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TAX INCENTIVES IN THE PERUVIAN AMAZON: NET GAIN OR NET LOSS? By: Fabiola Caceres Paurinotto Tax incentives in the Peruvian Amazon were introduced to address the difficulties faced by regions in this area of the country to boost their economic and social development due to their geographical location and isolation from the national economy. However, the effects of the incentives on the observed economic development of the area are not clear and evidence suggests that they have not been effective since i) the region’s percentage on national GDP has not been altered despite the generous incentives; ii) other regions outside the target zone have experienced higher growth rates than the beneficiary areas; and, iii) poverty rates remain high and, on average, one of every two residents in the Amazon still lives with an income that falls below the poverty line. On the other hand, the tax incentives have introduced high costs to the society in terms of equity and efficiency, since Peruvians outside the Amazon region pay higher taxes in exchange for a benefit that only 9.4% 1 of the population receives 2. As a consequence, instead of a net gain, the tax incentives in the Peruvian Amazon currently represent a net loss for the Peruvian society as a whole, and, therefore, I recommend their elimination. Nevertheless, considering the moral obligation to compensate these regions in the Peruvian Amazon historically forgotten and deprived of opportunities for development, and due to the expected political and social resistance to the policy, I suggest replacing the existing benefits with a direct subsidy to finance the Interoceanic Iquitos – Yurimaguas railway 3 that will allow to reconnect the Amazon with the rest of the country and, therefore, eliminate the obstacles faced to attract productive investment in a sustainable, and efficient and more equitable way. Background information 1 Population data for 2009 obtained from the National Institute of Statistics and Information- INEI (Available in www.inei.gob.pe) Since Lima, the capital city concentrates, on average, 88% of the total tax collections in Peru, the National Tax Collection Agency collects the resources and then the Ministry of Economy redistributes them to subnational governments considering variables like population density, poverty, inequality, between others. Consequently, a tax cut for a determined area is paid by all taxpayers on a national level. 2 3 Given the high economic and environmental costs of building a highway in the forest, the Interoceanic Iquitos – Yurimaguas railway represents a more efficient and low cost way to connect the Amazon with the rest of the country and provide a way out to the Pacific Ocean to facilitate the movement of goods and flow of passengers and boost economic development. 1 Tax incentives for the Peruvian Amazon region were first introduced in 1982, however, the number of benefits and their complexity increased at the end of the 1990s. According to the Peruvian ministry of Economy, 23 tax incentives are in place and benefit the Peruvian Amazon regions of Amazonas, Loreto, San Martin, Madre de Dios and Ucayali 4. The tax incentives provided to these specific regions were justified by the difficulties faced to attract investment and employment to these areas due to a complex geographic location that isolates the Peruvian Amazon from the rest of the country5. In that sense, the tax incentives were conceived as a sort of compensation to these abandoned regions and intended to promote the creation of businesses and employment in the area. As shown on figure 1 in the appendix, the five regions in the Peruvian Amazon targeted with the tax incentives are geographically isolated between the Andes Mountains and the Brazilian jungle, a situation that, combined with the poor and sometimes inexistent infrastructure, affect the ability of these areas to develop their economies. In addition, these regions face high poverty rates and scarce access to public services, arguments that build on to the necessity of providing some sort of compensation to help this regions path to development. The Amazon tax incentives and its effects To December 2010, twenty three different tax incentives for the Amazon region were in place, offering businesses in the region: i) a general tax exemption to the National Sales Tax (19% tax rate otherwise) for producers, wholesalers and retailers located in the Amazon 6; ii) exemption from the Selective Consumption Tax for gasoline producers, wholesalers and retailers for sales in the Amazon region market; iii) Sales tax refunds for businesses importing inputs; and; iv) a tax rate reduction of the National Corporate Income Tax from 30% to 5% or 10% 7, as shown in figure 2 in the appendix 8. 4 Selected districts from other regions in the Andes benefit as well if they are located in the Amazon region but there is no data available for those particular districts. 5 As an example, it is worth noting that the biggest city in the Peruvian Amazon, Iquitos, cannot be accessed by road and requires either air or boat transportation. According to the National Institute of Statistics and Information – INEI, 1 million people live in Loreto and close to 500,000 live in Iquitos, the capital city of Loreto. 6 7 Benefits are available for both activities that incentivize export jobs as well as local jobs. The tax rate applicable is 5% for regions in the “lower Amazon” and 10% for the “high Amazon”. 8Information available in the Peruvian Ministry of Economy (Available at: www.mef.gob.pe) 2 Assessing the benefits According to INEI data shown in figure 4, the beneficiary regions observed economic growth in the years following the implementation of the incentives, being San Martin and Ucayali the regions with better performance in the target area. However, when comparing the growth figures for the target regions with those observed in non -target areas, it becomes evident that the positive results in the Amazon cannot be attributed to the effect of the tax incentives alone since the country grew at an average annual rate of 6.4% between 2001 and 2008 and all regions experienced economic growth as well 9. In addition, as it can be observed in figure 4, regions lacking of tax incentives like Ica, Cusco, La Libertad and Arequipa experienced higher growth rates than those in the Peruvian Amazon 10. On the other hand, the evidence available suggests that the Amazon region has not performed better than non-targeted areas since the share of these regions on the national GDP has remained unchanged. According to the Ministry of Economy11, in 1997, before the tax incentives, Loreto represented 2.5%, San Martin 1.1%, Ucayali 0.9%, Amazonas 0.5% and Madre de Dios 0.4% of national GDP, and in 2009, Loreto and Madre de Dios reduced their contribution to national GDP to 1.91% and 0.38% respectively, while Amazonas, San Martin and Ucayali experienced slight improvements in its contributions to Peruvian GDP that grew to 0.65%, 1.29% and 1.06%, respectively. However, when considering the size of each Amazon regions and its contribution to GDP before and after the incentives, the region as a whole does not evidence significant effects and the situation observed in the Amazon relative to the rest of the country seems unchanged despite the tax incentives implemented. Finally, while poverty rates in beneficiary zones have declined, they remain high and even above the national poverty rate (on average 40% of population in the Amazon lived in poverty in 2009 and 34% on a national level 12), suggesting, at least that the policy has not been able to deliver the expected results in target zones. 9 Regional GDP 2008. Institute of Statistics and Information. 10 11 Regional GDP 2008. Institute of Statistics and Information. Ministry of Economy - Apoyo Consultoria (2003). 12 Poverty rates per region in 2010 obtained from the National Institute of Statistics and Information (Available at: www.inei.gob.pe) 3 In addition, it is worth noticing that despite the generous tax incentives, the beneficiary regions are still ranked between those with less attractiveness to investment13. As shown in figure 3, the Amazon still face obstacles such as poor infrastructure, education and low quality of institutions, factors that might explain the limited ability of the current tax incentives to attract investment and influence businesses decisions. Therefore, even when data availability does not allow to fully evaluate the impact of this policy, the evidence suggest that this economic development promotion tool has at least not been able to make significant reductions in poverty rates nor to compensate for the lack of infrastructure, absence of inputs in the region, low levels of education in their work force, health concerns, between other factors equally or more important for business development than tax rates As a consequence, the incentives have failed to provide the expected benefits to the Amazon regions.. Measuring the costs The current tax incentives have imposed costs to the society in terms of efficiency and equity and have increased the administrative costs of the National Tax Collection Agency. In the first place, tax incentives have narrowed the tax base and reduced the potential tax collections, therefore, forcing taxpayers outside the target zone (over 90% of the total population14) to pay indefinitely for the subsidy to the Amazon regions through higher tax rates or less public services. This situation is exceptionally unequal since all taxpayers on a national level and even in regions with higher poverty rates than those observed in the Peruvian Amazon have to pay the price of the tax incentives provided to this area. In addition, this unfair situation violates the “benefit principle” since taxpayers on a national level have to pay for a benefit they do not receive and directly subsidize a small share of businesses and Peruvian citizens. In addition, the tax incentives have created opportunities for evasion and fraud, particularly in the case of the tax exemptions for gasoline sales in the region. In that sense, in absence of adequate controls, businesses that benefit from the tax cuts illegally transport and sell gasoline in areas outside the Amazon without paying taxes. This situation has resulted not only in less collected taxes but also in a black market of gasoline in regions close to the Peruvian Amazon. Proof of that is the fact that the per 13 Regional Competitiveness Index 2009. Peruvian National Council of Competitiveness. 14 Population data for 2009 obtained from the National Institute of Statistics and Information- INEI (Available in www.inei.gob.pe) 4 capita consumption of gasoline in the Amazon region duplicated after the implementation of the benefit and remains high, a situation that is inconsistent with the size of the market, the share of population and the economic activity in the region 15. Finally, the tax incentives in the Peruvian Amazon represent an average annual cost of 0.43% of the Peruvian GDP in uncollected taxes that could be used more efficiently in the provision of public services on a national level after the deficit of infrastructure in the Amazon has been covered. On the other hand, the tax incentives have placed an administrative burden to the Peruvian National Tax Collection Agency given that despite the potential savings from not collecting taxes to a share of the taxpayers, the complexity of the current benefits and different provisions for determined industries and locations has resulted in greater resources required to enforce and audit tax payments. The proposed alternative Given the fact that the current tax incentives have not delivered the expected benefits and confronted with the costs of this particular policy, I propose eliminating the incentives and replacing them with investment in basic infrastructure such as the Iquitos – Yurimaguas railway that will reconnect the Amazon with the rest of the country and provide a way out to the Pacific Ocean. This proposed path represents a better option than the current policy since will address the most important obstacle for the region’s development, since, in absence of basic transportation systems, no firms will be attracted or jobs created, regardless of the incentives. In addition, this alternative represents a less inequitable way to support the Amazon region’s development since, i) financing infrastructure projects like the Iquitos – Yurimaguas railway that will connect the Amazon to both the Andes region and the Coast will increase trade and tourism benefiting not only the Amazon but neighbor regions as well; ii) paying for the development of the infrastructure will eliminate the indefinite time nature of the subsidy implied in the current tax incentives and will limit the size of the subsidy as well; and, iii) if we consider that taxpayers on a national level have subsidized infrastructure for other regions through the years but not for the Amazon, investing in this region’s basic transportation system will imply moving from an already inequitable situation to a less inequitable one. 15 Ministry of Economy - Apoyo Consultoria (2003). 5 Finally, the proposed alternative eliminates the costs derived from the tax evasion in gasoline and the incentives for fraud created by the policy and will reduce as well the administrative burden to the National Collection Agency. Conclusion The implementation of tax incentives in the Peruvian Amazon region was expected to boost economic development in an impoverished and isolated area. However, this policy seems to have limited effect on the development of the beneficiary regions in the presence of other factors important for business development that hinder their attractiveness to investment. On the other hand, the tax incentives in the Peruvian Amazon have imposed high costs for the Peruvian society as a whole, since they have eroded the tax base and reduced tax collections, while introducing efficiency and equity implications as well as higher administrative costs. Therefore, the current tax incentives have resulted in a policy that creates a net loss for society rather than a net gain, and, therefore, the best option available is to eliminate them and replace them with investment in infrastructure that will break this regions isolation from the national economy and will set the basis for sustainable economic development. While this alternative still implies a temporary subsidy from taxpayer outside the Amazon to those in the area, it represents a more efficient and less inequitable way to address the problem since the investment in a basic transportation system for the Amazon will not only eliminate the current administrative cost and reduce the size of the subsidy in time but will boost economic development in the Amazon and surrounding areas as well. 6 Appendix Figure 1: Regions that benefit from the Peruvian Amazon tax incentives Source: Peruvian Institute of Statistics and Information – INEI (www.inei.gob.pe) 7 Figure 2: Tax incentives in the Peruvian Amazon region Tax incentive Beneficiaries • Producers and wholesalers in the region • Retailers in the region • Consumers of gasolines and transportation services in the region Exemption on the Sales Tax • Producers in the region • Wholesalers in the region • Retailers in the region • Consumers in the regin • Businesses outside the region that buy inputs in the Amazon Sales tax refund for goods imported • Businesses in the region that import inputs without tariffs according to the Peru- • Exporters in the region • Businesses in determined economic activities in the region Reduction of the Corporate Income • Businesses that reinvest at least 30% of their profits in the tax from 30% to 5% and 10% region. Exemption from the Selective Consumption Tax for gasolines Source: Ministry of Economy of Peru Figure 3: Regions in the Peruvian Amazon and Regional Competitiveness Index 2009 Region Components Quality of institutions Infrastructure Economic development Health Education Business climate Innovation Natural Resources Overall position in the ranking (Out of 24 regions) Amazonas 8 23 22 10 22 24 20 21 Loreto 24 15 15 20 18 17 11 19 22 20 Madre de Dios 15 16 2 12 10 6 19 22 14 San Martin 5 12 19 15 21 16 13 15 15 Ucayali 1 14 8 18 16 7 7 23 12 Source: Peruvian National Competitiveness Council 8 Figure 4: Average annual growth rate by region (2001-2009) Amazonas Ancash Apurimac Arequipa Ayacucho Cajamarca Cusco Huancavelica Huanuco Ica Junin La Libertad Lambayeque Lima Loreto Madre de Dios Moquegua Pasco Piura Puno San Martin Tacna Tumbes Ucayali Average 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Source: National Institute of Statistics and Infromation (INEI). Figure 5: Amazon GDP by region as a share of national GDP (2001-2009) 2.50% 2.00% Amazonas 1.50% Loreto Madre de Dios 1.00% San Martin Ucayali 0.50% 0.00% 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: National Institute of Statistics and Information (INEI). 9