Philippine Markets Newsletter

MONDAY MACRO: Uniform ROAs give a glimpse of what business profitability will look like post-tax reform

February 22, 2021

While there is much talk about the proposed tax reform as a relief to struggling businesses, its real impact is yet to be seen in the years to come.

This chart shows how it is incorrect to just think of the CREATE Act as just a tax-saving mechanism for corporations. Rather, it is a policy that can jump-start the economy’s expansion through corporate earnings growth and job creation.

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Before the industrial revolution, governments played a much simpler role. They mainly functioned to provide security to people and to build roads and bridges.

The tax system wasn’t also given much thought in the past. The only concern was how to fill the government’s coffers, so almost everything was taxed such as people’s income, trade, jewelries, and other possessions.

In contrast to today, the government plays a much more involved and complex role in people’s lives, going beyond providing security and infrastructure. The government now needs to think about how to improve the welfare of its citizens.

As such, policies are under heavier scrutiny since they can create unintentionally negative outcomes. This similarly applies to the tax system, where economists have learned that the tax system impacts people’s behavior.

For example, when income taxes are too high, it reduces the incentive to work and may encourage people to work someplace else. Meanwhile, taxing trade may reduce the amount of economic transactions taking place.

We discussed in the previous Monday Macro report the impact of the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act on the Philippine government’s revenue. However, its impact on corporations involves more than just tax savings.

Sometimes, taxes are applied to things we want to curtail. Amidst rising health concerns in 2012, the government wanted to curtail tobacco consumption. As a result, the government passed the Sin Tax bill in 2012, which raised taxes on producers for each pack of cigarettes.

The producers responded by raising prices on their products, which caused demand to drop. Annual household consumption of cigarettes fell from an average of 62 packs in 2009 to 52 packs in 2015. This was also the same rationale behind imposing taxes on sugary drinks under the TRAIN law.

As for corporate income tax, higher tax rates reduce the incentive of corporations to generate earnings. On paper, this sounds neither good nor bad.

However, a company’s profits are used in two ways: returning capital to owners and reinvesting in the business. We want businesses to reinvest because they will need more facilities, machinery, and labor.

The facilities and machines will generate more activity for the suppliers, while labor will improve the country’s employment. Yet the corporate income tax makes no distinction between the two ways profits are used–both are taxed the same way.

As such, the terms of the CREATE Act wouldn’t just generate tax savings. Lowering the corporate income tax rate from 30% to 20% for SMEs and to 25% for large corporations would also reduce the discouraging effects of the tax and incentivize more businesses to reinvest.

Coupled with the fiscal incentives of the bill, a lot of companies would barely be affected by the corporate tax and its effects. If signed into law, the CREATE Act will allow companies with investment projects approved by the Investment Promotion Agencies (IPA) to enjoy income tax holidays.

We’ve seen in the past how a reduction in the corporate tax has helped drive profitability and asset growth.

The chart above shows the aggregate Uniform profitability (blue bars) of nearly all companies trading in the Philippine Stock Exchange. Right when the corporate income tax rate (red line) fell from 35% in 2008 to 30% in 2009, Uniform ROAs rebounded to historical highs of 7% from 2010-2019, excluding an underperformance in 2013-2014.

Uniform ROAs did decline to 5% in 2013 and 6% in 2014, but that was accompanied by significant asset expansion by corporations. During 2013, Uniform asset growth was at its historical peak of 27%.

If a more favorable tax environment supported such levels of earnings and asset growth, then the CREATE Act could possibly be even more impactful.

The Secretary of the Department of Trade and Industry estimates that the CREATE Act can bring in over PHP 200 billion of new investments and 1.4 million to 2 million new jobs. If the executive departments are as conservative as they are with the CREATE Act’s impact on government revenues, then the investment and labor numbers may be too low as well.

About the Philippine Markets Daily
“The Monday Macro Report”

When just about anyone can post just about anything online, it gets increasingly difficult for an individual investor to sift through the plethora of information available.

Investors need a tool that will help them cut through any biased or misleading information and dive straight into reliable and useful data.

Every Monday, we publish an interesting chart on the Philippine economy and stock market. We highlight data that investors would normally look at, but through the lens of Uniform Accounting, a powerful tool that gets investors closer to understanding the economic reality of firms.

Understanding what kind of market we are in, what leading indicators we should be looking at, and what market expectations are, will make investing a less monumental task than finding a needle in a haystack.

Hope you’ve found this week’s macro chart interesting and insightful.


Angelica Lim
Research Director
Philippine Markets Daily
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