Is the tax cut a good stimulus?

The CREATE bill (Corporate Recovery and Tax Incentives for Enterprises Act) has drawn sharp criticism from some economists. A major if not principal criticism is about the accelerated reduction of the corporate income tax (CIT) from 30% to 25% in the very first year of the law’s implementation, if passed.

Given that it has been certified urgent and it has gained support from the majority of stakeholders, it will pass. It is a matter of when it will be enacted and what the final design will be. Some provisions or features are up for revision or refinement.

The question is: How effective can a tax cut be as a stimulus?

The objective of a stimulus is to create spending of workers and households to boost aggregate demand. Hence, during the lockdown, wage subsidies and cash assistance for the poor and near poor are effective because they will certainly use the money for essential consumption. Their consumption hence will help the macro-economy.

To sustain consumption in a time of economic downturn, job preservation or job creation is the key. Recall the Keynesian figure of speech of creating jobs by having workers filling bottles with old bank notes, burying them and digging them up.

A tax cut can potentially serve the objective of preserving jobs. Worth citing is a National Bureau of Economic Research (NBER) working paper authored by Alexander Ljungqvist and Michael Smolyansky, titled “To Cut or not to Cut? On the Impact of Corporate Taxes on Employment and Income” (revised October 2018).

Based on data and observations regarding changes in CIT across US states, from 1970 to 2010, as well as establishing the counterfactual and checking biases for robustness, the authors conclude that “a one percentage point corporate tax increase (cut) leads to employment in the affected county falling (rising) by about 0.2 percent and total wage income falling (rising) by about 0.3 percent (as measured relative to the neighboring county across the border).”

But what is most relevant for this particular discussion is the insight that “when tax cuts are implemented during a recession… tax cuts lead to a sizeable positive response in both employment and wage income.”

To be sure, the conditions in the US and the Philippines are vastly different. One cannot use the NBER study to extrapolate for the Philippines. Nevertheless, the key finding resonates — that corporate tax cuts are responsive to employment and income, if done during a recession.

Undoubtedly, a tax cut is part of the toolbox for a stimulus. But it does not necessarily mean that it can deliver the “bang for the buck.” Fellow BusinessWorld columnist Raul Fabella has articulated the limited effectiveness of a tax cut as a stimulus (“Create,” BusinessWorld, May 27, 2020). Companies can “declare dividends to shareholders; they can shore up their balance sheet; they can engage in share buyback.”

So how do we avoid undesirable corporate behavior wherein the gains from the tax cut will hardly benefit the workers? The answer is actually simple: Tie the tax cut to job preservation, to new investments.

Remember that the cause of the economic downturn is the pandemic, not the lack of good economic fundamentals. Different economic and financial institutions have confidence in the Philippine economy. And we can expect investments to return, once government and society is able to manage the pandemic well.

But to enable investments, the government must not just provide incentives and assistance. There is no free lunch. It is proper for the government to introduce “conditionalities.” These can include what other countries like the US have done: restrictions on dividends, stock buybacks, and executive bonuses.

To quote the economists Mariana Mazzucato and Antonio Andreoni (“No More Free Lunch Bailouts,” Project Syndicate, June 25, 2020), “imposing such conditions help to steer financial resources strategically, by ensuring that they are reinvested productively instead of being captured by narrow or speculative interests.”

But let us not likewise forget that CREATE is not purely a stimulus. Its main features of modernizing and rationalizing fiscal incentives and reducing CIT for competitiveness (or for countering the aggressive tax competition, especially in the region) are long overdue.