippines has the scope to cut the statutory CIT rate toward the regional average in a gradual manner, which could encourage domestic investment and attract foreign direct investment.10 But the extensive use of tax concessions and exemptions—estimated to amount 1.5 percent of GDP in 2014—results in distortions and keeps CIT productivity in the Philippines at almost half of its better performing peers (Figure 2).11

Figure 2.Corporate Tax Landscape Across ASEAN

13. An alternative reform option is to limit the CIT on “excess returns” on equity instead of a firm’s entire stream of income, especially as ASEAN economies mature. According to the allowance for corporate equity (ACE) scheme, investments earning a “normal” return on investments are exempt from the CIT through a deduction of an imputed return on equity.12 This allowance equals the product of a firm’s equity capital including taxable profits net of corporate tax payments and an appropriate rate of interest such as the interest rate on long-term government bonds (Cnossen, 1996). The ACE allowance therefore approximates a firm’s normal profits, and the CIT is imposed only on economic rents (profits in excess of the allowance). The ACE system would also address discriminatory treatment of equity financing, eliminate the taxation of marginal investment, and provide opportunities for simplifying the corporate tax regime. While the ACE scheme would reduce investment distortions and promote long-term growth, it can also narrow the tax base and, consequently, lower revenue mobilization, especially in ASEAN countries with relatively low tax revenue-to-GDP ratios. Therefore, it is critical to develop a comprehensive approach to corporate tax reform aiming to reduce the tax burden while simultaneously strengthening tax compliance and introducing base-broadening measures, like phasing out tax incentives and preferential treatment, which complicate the system and erode the revenue base.


Prepared by Serhan Cevik and Fedor Miryugin and based on a forthcoming working paper (“Does Taxation Stifle Corporate Investment? Firm-Level Evidence from ASEAN Countries”).

Owing to data limitations, the empirical analysis is based on a sample of firms located in Indonesia, Malaysia, the Philippines, Thailand, and Vietnam.

The sectors include agriculture, construction, information technology, manufacturing, mining, professional and administrative services, real estate, transportation and storage, utilities, wholesale and retail trade, and a broad category referred as others.

The Orbis database covers both public (listed) and private (non-listed) firms including small and medium-sized enterprises (SMEs) in a broad universe of advanced and developing countries.

The number of firms included in the regression analysis is lower than 799,321 firms in our panel as we scale net investment with lagged assets.

The marginal effective marginal tax rate is arguably a better measure of the firm-specific tax burden (Devereux and Griffith, 1998), but its calculation requires data on depreciation and amortization, among others, which are not available for the great majority of ASEAN firms covered in this study.

While the focus is on taxation, the analysis also provides evidence for the importance of macroeconomic stability and governance reforms to raise private investment growth sustainably.

Due to the lack of observations in the Orbis database, it is not possible to estimate the model for Indonesia.

Using firm-level data from European countries, Benedek and others (2017) find evidence that size-related tax incentives can weigh on firm productivity and growth.

In the case of the Philippines, a one percentage point reduction in the statutory CIT rate would result in a revenue loss of about 0.1 percent of GDP.

The CIT productivity is measured as CIT revenue as a percentage of GDP, divided by the statutory CIT rate.

Klemm (2006) and De Mooji (2011) provide an overview and applications of the ACE scheme around the world.

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