We’ve sometimes used the term ‘tax wars’ instead of ‘tax competition’ to describe the process by which countries try to tempt mobile capital by offering tax breaks, prompting others to follow suit in a race to the bottom. Countries often do this in the name of ‘tax competitiveness,’ which as we’ve shown is generally a fools’ errand — even from a purely self-interested national point of view.
Now an Indonesian group called Prakarsa has issued a note entitled Anticipating Tax War in the ASEAN Economic Integration Era, which raises many familiar concerns, particularly tax holidays. As they argue:
“The Indonesian government plans to expand, simplify, and extend the duration of tax holiday policy up to 20 years to boost foreign investment. This might provoke tax competition with neighboring countries, and trigger a race to the bottom among ASEAN countries, especially after the implementation of the ASEAN Economic Community (AEC) later this year.”
The report noted that when tax holidays were first introduced in Indonesia in the 1970s it did not attract significant investment, and it was scrapped in 1984 (after which, presumably for other reasons, investment did increase.) They add:
“Research from Banga (2003) in 17 Asian countries including Indonesia concluded that tax incentives had no significant impacts on the increase of FDI inflows. Research from Dewi (2012) also concluded that tax holiday does not significantly influence the investment decision.”
And then there is the issue of what is sometimes known as ’round-tripping’, which tax holidays tend to encourage.
“Tax holiday facilit(ies) most likely can be exploited by “deceitful” companies to avoid taxes. Old companies might create a “new” company to gain a tax holiday facility. This can be carried out particularly by abusing weak tax administration in the developing countries such as Indonesia or by employing sophisticated concealment techniques, which have been proved in the tax evasion cases of a number of multinational companies (OECD, 2014).”
The report confirms findings from elsewhere, that taxes are usually only a minor factor in investment decisions, after things like the rule of law, infrastructure, educated and healthy workforces, and other (often heavily tax-financed) things.