Tax Competition in ASEAN

Asia
Is There Tax Competition in ASEAN?

Achmad Tohari*
and Anna Retnawati**
As a regional group, the Association of
Southeast Asian Nations (ASEAN) wants to
enhance its collective competitiveness to
attract foreign capital. At an individual country
level, each member country offers incentives to
encourage foreign investors. These two
interests often conflict and, in any event, this
article demonstrates that, although there has
been a significant decrease in statutory and
effective tax rates in recent years, tax
competition in ASEAN is not clearly evident.
1. Introduction
The world economy has become more integrated in
recent decades. One of the key aspects of integration is
the rapid growth in cross-border investment. Since the
1970s, most countries have reduced or eliminated con-
trols on foreign currency exchange, the purchase of for-
eign securities, and the ability of foreigners to buy
domestic securities and companies. Numerous bilateral
investment treaties have also been signed to reduce or
eliminate barriers to investment.
Foreign capital has, therefore, become more significant
as a financial source of economic development. The
recognition of the importance of foreign capital for
economies has encouraged governments to attract such
investment by offering foreign investors favourable con-
ditions for investment through a variety of instruments.
According to the World Bank,
1
commonly used instru-
ments include (1) the provision of targeted fiscal incen-
tives, such as tax holidays and specific subsidies, (2) the
improvement of domestic infrastructure, (3) the promo-
tion of the development of local skills to meet investors
needs and expectations, (4) the establishment of wide-
ranging foreign direct investment (FDI) promotion
agencies, (5) the strengthening of the regulatory envir-
onment and the reduction of red tape, and (6) the con-
clusion of international arrangements.
The most recently adopted instrument is tax incentive
policies, which are intended to attract FDI by reducing
corporate tax rates. As many countries attempt to attract
foreign investment, tax competition may arise, thereby
creating greater opportunities for potentially harmful
tax competition.
2
In this respect, the literature has
stressed the positive effects of tax competition on the
reduction of expenditure with regard to inefficient pub-
lic policies.
3
Such behaviour can, however, have negative
consequences. Specifically, in the presence of tax com-
petition, budget deficits may arise as governments are
unable to cover the cost of providing public services
with tax revenue.
4
Consequently, governments need to
find other sources to finance deficits. These sources
may, in the short term, be international capital or, alter-
natively, a reduction of public expenditure or increase
in taxes.
This issue has become important, as, based on empirical
evidence, enhanced tax competition occurs in develop-
ing, as well as developed countries. In developing coun-
tries, the effects of tax competition may be more severe,
as governments are often confronted by budgetary con-
straints. Consequently, any reduction in (tax) revenue
further reduces necessary expenditure.
5
As a regional group, the Association of Southeast Asian
Nations (ASEAN) would like to increase its collective
economic potential and competitiveness by attracting
foreign capital. At an individual country level, however,
each country offers many incentives to encourage for-
eign investors. Even though tax competition has not
been observed, these dual interests conflict with one
another.
The objective of this article is to measure the tax burden
relating to foreign capital and then investigate whether
or not there is tax competition between the ASEAN
Member countries. In this respect, section 2. surveys the
literature that considers the effect of tax competition
and summarizes previous studies on this topic. Section
3. deals with the measurement of tax burdens. How to
compute effective rates is also considered in this section.
Section 4. advances some empirical evidence regarding
the subject matter of this article. Finally, section 5. pro-
vides a short description of the possible responses to the
articles findings.
2. Reviewof the Literature
2.1. Effect of competition on tax policy
In order to increase the attractiveness of both ASEAN as
a region and of its individual Member countries, many
* United Nations Development Program (UNDP), Jakarta. The author
can be contacted at achmad.tohari@undp.org.
** Department of Accounting, Airlangga University, Surabaya. The
author can be contacted at anretna@yahoo.com.
The authors are very grateful to Harry Garretsen and Marc Schramm
of the Department of International Economics, Utrecht School of Eco-
nomics for their valuable comments on the draft article. The authors also
want to thank Michael P. Devereux, in particular, of Oxford University
for his patience in guiding them to be able to measure the effective corpo-
rate tax rate. The views expressed in this article are those of the authors
and not necessarily of the institutions they represent.
1. World Bank, Knowledge Resources for Financial & Private Sector
Development (2007).
2. OECD, Harmful Tax Competition: An Emerging Global Issue (Paris:
1998).
3. C.M. Tiebout, A Pure Theory of Local Expenditures, Journal of Politi-
cal Economy, Vol. 64 (1956), pp. 416-424.
4. H.W. Sinn, How much Europe? Subsidiarity, Centralization and Fiscal
Competition, Scottish Journal of Political Economy, Vol. 41(1) (1994), pp. 85-
107.
5. World Bank, supra note 1.
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IBFD BULLETIN FOR INTERNATIONAL TAXATION JANUARY 2010 | 51
restrictions on investments have been reduced. Conse-
quently, capital moves more freely to the most favour-
able investment location. This provides opportunities
for multinational enterprises (MNEs) to minimize or
even avoid paying corporate taxes through transfer pri-
cing and other policies. In these circumstances, tax com-
petition between countries may become more likely and
the possibility of a race to the bottom greater. The
pressure on corporate tax rates due to the greater free
movement of capital has also been addressed in the
standard tax competition literature. This literature sug-
gests that tax competition results primarily in increased
capital mobility, which gives rise to inefficiently low tax
rates and adversely affects the provision of public ser-
vices.
6
Tax competition has recently become more important
for tax authorities in modern economies. It has also
become a highly controversial subject and its effect on
the economy as a whole remains debatable. Modern lit-
erature, which is based on a study published in 1956 by
Tiebout,
7
concludes that tax competition has a positive
effect on the reduction of expenditure on inefficient
public services and policies. Tax competition is benefi-
cial, as it forces governments to impose efficient tax
prices on residents for the provision of public services.
This, in turn, should improve tax policy in competitive
economies and the result should be that the level of
taxes reflects typical preferences within each jurisdic-
tion.
In open economies with high capital mobility, tax policy
should have an important effect on the flow of capital.
This typically occurs when countries compete by lower-
ing corporate tax rates to attract FDI. From a corporate
point of view, tax policy is one of the key factors in
deciding on an investment location.
8
The assumption is
that, all other things being equal, higher tax rates reduce
after-tax earnings. As a result, (high) tax levied by tax
authorities causes mobile factors (capital) to relocate to
low-tax jurisdictions. Corporate tax rates may, there-
fore, be regarded as the price of investment in a country
in terms of the cost of doing business and obtaining
public services.
2.2. Corporate tax competition: empirical evidence
In response to global competition, in recent years, cor-
porate tax rate reductions have become a popular policy
of governments in many countries. This phenomenon is
supported by several studies. An example is the 2007
survey by KPMG, which reported that the average cor-
porate income tax rate (of a sample of countries) fell
from 38% to 26.8% between 1993 and 2007.
9
This
accords with the theories of international tax competi-
tion, which predict a reduction in corporate tax rates as
economies become more open and integrated.
10
On the
basis of prior studies of empirical evidence, the existence
of tax competition is, however, debatable. There are
essentially two views. The first view states that tax com-
petition exists, whilst the other stresses the uncertainties
regarding the existence of such competition.
Under the first view, it is argued that the phenomenon
of globally falling statutory corporate tax rates may be
an early indication of tax competition. This trend is
commonly seen as having being initiated by the tax
reforms of the mid-1980s in the United States and has
since spread to many countries.
11
Investigations regard-
ing the trend of falling statutory corporate tax rates have
become common and have been repeated numerous
times with similar results.
Empirical evidence based on data up to the 1990s sug-
gests that the trend in respect of statutory tax rates may
be characterized by converging, as well as falling, tax
rates. For instance, Singleton
12
found a falling and con-
verging trend in the statutory tax rates of 10 Asian coun-
tries between 1979 and 1996. Wunder also found similar
evidence of this trend in 29 countries, including the
United States and countries in Europe and Southeast
Asia, in the period from 1985 to 1999.
13
A more recent approach to this issue, however, argues
that falling statutory corporate tax rates cannot be used
to evaluate the existence of tax competition. These stu-
dies not only utilize trends in the statutory corporate tax
rates as an indicator of tax competition, but also use the
effective tax rate, tax revenue and transfers in respect of
tax burdens as indicators of tax competition. In this
regard, studies have been undertaken by the Ruding
Committee,
14
Chennells and Griffith,
15
Devereux et al.
16
and Simmons.
17
These studies, however, rarely selected
Asian countries as their sample, except for Japan as an
OECD Member country.
The Ruding Committee examined statutory corporate
tax rates in the then 12 Member States of the European
Union between 1980 and 1991. The Committee noted
that tax rates had increased in some countries and fallen
in others, although there was an overall reduction in the
mean tax rate. Only a small degree of convergence was,
6. G.R. Zodrow and P. Mierekowski, Pigou, Tiebout, Property Taxation,
and the Underprovision of Local Public Goods, Journal of Urban Economics,
Vol. 19 (3) (1986), pp. 356-370.
7. See Tiebout, supra note 3, p. 422.
8. A.D. Viard, Three Cheers for the Decline of the Corporate Income
Tax, American Enterprise Institute for Public Policy Research Bulletin, No. 2
(April 2008), pp. 1-6.
9. KPMG, KPMG Corporate and Indirect Tax Rate Survey (2007), avail-
able at www.kpmg.com.
10. H.F. Wunder, Tanzi (1987): A Retrospective, National Tax Journal,
Academic Research Library, Vol. 54 (4) (December 2001), pp. 763-770 and R.
S. Simmons, Does Recent Empirical Evidence Support the Existence of Inter-
national Corporate Tax Competition?, Journal of International Accounting,
Auditing and Taxation, Vol. 15 (2006), pp. 16-31.
11. V. Tanzi, The Response of Other Industrial Countries to the U.S. Tax
Reform Act, National Tax Journal, Academic Research Library, Vol. 40 (3)
(September 1987), pp. 339-355.
12. R. Singleton, An analysis of the Taxation of Income from Capital in the
Asian Region, Asia-Pacific Journal of Taxation, Vol. 3 (3) (1990), pp. 75-95.
13. Wunder, supra note 10, p. 763.
14. Ruding Committee, Report of the Committee of Independent Experts
on Company Taxation, European Commission (Brussels: 1992).
15. L. Chennells and R. Griffith, Taxing Profits in a Changing World (Lon-
don: Institute for Fiscal Studies, 1997).
16. M.P. Devereux, R. Griffith and A. Klemm, Corporate Income Tax
Reforms and Tax Competition, Economic Policy, Vol. 17 (35) (2002), pp.
451-495.
17. Simmons, supra note 10, pp. 21-22.
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IBFD 52 | BULLETIN FOR INTERNATIONAL TAXATION JANUARY 2010
however, apparent. Trends in effective tax rates have
also become the focus of attention.
18
These indicate that
there was little change in the mean effective marginal
tax rate (EMTR) in the European Union between 1980
and 1991, but that there had been considerable conver-
gence between the Member States. With regard to cor-
porate tax revenue, these studies found little support for
the anticipated decline and reported that revenues from
corporate income taxes as a percentage of GDP and as a
percentage of total tax revenue actually rose slightly in
the sample Member States.
Chennells and Griffith
19
analysed movements in statu-
tory corporate tax rates from 1979 to 1994 in 10 OECD
Member countries and reached similar conclusions to
those of the Ruding Committee. Their results, in respect
of both the EMTR and the effective average tax rate
(EATR), did not indicate any clear conclusions on the
direction and convergence of rates. With regard to cor-
porate tax revenue, Chennells and Griffith found a sig-
nificant variation in the trends of individual OECD
Member countries. Some had a constant trend, whilst,
in others, the trend was inconsistent. The relevant tax
percentages for the OECD Member countries as a whole
were found to be remarkably stable, which suggests that,
in general, the fall in corporate tax rates has had little
effect on revenue. Whilst corporate tax rates have fallen,
revenue data for OECD Member countries indicates
that corporate tax revenues have actually increased
since the early 1990s.
Devereux et al.
20
investigated the change of rates in 16
OECD Member countries between 1982 and 2001, but
did not comment on possible convergence. They found
that the mean statutory tax rate of the countries in their
study had fallen significantly in this period from
approximately 48% to 35%. They also found that,
between 1982 and 2001, there had been an increase and
then a fall in the mean of the EMTR. For the period as a
whole, the mean EMTR decreased slightly. The mean of
the EATR had also fallen in the period from around 42%
to 33% and the pattern was similar to the fall in statutory
corporate income tax rates. Devereux et al. also noted
stability in corporate tax revenue as a proportion of
GDP, although they found that corporate tax revenue as
a percentage of total tax revenues fell in the period.
A study by Simmons
21
analysed the tax rate and tax rev-
enue trends in 19 developed countries for the 1982-2003
period. He found that statutory and effective corporate
tax rates had declined and converged in the period. This
convergence could be largely attributed to tax reforms
at the time in three countries (Germany, Italy and
Japan), where statutory tax rates fell sharply towards the
international average. In contrast, the tax revenue data
revealed that the anticipated fall in tax revenue from
corporate tax did not occur and, instead, a significant
increase was reported. These findings are similar to the
results of earlier research. The anticipated result of the
transfer of the tax burden from corporate profits to less
mobile factors also failed to materialize.
In summary, the studies clearly found a reduction in
corporate tax rates, but the evidence of tax competition
in respect of real investment was not conclusive.
22
This
may be due to the apparent paradox that a fall in corpo-
rate tax rates does not necessarily result in reductions in
corporate tax revenue.
23
A possible explanation for this
inconsistency is the broadening of tax bases. Broadening
tax bases can be seen as a means of protecting corporate
tax revenues as a result of tax rate adjustments.
3. Measurement Issues
3.1. Introductory remarks
As countries increasingly compete with each other to
attract investment by offering tax incentives, the issue of
how to measure the relevant indicators required to
investigate this specific form of tax competition needs
to be addressed and, consequently, the way in which
corporate income is taxed. In this respect, it is useful to
analyse the tax burdens associated with different tax sys-
tems. In general, there are two approaches to the mea-
surement of tax burdens: forward and backward
looking.
24
Under the forward-looking approach, two common
methods are typically used: (comparing) statutory tax
rates and (measuring) effective tax rates. The first
method comparing statutory tax rates is a basic and
common measurement. This measurement only consid-
ers the interrelation of statutory tax rates, i.e. the legally
imposed rates as set by governments. Differences in tax
bases are not considered under this measurement. This
method may, however, be informative, as statutory tax
rates are an important parameter in the tax system of a
country. Nevertheless, the measurements derived from
this method cannot be classified as effective tax rates.
The effective tax rate refers to the actual or implicit tax
rates,
25
which are not only defined by law but are an eco-
nomic measure. This also considers the effect on the tax
base.
26
Both average and marginal tax rates can be
expressed as effective tax rates.
Another approach to the measurement of tax burdens
that is categorized as backward looking is based on tax
revenue. This approach includes measurements that
scale observed tax revenue by reference to GDP, total
tax revenue or approximations of the tax base.
Forward and backward-looking approaches are well sui-
ted to a number of circumstances and there are few dif-
ferences between the approaches. One of the most
18. L. Lammersen, The Measurement of Effective Tax Rates: Common
Themes in Business Management and Economics, Centre for European Eco-
nomic Research (ZEW), Discussion Paper No. 02-46 (June 2002), available at
ftp://ftp.zew.de/pub/zew-docs/dp/dp0246.pdf, p. 1.
19. Chennells and Griffith, supra note 15, p. 12.
20. Devereux, Griffith and Klemm, supra note 16, p. 452.
21. Simmons, supra note 10, p. 22.
22. Ruding Committee, supra note 14, p. 167.
23. Simmons, supra note 10, p. 28.
25. Id., p. 460.
26. Lammersen, supra note 18.
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significant advantages of the forward-looking approach
is, however, that it captures the effect of tax on future
expected earnings with regard to a specific investment
project.
27
This method can be used to examine the
expected tax payments associated with particular deci-
sions. It is, therefore, potentially well suited to estimat-
ing the effects of taxation on business decisions. In
contrast, the backward-looking approach cannot be
used to evaluate future tax payments. Accordingly, this
method cannot provide any information on the effect of
taxation on the future competitiveness of firms. Back-
ward-looking measures can, however, be useful for ex-
post analysis on who paid the taxes in an economy,
which could be an indicator in respect of the distribu-
tional aspects of a tax system.
28
In practice, both approaches have advantages and disad-
vantages. First, with regard to backward-looking mea-
surement, the tax base considers companies with losses,
whereas the forward-looking method assumes that the
return on investment projects is at least as great as the
capital cost. Second, empirical tax ratios in backward-
looking measurement may have the disadvantage that
the national tax payments of MNEs are scaled by their
worldwide profits. In this situation, the tax base in the
denominator is too large. Third, the backward-looking
approach reflects not only current investment decisions
and the present structure of taxation, but also past com-
pany decisions and previous tax systems.
29
3.2. The importance of the EMTR and the EATR
The effective tax rate is a useful tool to summarize the
effect of the tax system on the required rate of return.
30
The EMTR is the effective rate of tax that applies to a
marginal investment project. It focuses on the present
value of the accumulated cash flow that would be gener-
ated by an additional dollar of investment. As it mea-
sures ex-post performance and is concerned with
marginal decisions, it can be used to estimate the incen-
tive effects arising from a tax system. Recently, the
EMTR has been recognized as an internationally
accepted measurement of the tax burden on capital
income.
31
In other words, a higher EMTR increases the
cost of capital and, therefore, reduces capital inflows.
Conversely, the EATR is an effective rate of tax that
applies to an investment project earning some economic
rent. Theoretically, the EATR can be calculated as the
proportional difference between the pre and post-tax
economic profit for a given pre-tax rate of return. Tradi-
tionally, it is useful in deciding the choice of location.
Subject to limitations, the EATR can also be relevant in
respect of the liquidity and distributional aspects of
taxation. To summarize, there is an argument to the
effect that the optimal indicators in analysing the effect
of taxation on investment behaviour are the forward-
looking measures of the EMTR and the EATR.
32
Never-
theless, such values should be derived from models.
3.3. Forward-looking measurement: the effective tax
rates
There are several different approaches to measuring
effective tax rates on capital income. The most popular
is that established by King and Fullerton
33
as expanded
on by Devereux and Griffith.
34
These approaches are
similar in some ways in that they are rooted in neoclassi-
cal investment theory,
35
but differ in their detail. In this
regard, Devereux and Griffiths approach prefers that
the EATR should be calculated in addition to the
EMTR, as computing the EATR on the basis of rates of
return can secure consistency between these terms.
The measurement of effective tax rates, especially for
the corporate sector, is not straightforward,
36
as it
involves activities amongst various economic entities. It
is, however, preferable on theoretical grounds.
37
Accordingly, in making a calculation, a significant num-
ber of assumptions with regard to the actual situation
are required. The methodology for calculating effective
tax rates adopted in this article is that of Devereux and
Griffith.
38
Under the approach of Devereux and Griffith, an
increase in capital stock for one period is analysed. The
return on the investment project is then compared with
the opportunity cost of an alternative project. The cost
of capital, which is the economic rent that makes an
investor indifferent between the investment project and
an alternative investment, can subsequently be used to
calculate the EATR. In calculating the EATR, several
assumptions regarding the pre-tax rate of return, the
amount of debt financing, inflation and the type of
investment project must be made.
For instance, take a firm that increases its capital stock
for only one period. It does this by increasing its invest-
ment by 1 at the beginning of the period and reducing it
by 1 at the end of the period, where represents eco-
nomic depreciation. The higher capital stock generates a
return at the end of the period of p+, where p is the
financial return. The discount rate is r in a scenario that
ignores inflation.
28. Lammersen, supra note 18, p. 9.
30. Chennells and Griffith, supra note 15, p. 36.
31. Commonwealth of Australia, International Comparison of Australias
Taxes (Canberra: 2006), available at http://comparativetaxation.treasury.
gov.au.
32. Id.
33. M.A. King and D. Fullerton, The Taxation of Income from Capital: A
Comparative Study of The U.S., U.K., Sweden, and West Germany: The The-
oretical Framework, National Bureau of Economic Research, Working Paper
No. 1058 (January 1983).
34. M.P. Devereux and R. Griffith, Evaluating Tax Policy for Location
Decision, International Tax and Public Finance, Vol. 10 (2) (2003), pp. 107-
126.
35. Lammersen, supra note 18, p. 9.
36. King and Fullerton, supra note 33, p. 6.
37. M.G. Asher and R.S. Rajan, Globalization and Tax Systems: Implica-
tions for Developing Countries with Particular Reference to Southeast Asia,
ASEAN Economic Bulletin, Vol. 18 (1) (April 2001), pp. 119-139.
38. Devereux and Griffith, supra note 34, p. 109.
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One unit of capital generates a tax allowance with a net
present value (NPV) of A.
39
Accordingly, the cost of the
asset is 1A, whilst the saving from the subsequent
reduction in investment is (1)(1A). The total return,
p+, is taxed at the rate of . As a result, the NPV of the
investment with tax is:
R =
(p +)(1) (r +)(1 A)
1+ r
The cost of capital is the value of p, denoted by p
, in
respect of which the investment is marginal, i.e. R=0.
The EMTR is (p
r) / p
.
The definition of the effective average tax rate is
expressed as the proportion of the NPV to total pre-tax
capital income, i.e. V* = p / (1+r). This is comparable to
other commonly used measures of computing the aver-
age tax rate. With regard to a marginal investment, the
EATR is equal to the EMTR. For a highly profitable
investment, the EATR approaches. The cash flow is
slightly different for a debt-financed investment, but the
concepts of the EMTR and the EATR are unchanged.
40
4. Empirical Evidence
4.1. Introductory remarks
Following the earlier studies undertaken by the Ruding
Committee, Chennells and Griffith, Devereux et al. and
Simmons (see 2.2.), this section attempts to measure
several important early indicators to examine the pre-
sence of tax competition in ASEAN. The measurements
include a comparison of statutory tax rates, effective tax
rates (the EMTR and the EATR), tax ratios and transfers
of tax burdens.
4.2. Statutory tax rates
Table 1 sets out the mean values and the coefficients of
variation (CVs) of the statutory corporate income tax
rates, the EMTR and the EATR in respect of the
ASEAN-5 countries from 1980 to 2005. During the
1980s, as revealed in the second and third columns, the
mean values declined slightly from 35% to 32.4%, with a
fall statistically significant at the 1% level (p=0.000). In
the 10-year period that followed, 1990 to 2000, the mean
values continued to fall from 32.4% to 29.2%. The fall is
significant at the 1% level (p=0.000). The mean values
continued to fall until the mid 2000s (20002003),
Table 1: Means () (%) and CVs (%) in respect of statutory corporate income tax rates, EMTRs and EATRs, ASEAN-5 (19802005)
Statutory rate (%)
a
EMTR
b
EATR
c
CV CV CV
1980 35.00 14.29 39.87 8.82 39.17 9.59
1981 35.00 14.29 37.33 13.44 36.72 18.26
1982 35.00 14.29 33.65 12.24 32.54 16.08
1983 35.00 14.29 35.68 14.18 34.98 13.93
1984 35.00 14.29 32.45 15.72 32.27 16.22
1985 35.00 14.29 28.47 5.73 28.19 13.07
1986 33.60 12.38 17.67 72.05 19.55 64.89
1987 33.60 12.38 33.10 16.15 32.82 13.22
1988 33.60 12.38 34.15 9.65 33.11 9.60
1989 32.40 7.75 32.49 9.14 31.11 10.23
1990 32.40 7.75 32.43 12.95 30.95 14.94
1991 32.40 7.75 33.04 14.66 31.50 16.48
1992 32.00 8.56 30.00 13.05 28.76 14.90
1993 31.20 10.48 30.10 13.92 28.90 12.78
1994 30.80 9.58 30.24 16.50 28.77 17.39
1995 30.40 9.48 29.64 16.27 28.22 17.59
1996 30.20 10.58 28.87 18.97 27.61 18.96
1997 30.20 10.58 28.90 20.12 27.84 18.73
1998 29.60 10.02 32.25 31.61 32.06 31.54
1999 29.40 8.87 23.77 44.14 24.50 31.73
2000 29.20 7.81 28.93 19.98 27.98 19.14
2001 29.10 8.45 25.38 32.52 24.96 31.21
2002 30.70 17.60 27.11 29.09 27.10 26.71
2003 28.40 13.55 24.80 23.07 24.05 19.95
2004 28.40 13.55 26.61 19.56 25.27 21.69
2005 28.00 16.75 27.39 27.84 26.28 25.18
a Statutory corporate income tax rate for ASEAN-5. Source: KPMGs Corporate Tax Rates Survey.
b The EMTR calculation assumes that the investment is in plant and machinery, financed by equity or retained earnings, subject to depreciation of 12.5%, a
real interest rate of 10% and no personal taxes. The calculation uses time and country-specific inflation rates instead of a fixed rate. Source: authors own cal-
culations.
c The EATR calculation assumes an expected rate of economic profits of 10% and, therefore, a financial return of 20%. Source: authors own calculations.
39. Straight-line depreciation is used. Accordingly, the present value of
allowances per unit of investment, A
sl
, at the nominal discount rate, i, can be
written as:
dy e
Y
A
iY
y
sl
=
0
1
where y indexes the change in time from 0 to Y, whilst Y is the number of
years over which the assets can be depreciated for tax purposes. Integrating
the equation converts it into the formula used to compute present values
(Congress of the United States, Computing Effective Tax Rates on Capital
Income, Congressional Budget Office Background Paper, Des. Congressional
Budget Office (2006), i.e.: A
sl
= 1 e
iY
/ iY.
40. Devereux, Griffith and Klemm, supra note 16, p. 461 and Devereux and
Griffith, supra note 34, p. 113.
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although the fall was smaller than before. The mean
values over the 2000 to 2005 period fell from 29.2% to
28% and were significant at the 5% level (p=0.0203).
Over the periods observed, the mean value fell signifi-
cantly from 35% to 28%. In this period, only Indonesia
and Thailand did not adjust their rates. In contrast, Sin-
gapore rapidly reduced its rate: eight downward adjust-
ments caused the rate to fall from 40% in 1980 to 22% in
2005. Malaysia adopted a similar policy, although the
fall here was not as significant. Specifically, in the rele-
vant periods, Malaysia reduced its rate five times, from
40% in 1980 to 28% in 2005. The Philippines reduced its
rate from 35% in 1980 to 32% in 2005 by means of four
downward adjustments. Based on this, it is arguable that
there is a form of tax competition in East and Southeast
Asia, potentially in response to the rapid reduction in
tax rates in Singapore and Malaysia.
41
Unlike the mean value, the CVs demonstrate a different
pattern. Overall, in the observed periods, there is no
clear trend with regards to CVs. After 2001, the values
of CVs also increase and, therefore, do not reveal a con-
vergence pattern. This may suggest that there are several
countries that have rapidly reduced their statutory tax
rates (for example, Malaysia and Singapore), whilst
others have not (for example, Indonesia and Thailand).
This asymmetric policy may be a reasonable explanation
for the situation.
4.3. The EMTR
The mean and CV values of the EMTR are set out in the
fourth and fifth columns of Table 1. During the 1980s,
the mean values decreased from 39.87% in 1980 to
32.43% in 1990. The fall is, however, steep and statisti-
cally significant at the 10% level (p=0.0863). In the
1990s, this trend continued, although at a slower rate. In
this respect, the mean value fell from 32.43% in 1990 to
28.93% in 2000 and is statistically significant at the 5%
level (p=0.0499). Finally, a small, but not statistically sig-
nificant reduction is evident in the 2000s (p=0.1570).
Over the observed periods, the mean value generally fell
from 39.87% to 27.39%, but the fall does not appear to
be continuous. It is also difficult to see a clear falling
trend on an individual-country basis, as the values
appear to fluctuate significantly. This is because each
country experienced inflation differently over the peri-
ods and this influenced the effective tax rates.
The EMTR trend over the periods observed does not
demonstrate a convergence pattern. To do so, the trend
would need to be downwards, following the trend of
Singapore. The historical trend of the EMTR on an indi-
vidual-country basis is shown in Figure 1. Overall, the
CVs of the EMTR do not reveal any particular trend, as
the values move in a volatile manner up and down.
Accordingly, the tendency to converge or diverge can-
not be defined. In the 1990s, the EMTR trends of
ASEAN countries were similar and indicated a falling
trend. In the following period, however, the trend chan-
ged and, for Malaysia, Singapore and Thailand, the
EMTRs were below those of Indonesia and the Philip-
pines. This may have been the result of the stronger eco-
nomic growth in the first three countries, which were
commonly thought of as new industrial countries.
Figure 1: The EMTR values on an individual-country basis
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
2
0
0
2
2
0
0
4
2
0
0
6
Indonesia Malaysia Singapore Thailand Phillipines
4.4. The EATR
The mean and CV values of the EATR are shown in the
sixth and seventh columns of Table 1. In this regard, the
mean value fell from 39.17% to 30.95% during the 1980s
(statistically significant at the 5% level, p=0.0303) and
from 30.95% to 27.84% in the 1990s (p=0.0171), whilst a
small, but not statistically significant, fall occurred in
the 2000s, i.e. from 27.84% to 26.28% in the period from
2000 to 2005 (p=0.1298).
Over the observed periods, the mean fell from 39.17% to
26.28%, even though the fall was not smooth. Within
individual countries, it is also hard to assess the falls, as
the values sometimes show volatile movements from
year to year. As with EMTRs, fluctuating EATRs are
influenced by the macroeconomic conditions of each
country, as the calculation uses the time and country-
specific data for the inflation rate. It is commonly
known that the economies of many Southeast Asian
countries are vulnerable to external events and factors.
In general, the CVs of the EATR do not reveal any parti-
cular trend, as the values move in a volatile manner.
Accordingly, the tendency to converge or diverge can-
not be well defined. In fact, the trend displays a pattern
of movement that is similar to that of the CVs for the
EMTR. The general convergence trend of both the
EMTR and the EATR in recent years has been up, except
for Singapore, but, nonetheless, this is not very clear.
The historical trend of the EATR for each individual
country is shown in Figure 2.
41. N.C. Chia and J. Whalley, Patterns in Investment Tax Incentives
among Developing Countries, in A. Shah (ed.), Fiscal Incentives for Invest-
ment and Innovation (Oxford University Press, 1995), pp. 437-454.
Articles
Figure 2: The EATR values on an individual-country basis
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
2
0
0
2
2
0
0
4
2
0
0
6
Indonesia Malaysia Singapore Thailand Phillipines
To summarize, there is no evidence of convergence in
statutory tax rates or either type of effective tax rate (the
EMTR and the EATR) over the observed periods in the
ASEAN-5. It is, therefore, not possible to arrive at any
clear conclusions as to the direction or convergence of
these rates.
4.5. Movements in tax burdens
This section presents an analysis of tax revenue ratios.
The analysis is classified as a backward-looking analysis.
In this respect, it should be noted that tax revenues from
corporate profits as a percentage of total tax revenues
would be expected to fall, whilst other sources of tax
revenues (personal income, social security, property and
goods and services tax (GST)) would be expected to
increase.
In order to examine any indication of tax competition,
the proportion of corporate tax revenues to total tax
revenues and GDP are considered. Tax revenues from
corporate income, both as a percentage of total tax rev-
enues and GDP, would be expected to fall in the pre-
sence of corporate tax competition. Such indications
cannot, however, be ascertained from the results of this
analysis in most countries. The trend shows a decline in
Indonesia and Singapore, but an increase in the other
countries.
In Indonesia, although corporate income tax rates did
not decrease during the periods observed, the propor-
tion of corporate tax, in respect of both total tax reven-
ues and GDP, fell significantly in the 2000-2005 period.
Such a trend is rare and occurs only in special circum-
stances. The phenomenon may be explained in various
ways. At the outset, it should be noted that there was a
significant change in the state budget format, its compo-
sition and structure, and other policy changes. This
included changing the fiscal year from April to March to
January to December in 2000. At the same time, Law 25/
1999 on Central and Local Fiscal Balance was enacted.
As a result of these changes, it is likely that the reporting
of revenue was misleading. Indonesia also began to
apply a Government Financial Statistics 2001 reporting
system in 2005.
Singapore experienced eight reductions in its corporate
income tax rates in the periods observed. Currently, Sin-
gapore has the lowest corporate income tax rate 18%
for 2007. The proportion of corporate tax revenue in
respect of GDP reveals a declining trend, but this is not
present with regard to corporate tax revenue in respect
of total tax revenues. Specifically, the proportion of cor-
porate tax revenue in respect of total tax revenues
appears to be stable in the periods observed. Based on
these facts, it is difficult to conclude that tax competi-
tion existed, as no clear evidence to this effect exists.
In order to find further evidence of tax competition, it is
necessary to consider movements in tax burdens. This is
important for Singapore, which experienced a fall in its
corporate tax revenue in proportion to GDP. Theoreti-
cally, the decline in corporate tax revenue may be
explained by reductions in the corporate income tax
rates. In order to finance public expenditure, a govern-
ment must find another source of revenue and, conse-
quently, may transfer the tax burden to another tax
base. The transfer may be to personal income tax, social
security, property tax or GST.
In Indonesia, except for corporate and personal income
tax, which the authors consider to be exceptions, the
trend in tax revenues shows an increase over the periods
observed. In Malaysia, the trend in respect of personal
income tax showed a decrease, whilst that of corporate
income tax showed an increase. Both trends are gradual.
The remaining sources of tax revenue were stable in the
periods observed. In the Philippines, the trends are
quite similar to Malaysia, except for GST, which is gra-
dually declining. In Thailand, most sources of tax rev-
enue were stable, except for corporate income tax
revenue, which increased, and property tax, which fell.
In summary, there is no evidence of movement in the
tax burden in any of these countries.
With regard to Singapore, it cannot be said that there is
no tax competition, as Singapore experienced a rapid
decrease in its corporate income tax rates. Singapores
corporate tax revenue in relation to GDP also fell.
Further study reveals that tax revenue in respect of GDP
for all taxes fell over this period. With regard to GST, it
should be noted, however, that, even though the propor-
tion in respect of GDP fell, the proportion in respect of
total tax revenues significantly increased. It is, therefore,
possible to argue that this indicates a movement of the
tax burden from corporate income tax to GST and that,
based on the tax competition model, the tax burden was
transferred to less mobile sources. This is supported by
the following statement by the Prime Minister to the
Parliament:
If we have to bring our corporate tax down, every percentage
point we bring it down will cost us $400 million a year. It is big
money. Therefore, we need to consider raising indirect taxes, in
other words, the Goods and Services Tax (GST). It is now five
percent; I think we need to push it up to seven percent. Even
seven percent will still be lower than nearly all other countries
that have GST or VAT. But if we raise it from five percent to
Articles
seven percent, it will give us precious extra resources to imple-
ment social programs.
42
Simply put, the trend with regard to corporate tax rev-
enues as a percentage of GDP and total tax revenue
shows a slight increase over the periods observed, except
for Indonesia, which the authors consider to be an
exception. This conflicts with the predictions in the the-
oretical tax competition literature. Recent trends in tax
revenues from other sources also reveal little evidence
for movements in tax burdens. The analysis presented
in Table 1 also provides evidence of a significant fall in
statutory and effective tax rates in recent years. Never-
theless, it is difficult to find evidence of convergence.
The outcome suggests that the existence of tax competi-
tion is still not evident.
5. Conclusions: Why is There No Tax Competition
in ASEAN?
From the analysis in 2., 3. and 4., it can be concluded
that there is a lack of evidence of the presence of tax
competition in ASEAN except with regard to Singapore
and Malaysia. The findings based on a descriptive analy-
sis are that there is (1) a fall in the mean of statutory and
effective tax rates in recent years, (2) no evidence of con-
vergence in statutory tax rates and both forms of effec-
tive tax rates (the EMTR and the EATR), (3) no
reduction in tax revenues due to falling tax rates and (4)
no evidence of movements in tax burdens. The results
from the econometric analysis lead to a similar conclu-
sion. As such, there is no convincing evidence of the
existence of tax competition. This section, therefore,
Table 2: Tax revenues by sources of taxation as a percentage of total tax revenues (TTR) and GDP (5-year intervals, 1975 to
2005)
Personal income tax Corporate income
tax
Social security Property tax GST
TTR (%) GDP (%) TTR (%) GDP (%) TTR (%) GDP (%) TTR (%) GDP (%) TTR (%) GDP (%)
Indonesia
1975 3.11 0.49 69.18 10.89 0.00 0.00 1.84 0.29 14.04 2.21
1980 1.66 0.34 80.76 16.35 0.00 0.00 0.93 0.19 9.08 1.84
1985 3.80 0.70 70.68 12.95 0.00 0.00 1.26 0.23 18.42 3.37
1990 4.12 0.73 59.92 10.68 0.00 0.00 2.17 0.39 25.06 4.46
1995 28.85 4.63 22.06 3.54 6.61 1.06 0.61 0.10 36.75 5.89
2000 9.72 1.25 47.61 6.12 2.79 0.36 2.46 0.49 37.42 4.81
2005 26.31 3.42 7.58 0.99 3.41 0.44 4.63 0.60 44.05 5.73
Malaysia
1975 9.69 1.71 32.86 5.81 0.55 0.10 0.62 0.11 22.71 4.01
1980 7.84 1.78 34.09 7.73 0.44 0.10 0.51 0.12 18.76 4.25
1985 7.09 2.27 57.19 18.29 0.50 0.16 0.43 0.14 15.31 4.89
1990 8.46 2.11 48.24 12.02 0.80 0.20 0.32 0.08 21.50 5.36
1995 14.16 2.75 31.81 6.17 1.54 0.30 0.64 0.12 32.03 6.21
2000 14.87 2.04 42.40 5.83 0.00 0.00 0.00 0.00 30.56 4.20
2005 10.73 1.76 52.29 8.58 0.00 0.00 0.00 0.00 29.36 4.82
Singapore
1975 16.54 2.80 34.49 5.84 0.00 0.00 13.85 2.34 20.09 3.40
1980 14.31 2.51 32.74 5.74 0.00 0.00 13.33 2.34 22.86 4.01
1985 17.23 2.83 28.13 4.62 0.00 0.00 16.44 2.70 23.19 3.81
1990 14.96 2.30 29.68 4.56 0.00 0.00 11.52 1.77 27.88 4.29
1995 13.38 2.20 28.12 4.62 0.00 0.00 8.95 1.47 32.86 5.40
2000 21.21 3.27 28.97 4.46 0.00 0.00 6.52 1.00 31.19 4.80
2005 17.72 2.24 29.64 3.75 0.00 0.00 7.76 0.98 36.75 4.65
Thailand
1975 7.64 0.85 10.34 1.16 0.00 0.00 1.28 0.14 49.33 5.52
1980 11.09 1.46 11.09 1.46 0.00 0.00 1.34 0.18 50.13 6.58
1985 13.26 1.82 10.04 1.38 0.00 0.00 1.49 0.20 51.07 7.00
1990 10.45 1.78 15.32 2.61 0.00 0.00 3.59 0.61 45.02 7.68
1995 11.74 1.99 27.56 4.66 0.00 0.00 2.31 0.39 43.22 7.30
2000 13.28 1.77 22.50 3.00 0.00 0.00 0.55 0.07 49.87 6.65
2005 11.32 1.94 28.90 4.96 0.00 0.00 0.02 0.00 49.15 8.44
Philippines
1975 7.84 1.04 13.68 1.81 0.00 0.00 0.92 0.12 27.64 3.65
1980 11.08 1.39 12.60 1.58 0.00 0.00 0.74 0.09 46.91 5.87
1985 9.31 1.00 20.48 2.19 0.00 0.00 0.89 0.10 40.78 4.37
1990 10.33 1.46 22.21 3.13 0.00 0.00 0.68 0.10 35.34 4.98
1995 12.45 2.03 23.35 3.81 0.00 0.00 0.13 0.02 28.00 4.56
2000 18.04 2.49 18.67 2.58 0.00 0.00 0.10 0.01 30.45 4.20
2005 16.62 2.15 21.94 2.84 0.00 0.00 0.14 0.02 27.12 3.51
Source: government financial and international financial statistics, 1975 to 2005.
42. KPMG, supra note 9.
Articles
considers possible reasons why international tax compe-
tition is not present in ASEAN.
In answering this question, it should first be noted that
ASEAN consists of countries at various levels of devel-
opment. This obviously gives rise to different opportu-
nities for each country, depending on their level of
development. Consequently, (economic) policies in the
various countries differ in order to deal with each coun-
trys specific requirements. Because of the differences,
the collective policies within the region may be imple-
mented differently with various results. In other words,
economic policies, as well as tax policies, amongst
ASEAN countries diverge.
This divergence has been recognized since the 1980s,
when tax reform started in ASEAN. Revenue generation
is the most common objective of tax reform.
43
It is, how-
ever, surprising that, in ASEAN, revenue enhancement
appears not to be a major concern, especially in Malay-
sia and Singapore. In these two countries, tax reforms
generally reduced tax revenue.
44
This is reasonable, as
the two countries have traditionally enjoyed surpluses
with regard to their fiscal balance. Accordingly, their tax
reform programmes were intended to reduce tax rates,
provide generous investment incentives and narrow the
tax base. In contrast, in Indonesia, the Philippines and
Thailand, revenue generation was a significant consid-
eration in tax reform and these countries policies also
widened the tax base.
45
It is, therefore, important to note that the variation in
tax policies and the definition of tax base result in
greater differences amongst the ASEAN countries. Con-
sequently, the authors find no evidence of a conver-
gence in tax rates, i.e. there is no evidence of
convergence in statutory tax rates, the EMTR or the
EATR. This suggests an absence of tax competition
between the ASEAN countries.
The investment incentive policies in most ASEAN
countries, however, demonstrate an attempt to provide
wide-ranging benefits to encourage foreign investors.
46
It is, consequently, difficult to say that there is no com-
petition amongst the ASEAN countries. As Charlton
47
states, competition for FDI in the ASEAN countries has
been a key factor contributing to the growth of invest-
ment incentives.
Investment incentive programmes were introduced in
the late 1950s by both Malaysia and Singapore through
tax holidays for firms investing in Pioneering Indus-
tries. These countries have, therefore, used preferential
tax treatment and other incentives to promote foreign
investment, which has dramatically increased their
GDP. By the mid-1980s, most ASEAN countries had
wide-ranging investment incentive programmes. Since
then, Singapore has become the regional leader in
increasing both the range and the sophistication of its
incentives and encouraging its ASEAN neighbours to
follow suit. This is in line with the literature, which sug-
gests that an increase in incentives by one government
puts pressure on the others to match those incentives.
In addition, because they have the lowest corporate
income tax rates in the ASEAN region,
48
it can be
argued that the economies of Singapore and Malaysia
exist because of tax competition, as the governments in
these countries have encouraged FDI by means of
advantageous investment incentives and tax rates for
companies. This is consistent with the view that the
existence of some form of tax competition in East and
Southeast Asia is potentially a response to the rapidly
falling tax rates in Malaysia and Singapore.
49
It is obvious that the taxation and incentive policies in
Malaysia and Singapore are intended to create an invest-
ment-friendly regulatory environment. This is particu-
larly the situation with regard to Singapore, in that its
major objectives with regard to tax reform are to attract
foreign investment, reduce business costs, improve
national and international competitiveness, and provide
impetus to the local and foreign workforce to continue
working in the country.
50
This is in contrast to the
objectives of other countries, such as Indonesia, the Phi-
lippines and Thailand. It is, therefore, implied that, in
terms of taxation policy, the ASEAN countries diverge.
It is, therefore, arguable that tax competition in ASEAN
does not encompass all of the countries, but only Malay-
sia and Singapore. In other words, tax policy competi-
tion is present at an individual-country level and in
response to international tax competition. This stimu-
lates the other countries in ASEAN to adopt this policy.
Consequently, tax competition is unavoidable and
potentially results in harmful tax competition.
From another perspective, tax competition may be
expensive for countries that want to generate optimum
tax revenues, such as Indonesia, the Philippines and
Thailand. A tax incentive policy potentially reduces tax
revenues, which are very important to the development
of these countries, as their economies are not as
advanced as those of Malaysia and Singapore. Accord-
ingly, their need for social and public spending is gener-
ally greater.
Finally, considering the experience of the European
Union, in which 85% of the headquarters of MNEs are
located, incentives for FDI are typical in a region.
Within ASEAN, therefore, not all countries can go it
alone in setting policy; rather, this should be resolved
43. A. Virmani, Tax Reform in Developing Countries: Issues, Policies,
Information Gaps, Public Finance, Vol. 43(1) (1988), pp. 19-38.
44. M.G. Asher, Tax Reform in Singapore, The Indian Economic Journal,
35(2) (1987), pp. 132-151.
45. R.G. Manasan, A Review of Fiscal Policy Reforms in the ASEAN Coun-
tries, Philippine Institute for Development Studies, Working Paper No. 90-14
(May 1990), pp. 18-19.
46. K. Fletcher, Tax Incentives in Cambodia, Lao PDR, and Vietnam,
paper prepared for the IMF Conference on Foreign Direct Investment for
Cambodia, Lao PDR and Vietnam, Hanoi, Vietnam 16 and 17 August 2002.
47. A. Charlton, Incentive Bidding for Mobile Investment: Economic Con-
sequences and Potential Responses, OECD Development Centre, Working
Paper No. 203 (January 2003).
48. From 1 January 2007, the corporate income tax rate is 18% in Singapore
and 26% in Malaysia.
49. Chia and Whalley, supra note 41, pp. 448-449.
50. Asher, supra note 44, p. 148.
Articles
collectively by way of policy coordination. It has been
argued that the best focus should be on streamlining
incentives and designing incentives to create a better
investment climate within ASEAN. There are several
preconditions for this. In this regard, all of the Member
countries of ASEAN should form closer ties and work
together to provide (1) stable corporate and securities
law protection for investors, (2) a competitive and coor-
dinated basis for taxation, (3) reform in respect of eco-
nomic policy with a view to creating a friendlier
business climate and (4) better infrastructure, as foreign
investors often select a location that provides a high
level of services. Consequently, minimizing competition
between Member countries in attracting FDI for similar
industries should also make ASEAN stronger economic-
ally.
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