Monday, 4 March 2013

Taxation and foreign investment: Some counterintuitive evidence from Chile

By Carlos Fortin 

A recommendation to increase the taxation of mining contained in the latest OECD report on the Chilean economy has fuelled a controversy in Chile. Mining is the main export sector for the country. The argument of the report is that the tax burden is low enough to allow for the rise without negatively affecting investment.

The issue had in fact already come up in a more general way in the Chilean public debate in 2010 as the centre-right government of Sebastián Piñera sought additional fiscal revenue to meet the needs for reconstruction in the aftermath of the February 2010 earthquake.  For those purposes it increased the tax on corporate profits from 17% to 20%, a move that was met by business spokespersons and right-wing politicians with warnings of dire consequences in the form of a drying up of investment and output and reduced fiscal intake.

The objection was presented with special forcefulness as applied to foreign direct investment: the rise in taxes would, it was argued, inevitably scare potential foreign investors away. The latest figures on foreign direct investment inflows released by the Chile Committee on Foreign Investment seem to give the lie to those predictions.  Direct foreign investment as a percentage of GDP in the 2011-2012 period (when the higher tax was applied) was 129% higher than in the period 2002-2010. In per capita terms the 2011-2012 average was 250% higher than the average for 2000-2009. It seems clear therefore that the tax increase did not frighten away foreign investors.

The point is confirmed by the findings in the 2011-2012 Survey of Mining Companies of the Fraser Institute. The survey covers the main metal mining and exploration companies and mining consultants in the world to assess how mineral endowments and public policy factors such as taxation and regulation impact on exploration investment. One of the questions in the survey specifically explores how the taxation regime, including personal, corporate, payroll, capital, and other taxes, and complexity of tax compliance, affects investment. The respondents are asked whether the tax regime:
  1. Encourages investment
  2. Is not a deterrent to investment
  3. Is a deterrent
  4. Is a strong deterrent
  5. The company would not pursue investment due to this factor. 
The responses are presented in the following table, together with the figures for 2009-2010 for comparison:

      World mining companies and investment in Chile: impact of the tax regime
Not a
Would not

The impact of the tax increase in 2011-2012 is negligible and, in fact, counter-intuitively positive for foreign investment. The percentage of those not deterred or feeling encouraged went up from 83% to 86% and no respondents felt they would not invest in 2011-2012 because of taxation, as against 1% in 2009-2010 when the corporate tax was lower.

The conclusion is not, of course, that higher taxes attract foreign investors. It is, though, that the serious and economically sophisticated international investor looks at a host of factors, including the availability of raw materials, the quality of the labour force, the institutional and legal context, and the investment climate as whole, of which taxation is only a part, and clearly not a deciding one.