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Taxation of Capital Gains in Developing Countries

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Taxation of Capital Gains in Developing Countries Taxation of Capital Gains in Developing Countries Juanita D. Amatong * ECONOMISTS GENERALLY AGREE that gains from capital JC/ are a proper source of taxation in developing countries. This view was expressed in the Technical Assistance Conference on Comparative Fiscal Administration in Geneva in 1951 and more recently in the Santiago Conference on Fiscal Policy for Economic Growth in Latin America.1 A capital gains tax is on the appreciation of capital assets and is commonly imposed only when the increase in value is realized through sale or exchange. It should be distinguished from net wealth tax, death duties, and other capital taxes in that these are assessed on the total value of assets. Capital gains in developing countries differ from those in developed countries. In the former, capital gains are mainly from the sale or exchange of real estate, and in the latter, chiefly from the sale of securi- ties. Three reasons account for the preponderance of capital gains from real estate in developing countries: the concentration of wealth held in real estate; the dominance in the corporate sector of foreign corporations whose shares are owned by nonresidents who are taxed abroad; and the widespread use of bearer shares, which limits the effectiveness of taxa- tion of capital gains from shares. Because capital gains in developing countries result largely from investments in land, the taxation of these gains is justifiable in that such investments are not socially productive and are highly speculative. Therefore, a capital gains tax discourages investments that are not in line with the social and economic objectives of developing economies. A capital gains tax is on an increment which generally accrues to the high-income group and thus provides an element of progressivity in the tax system. This function is particularly important in developing coun- * Mrs. Amatong, a graduate of Silliman University in the Philippines and of Syracuse University, was an economist in the Fund's Fiscal Affairs Department when this paper was prepared. She is now on the faculty of Andres Bonifacio College in the Philippines. *See United Nations, Technical Assistance Administration, Taxes and Fiscal Policy in Under-Developed Countries (New York, 1954); Joint Tax Program of the Organization of American States, Inter-American Development Bank, and Economic Commission for Latin America (hereinafter referred to as Joint Tax Program, OAS/IDB/ECLA), Fiscal Policy for Economic Growth in Latin America (Baltimore, 1965), pp. 164-65 and 187-96. 344 ©International Monetary Fund. Not for Redistribution TAXATION OF CAPITAL GAINS IN DEVELOPING COUNTRIES 345 tries with a high concentration of wealth and/or with an otherwise regressive tax system. A capital gains tax combined with a well- structured progressive income tax and levies on capital would be useful in promoting tax equity. The lock-in effect of a capital gains tax in developing countries may have important repercussions on the mobility and composition of invest- ments; on the other hand, the adverse effect on investments is less serious than claimed, judging from the general low rate structure and the restricted nature of the capital gains tax in many developing countries. Administration and the revenue potential of the tax are to be con- sidered in the introduction of a capital gains tax. Such a tax is complex and necessitates high administrative cost to make it effective. Experience in many countries shows that the revenue yield from the tax is low. However, the high cost of administering a capital gains tax and the low potential yield may be partly compensated for by the fact that tax administrators may gain access to records that aid in the administration of the income tax and other taxes. A developing country considering the adoption of a capital gains tax should weigh carefully its economic, social, administrative, and revenue consequences. This paper is divided into five sections: Section I discusses the nature of capital gains in developing countries; Section II evaluates the factors to be considered in the taxation of capital gains; Section III describes the various forms under which realized capital gains are taxed in selected countries; Section IV assesses the size of the contribution made by capital gains tax to total revenue in these countries; and Section V discusses some of the problems in administering a capital gains tax in less developed countries.2 I. Nature of Capital Cains in Developing Economies The composition of capital gains in developing countries is different from that in advanced countries. In advanced countries, a considerable proportion of capital gains comes from the sale of securities. In the United States, for example, 42 per cent of the reported gross capital gains in 1962 came from security sales and exchanges.3 In the United 2 Principally Argentina, Bolivia, Burma, Ceylon, Chile, Colombia, Republic of China, Ecuador, El Salvador, Ghana, India, Israel, Malagasy Republic, Mexico, Pakistan, Panama, Peru, Philippines, and Venezuela. Although Ghana repealed its tax in 1967, reference is made to its provisions. 3 Securities here include corporate stock, U.S. Government obligations, state and local securities, bonds, notes, and debentures. The ratio rises to 70 per cent if all other npnphysical assets are included. U.S. Treasury Department, Internal Revenue Service, Statistics of Income, 1962, Supplemental Report (Washington), September 1966, pp. 21-27. ©International Monetary Fund. Not for Redistribution 346 INTERNATIONAL MONETARY FUND STAFF PAPERS Kingdom it is estimated that the proportion of capital gains from the sale of securities would approximate that of the United States. In con- trast,4 in developing countries gains resulting from the sale or disposal of physical assets, particularly in the form of real estate, predominate. Several reasons account for this phenomenon: (1) the concentration of wealth in developing countries held in real estate; (2) the prevalence of foreign-owned or foreign-dominated corporations whose shares are traded in the home country or in other foreign capital markets; (3) the widespread use of bearer shares, which makes it difficult to enforce a tax on capital gains arising from securities. These reasons are examined in the following section. CONCENTRATION OF WEALTH HELD IN REAL ESTATE In advanced countries wealth is principally in the form of securities. In the United States, for example, it is estimated that of total investment by the household sector investment in real estate is 28 per cent, against 29 per cent in corporate securities.5 The pattern of investments of top wealth holders in the United States shows that their investment in cor- porate shares is almost double that in real estate, the former representing 40 per cent and the latter only 22 per cent of the total. Smaller percentages are held in bonds, mortgages and notes, life insurance reserves, etc. In contrast, wealth holding in developing countries is gen- erally concentrated in real estate and other physical assets, while only a small proportion is in corporate securities.6 Table 1 gives a classification of investments for four Asian countries. Investment in corporate stocks is on average 6.1 per cent of total investments in Malaysia, 23.3 per cent in the Philippines, 6.5 per cent in India, and a negligible 0.1 per cent in Ceylon. Investments in physical assets (land, residential con- struction, and consumer durables) constitute a major proportion of the total investment in these countries, ranging from 39 per cent to 67 per cent. In Ceylon, 60 per cent of total investment was in real estate. In the 4 See, for example, Ifigenia M. de Nayarrete, "El Impuesto a las Ganancias de Capital en la Teoría y en la Práctica Fiscal," El Trimestre Económico (Mexico, D.F.), April-June 1963, p. 210; Ram Niranjan Tripathy, Public Finance in Under-Developed Countries (Calcutta, 1964), p. 142; J.J. Puthucheary, Ownership and Control in the Malayan Economy (Singapore, 1960), pp. 136-37. 5 Estimates were based on the estate multiplier method as used by Robert J. Lampman, The Share of Top Wealth-Holders in National Wealth, 1922-56 (National Bureau of Economic Research, Princeton University Press, 1962), pp. 157 and 192-93. 6 A good socioeconomic study of savings and wealth in South Asia is found in United Nations Educational, Scientific and Cultural Organization, The Role of Savings and Wealth in Southern Asia and the West, ed. by Richard D. Lambert and Bert F. Hoselitz (Paris, 1963). ©International Monetary Fund. Not for Redistribution TABLE 1. SELECTED ASIAN COUNTRIES: PATTERN OF ASSETS IN HOUSEHOLD SECTOR TAXATIO (In per cent of total) Financial Assets Physical Assets N Currency O and net Residential F bank Corporate construc- Grand CAPITA Country deposits securitiesi Others 2 Total tion Others 3 Total Total Ceylon, 1962/63 -0.4* 0.1 33.6 33.3 59.7 5 7.0 β 66.7 100.0 L India, 5-year average GAIN (1959/63) 20.0 6.5 20.6 47.1 52.9 100.0 Malaysia, 5-year average (1954/58) 5.4 6.1 30.3 41.8 58.2 100.0 S Philippines, 5-year average I (1956/60) 19.8 23.3 17.5 60.6 28.6 10.8 39.4 100.0 N DEVELOPIN Sources: Central Bank of Ceylon, Report on the Sample Survey of Consumer Finances, 1963 (Colombo, 1964), pp. 122-25; Reserve Bank of India Bulletin, March 1965, p. 324; Richard W. Hooley, Saving in the Philippines, 1951- 1960 (University of the Philippines, Manila, 1963), pp. 22-32; Indian Institute of Asian Studies, Savings in Asian Econ- omy, ed. by M. R. Sinha (Bombay, 1965), pp. 198-214. 1 In the Philippines, corporate securities represent net investment in new security issues of corporations and amounts G paid as capital subscriptions in partnerships and proprietorships.
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