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17
Giorgi KUPARADZE
Doctorate Candidate at Ivane Javakhishvili Tbilisi State University, Researcher at the Caucasian Institute for Economic and Social Research, Editor of the Scientific-Analytical Journal Caucasian Economic Triangle
(Tbilisi, Georgia).
TAX POLICY AND FOREIGN DIRECT INVESTMENTS (A GEORGIAN CASE-STUDY)
Abstract
This research examines the role and influence of tax policy on foreign direct investments using the example of Georgia. The study covers the period between 2003 and 2012. Countries that have been in transition since the 1990s require new investment resources as their traditional mode of production was uncompetitive in the market economy. This has created specific competition among governments offering generous tax and other kinds of incentives to international investors for investing in their area. In the academic sphere, it has aroused a considerable debate about whether these tax incentives are conducive to attracting foreign direct investments compared to other investment factors. This debate is still going on and is relatively new for transition economy countries.
This article examines the relation between tax policy and FDI inflows into Geor-
gia. Since 2005, radical reforms have been carried out in the tax administration sphere. Georgia has been experiencing unprecedented growth in foreign direct investments during this time. Tax policies are obviously capable of affecting the volume and location of FDI, since, all other considerations being equal, higher tax rates reduce after-tax returns. However, all other considerations are seldom equal. In this research I tried to answer the following questions: what impact does tax policy have on inflows of FDI into Georgia? What is the role of tax policy when making the decision to invest in Georgia? The main thesis suggested here is that tax policy factors act as a marginal factor in making decisions to invest in Georgia. Tax policy has an indirect influence on investors and creates the overall impression of Georgia as a tax-friendly country.
KEYWORDS: Georgia, transition economies, foreign direct investments, tax policy, investment environment.
Introduction
Foreign direct investments have become the main driving force behind economic growth in countries around the world and especially in transition economy countries. According to UNCTAD
This article was written with the help of a research grant from the Shota Rustaveli National Science Foundation, "The Impact of Tax Policy on Investments in the Real Sector of the Economy, A Georgian Case-Study, " Georgia, Presidential Grants for Young Scientists, Grant # PG/44/2-230/12.
THE CAUCASUS & GLOBALIZATION
statistics, FDI flows for 2012 reached $1.3 trillion compared to $315 billion for 1995.1 In spite of the economic crisis and fluctuations in the economy, the role and volume of FDI is continuously increasing. For most of countries, FDI inflows are the main source of economic growth. Investors making investments abroad search for new resources and markets in pursuit of higher efficiency and profitability of their business activities. FDI inflows in general are mutually beneficial for both parties.
The trade liberalization and opening up of the borders of closed economies that occurred at the end of the 20th century created new possibilities for developing countries to import knowledge and technological innovations into the domestic economy. This made it possible for less developed and transition economy countries to improve their national economies in a comparably short period of time based on the knowledge accumulated in the developed world. The most effective way of transferring technological innovations and financial resources is foreign direct investments. It is common knowledge that FDIs provide recipient countries with the unique opportunity to acquire the gains of technological revolution and import capital and superior knowledge-based assets into the domestic economy.
Attracting a substantial amount of foreign direct investments is regarded as an important factor for overcoming the crises that exist in transition economy countries and achieving economic growth in the national economies. Many researchers have found a strong correlation between FDI inflows and GDP growth in transition economies.2 Countries that have managed to attract a significant volume of FDI have largely been able to achieve economic growth by improving productivity through transferring advanced technologies, on the one hand, and efficiency "spillovers," on the other.
Based on the direct and spillover effects that FDIs have been having on national economies in recent decades, an increasing number of governments have tried hard to attract substantial levels of foreign direct investments. The main attention was focused on those factors that determined the inflows of FDI into specific countries. The decision-making process of investors has been explored in a number of studies.3
Governments, especially in small countries, are mainly using fiscal incentives in the competition to attract FDIs. Such competition has generated debates about the effectiveness of fiscal incentives. Are these incentives able to attract a substantial amount of FDI? This debate about the effectiveness of fiscal incentives is new for transition economy countries.
This research focuses on the relation between tax policy and inflows of FDI into Georgia. In my research I tried to answer the following question: are tax incentives that reduce budget revenues able to attract foreign investments?
Two main approaches have been used so far to analyze the posed question: a time series econometric analysis and selective surveys of international investors.4 This research uses selective surveys of international investors. It should be mentioned that, in the case of Georgia, for a number of different objective and subjective reasons, the quantitative aspect of foreign investment inflows into the
1 See: UNCTAD (1996) World Investment Report 1996 (United Nations Conference on Trade and Development) UNCTAD (2013) World Investment Report 2013, available at [http://unctad.org/en/PublicationsLibrary/wir2013_en.pdf], 14 March, 2013.
2 See: D. Dyker, Foreign Direct Investment and Technology Transfer in the Former Soviet Union, Edward Elgar Publishing Limited, Cheltenham, UK, 1999, p. 9.
3 See: J.H. Dunning, International Production and Multinational Enterprise, Allen & Unwin, London, 1981; D. Lim, "Fiscal Incentives and Direct Foreign Investments in Less Developed Countries," Journal of Development Studies, No. 19 (2), 1983, pp. 207-212.
4 For a review of the literature, see: J. Morisset, N. Pirnia, How Tax Policy and Incentives Affect Foreign Direct Investment, A Review, Foreign Investment Advisory Service (FIAS), The World Bank, 2000. For a discussion of the different quantitative models of the potential influence of tax policies on the economy, see: "Tax Effects on Foreign Direct Investment," Recent Evidence and Policy Analysis, No. 17, OECD, 2007, pp. 28—34; I. Aniashvili, V. Papava, "Models Estimating the Tax Burden Impact on the Efficiency and Volume of the Use of Resources," Ekonomisti, No. 1, 2011, pp. 8—29 (in Georgian).
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country is almost completely beyond the scope of a statistical survey, and as a result, a more or less realistic assessment of the processes can only be made through indirect estimations. The situation with private capital circulation is especially difficult. Available statistical data is incomplete, scarcely covering only very large and notorious investments. In order to fill in the data gap, I conducted quite a time-consuming foreign investors survey using specially designed questionnaires.
FDI Inflows and Tax Policy in Georgia
As already mentioned, FDI is the main source of economic growth for transition economy countries. Foreign direct investment has been a major driving force behind Georgia's economic development, reaching a high of $1.56 billion in 2008,5 accounting for 12.2 percent of gross domestic product (GDP). Net cumulative FDI also reached 44.5 percent of GDP that year. The twin shocks of the 2008 war with Russia and the global recession resulted in a dramatic drop in FDI inflows. Growth in FDI inflows began in 2010 and reached $814.5 million that year. In view of how important foreign direct investments are in Georgia, it is essential to identify which factors of investment environment are essential for attracting additional amounts of investments.
The importance of the problematic aspects of the investment environment changes over time. Since the 1990s, Georgia has been striving to attract foreign direct investments. Between 1995 and 2003, the main thrust was toward achieving macroeconomic stability and reducing corruption6. Since 2003,7 the radical changes in the country's political life have also caused changes in the problematic economic factors. Corruption and macroeconomic stability have been losing their importance as the government finds successful solutions for these problems. Successful reforms have been carried out in the taxation system. Foreign investors have been offered generous tax incentives. By tax policy we mean a targeted policy using the following tools: differentiable tax rates and deduction of costs, tax exemptions, and tax administration.
The new economic and political course implemented since 2005 had its own impact on FDI inflows. In 2006, FDI inflows reached $1,190.4 million, which was 128 percent higher than the previous year. For that year, FDI amounted to 47 percent of all investments in Georgia and 15 percent of GDP. In 2005, the share of FDI in all investments was only 25 percent.8
The rising trend of FDI inflows continued in 2007 as well and reached its maximum of $2,014.8 million. This was 1.96-fold more than the previous year (see Fig. 1). The sharp increase in FDI inflows was the direct result of improvements in the business environment in Georgia.9 In addition to the radical political changes, there were changes in tax administration that resulted in greater mobilization of tax revenues and a reduction in corruption of the tax authorities. All of these measures were acknowledged in a number of reports by international organizations.
In 2008, there were two crises—the war with Russia and the world economic crisis—that decreased FDI inflows. After the economy's essential recovery in 2009, the Georgian government
5 See: National Statistics office of Georgia, available at [http://www.geostat.ge/index.php?action=page&p_ id= 140&lang=eng], 10 April, 2013.
6 For more on the discussion of Georgia's economic policies, see: V. Papava, "Economic Achievements of Post-Revolutionary Georgia," Problems of Economic Transition, Vol. 56, No. 2, June 2013, pp. 51-65.
7 The Rose Revolution brought about a change in power in Georgia in November 2003 through peaceful protests over the disputed parliamentary elections. The new government began implementing new policies and carrying out radical reforms in the economic and political spheres.
8 See: National Statistics Office of Georgia.
9 See: M. Gelashvili, "The Role of FDI in Stabilization of the Economy," Collection of Scientific Works of Sukhumi State University, Economics Division, Vol. III, 2008, p. 159.
Figure 1
FDI Dynamics in Georgia, 2000-2011, $m
1,000
1,500
2,00C
500
2,50
0
maintained a course toward attracting substantial amounts of foreign direct investments. The main priority for 2009 was to achieve the level of the previous year. In addition to Georgia's political problems, there were the limits on the availability of free capital resources, since the world economic crisis decreased investment resources and created impediments for the new investments.10
In the first quarter of 2011, FDI amounted to $174 million, which exceeds the same data for 2009 and 2010 by 1.5-fold and 2.3-fold, respectively. Furthermore, from the graph above, it can be seen that annual FDIs have been increasing since 2009, i.e. from $658.4 million in 2009 to $814.5 million in 2010.
In order to increase FDI, the Georgian government passed a law on the creation of Free Industrial Zones (FIZ), where businesses can enjoy a business-friendly climate, strategic geographical location, liberal trade regimes on exports, and an educated workforce, while also being exempt from taxes. Currently, there are three FIZs in Georgia—in Poti, Kutaisi, and Tbilisi.11 These FIZs are still in the process of attracting investors and setting up businesses, mostly in the field of industry.
As we can see, since 2005, the radical and positive changes in economic and political spheres have resulted in a rise in FDI inflows, which reached its peak in 2007. After that, external and internal factors beyond economic regulation reduced FDI inflows into Georgia. Recovery began in 2009, but it has still not reached the 2007 level. Accordingly, if we exclude external factors, there has been a steady growth in FDI inflows since 2006, which was preceded by radical reforms in the tax administration sphere. A number of international organizations acknowledged these reforms as positive and yielding effective results.
A number of scientists have been exploring the effects of FDI in transition economy countries. Most of them agree that FDI has a direct effect on economic growth. In the case of Georgia, some researchers have carried out a quantitative analysis of the relation between FDI and economic growth.12 If we observe only the quantitative share of FDI in GDP, it reached 20 percent in 2007. But here we should note that the effect of every investment unit has a more lasting impact when we consider foreign direct investments. According to some scientists, a one percent increase in FDI leads to a 0.42 percent
10 See: Georgian Economic Outlook—The First Half of 2011, Economic Policy Research Center, Tbilisi, 2011, p. 20.
11 Main cities of Georgia (see: Ministry of Finance of Georgia, available at [www.mof.ge], 15 April, 2013).
12 See: T. Kbiltsetskhlashvili, "Attracting Investors: Case of Impact of FDI on the Achievements of Economic Growth in Georgia," IBSU Scientific Journal, No. 4 (2), 2010, p. 36.
increase in GDP in Georgia.13 FDI positively influences economic growth in Georgia and thus the increase in FDI inflows is of immense importance for Georgia's economic prosperity. The greatest importance, when talking about FDI inflows into Georgia, pertains to the existing investment climate, which is the major determinant of the amount of FDI inflows.
As I already mentioned, radical reforms of the tax system have been carried out in Georgia since 2004. The main priority of tax policy, as it was announced, was to create a friendlier environment for business and investment. The main outcome of this liberal reform agenda is a simplified taxation procedure and reduced number of taxes. The number of taxes has dropped from 21 in 2004 to 6 today. Tax reduction has had two potential results for investments: first, it reduced tax costs and second, it made bookkeeping less complicated. Articles of the tax code became clearer, but, as in other respects, a perfect tax code has far from been created.
With respect to foreign investments, special features apply to foreign investors:
—No payroll tax or social insurance tax;
— Capital expenditure can be depreciated fully in the year it occurred, and a 10-year loss carry forward is available;
—No capital gains tax;
Figure 2
Income and Dividend and Interest Tax Rates for 2004-201414 (according to the announced changes), %
I Corporate Profit Tax
Dividend and Interest Income Tax
13 See: T. Kbiltsetskhlashvili, op. cit., p. 47.
14 Ministry of Finance of Georgia [www.mof.ge], 15 April, 2013.
—No wealth tax, inheritance tax, or stamp duty;
—Foreign-source income of individuals is fully exempted.
A special status for foreign investors has been introduced into the tax code: international plant, branch of foreign company. Special economic zones where taxation is zero have been created for investment purposes. There are 3 tax-free regimes to take advantage of:
—Free Industrial Zones;
—Free Warehouse Enterprise;
— International Finance Company.
If we compare the rates at which international companies are taxed with domestic companies (see Figs. 2 and 3), it is evident that tax policy toward foreign investors is quite liberal and friendlier with respect to taxation of investment profits and income.
Figure 3 15
Tax Rates in Free Industrial Zones Compared to Territories Other Than FIZ, %
■ In Free Industrial Zones
■ In the Territory other than FIZ
15 Ministry of Finance of Georgia, 15 May, 2013.
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The rates presented in Fig. 2 are for all domestic economic units carrying out operations in the territory of Georgia, except for free industrial zones. If we compare these rates to those in effect in free industrial zones, it is clear that main dimension of tax policy tax rates applies quite liberal approaches to foreign investors. Corporate tax rates have decreased from 20 percent to 15 percent. As for dividend income tax, it will drop from 3 percent in 2012 to zero. With respect to economic policy, lowering the tax rates on dividends will trigger the development of joint stock companies and so attract additional financial resources by issuing financial instruments. Our research focuses on the impact of these changes on FDI inflows. First, let us review the anticipated results of this tax policy and then we will combine this with an impact analysis of investors' assessments.
A special taxation regime is offered in the free industrial zones. As we can see from Fig. 3, there is no corporate profit tax, value added tax, customs, or property tax. It should be mentioned that investing in these areas is not becoming an integral part of the Georgian economy, as such companies are not allowed to import into other parts of Georgia using these tax free regimes. As in previous cases, there are two effects: indirect and direct. The direct effect lowers tax costs for companies, while the indirect effect creates a positive image of the countries' economic policy.
Tax policy directions are also included in ratified conventions on "Avoiding Double Taxation." The main aims of these conventions are16: to propose certain guarantees for investors, to promote, by eliminating international double taxation, exchanges of goods and services, and to enhance the movement of capital and labor. Georgia has signed and ratified these conventions with nearly all of its trade partner and main investment countries (33 countries). These conventions guarantee that investors from the treaty countries will not be taxed twice, in Georgia and in source country as well. Based on the tax burden, the investor can choose where he wants to pay taxes: in the source country or at home. Also these treaties offer lower tax rates on dividend and interest income. For example, if dividends are taxed at 5 percent by the tax code, the investor can get 0 percent tax rates on dividend income according to the double taxation conventions. Average dividend income tax rates, according to the ratified conventions, are 4 percent, 3 percent for interest, and 4 percent for royalties. Tax rates and exemptions vary depending on the specific country, but overall Georgia's policy, as evident from these conventions, is quite liberal and is aimed at promoting foreign investments in Georgia.
These changes lead to a liberal environment for business and investments, what has been acknowledged by several researchers and the rankings of some reputable organizations.
In 2008, Forbes Magazine assigned Georgia the ranking of "4th Least Tax-Burdened Country."17 This ranking was based on the Tax Misery & Reform Index. The misery score is the sum of taxes: corporate income tax, personal income tax, wealth tax, employment social security, VAT/Sales. This aggregate sum was used to evaluate whether the policy attracts or repels capital and talent. The countries at the top of the chart impose the heaviest taxes, while those at the bottom are the most tax friendly. The Reform column reflected a reduction in misery. According to this ranking, Georgia was in fourth place after Hong Kong and ahead of most of the advanced economy countries. Georgia retained the same position in 2009 as well.
According to the report of the Fraser Institute, Economic Freedom of the World18: 2011 Annual Report, Georgia ranked 27th among 141 countries (Economic Freedom Score 7.49). In the previous year, Georgia occupied 23rd place, and in 2009 Georgia ranked 45th. The world economic freedom index is published by the Fraser Institute and based on the following main economic freedoms: size of government (costs, taxes, and plants), legal structure and property rights, access to stable currency, freedom of international trade, regulation of labor market and business.
16 See: OECD Commentary on Art 1, Para 7, Model Tax Convention on Income and on Capital, Condensed Version, Paris, 2005.
17 [http://www.forbes.com/global/2008/0407/060_2.html].
18 [http://www.freetheworld.com/release.html].
Economic reforms and the degree of freedom with respect to doing business are analyzed on an annual basis by the World Bank in a publication called Doing Business. It provides objective measures of business regulations and their enforcement across 183 economies and selected cities at the sub-national and regional level. One of the main components is paying taxes and transparency of tax systems. According to an overall view, Georgia has retained one of the leading positions (see Fig. 4).
Figure 4
Georgia's Ranking according to Doing Business,19 2006-2011
Georgia ranks 42nd in terms of paying taxes. The World Bank's report mentions Georgia as one of the leading country in the "Ease of Doing Business" index. The report lists Georgia as one of the twelve economies that do not require the payment of any social security contributions or labor taxes.20 The report also mentions that Georgia is one of the few countries that introduced or enhanced its electronic systems and simplified the tax compliance process in order to make paying taxes easier and lower the tax burden.
Reformation of the tax system along with reform of other regulation mechanisms in Georgia was positively reflected in: Economic Freedom Index of Heritage Foundation and the Global Competitiveness Index of the world economic forum.
How Investors Make Decisions: Results of Selective Investors Surveys
In order to fill in the gap in the official statistics and obtain more precise results in my research, I conducted investors surveys using specially designed questionnaires (interviews were held in
19 [http ://www. doingbusiness.org/reports/global-reports/doing-business-2012].
20 [http://www.doingbusiness.org/~/media/FPDKM/Doing%20Business/Documents/Special-Reports/Paying-Taxes-2012.pdf], 20 June, 2013.
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March-May of 2013).21 I got my list of foreign investor companies from the National Statistics Office of Georgia. Although there were approximately 55 companies on my list, only 25 of them filled out the questionnaire. I mailed all 55 of the companies and visited 35 of them personally. Notwithstanding the low rate of response, the answers I received are important since these 25 companies were major investors in Georgia in 2009-2011. They are at the top of the list of main foreign investors in Georgia, thus their view can be extrapolated to other respondents as well. Overall a "typical" response rate is about 50 percent; a good one is between 60 and 70 percent (B. Kervin, Methods of Business Research, 1992).
The survey questionnaire was filled out by the managers of 25 companies in Tbilisi. These companies were formed with foreign capital in 2009, 2010, and 2011. The sector breakdown of the companies was as follow: Services 13, Manufacturing 10, Energy 2. Most of the respondents were people who represent their home companies in Georgia, i.e. manage the capital of their enterprises in Georgia and make strategic decisions to some degree (Country Coordinators). The questionnaire was designed specifically to account for tax factors in the investment environment. The questionnaire consisted of 10 questions and took approximately 20-25 minutes for each respondent to fill out. The questionnaire forms were sent to some respondents electronically as e-mail attachments or using Google questionnaire forms.
A special effort was made to ensure the questionnaire was worded in simple terms and to keep the structure and scaling simple. The first section the questionnaire asked for general information about the company: production sphere, size of assets, years of investing in Georgia, and legal forms of business. The second part of the questionnaire concentrated on factors that might contribute to the investor's decision to invest in Georgia. I selected these factors based on theoretical assumptions that are developed in western scientific literature, and also took the special features of a small and transition country into account. With the fifth question I wanted to identify if investors consider tax policy to be an important factor in their decision to invest in Georgia or not. I split the tax policy factor into the following subfactors: tax rates, depreciation rates, and tax administration. This approach is justified by the model that we have already discussed "OECD Tax Policy Model for FDI."22 This model was also used to formulate other questions in the survey questionnaire.
The last part of the questionnaire was about tax policy factors. Again, the special features of a small and relatively resource-poor country were taken into account. The data collected were analyzed using the statistical package for social sciences (SPSS). The retrieved data were used to find out if tax policy matters when making a decision to invest in Georgia.
Among the ten factors relating to making investments in Georgia, tax factors ranked fourth after macroeconomic stability, labor regulations, and transportation costs. I used a ten score scale for this fifth question in ascending order of importance. When calculating the mean scores, 5.33, for tax rates, and 7 for tax administration (see Fig. 5), I excluded the basic factors of investment—market and resources—since these factors are included in later questions. This structure for the fifth question enabled me to concentrate on business infrastructure factors according the OECD Policy Framework Model.
As we can see from Fig. 5, the most important institutional factors of the investment environment are: property rights, macroeconomic stability, tax administration, and labor regulations. In this case, it should be noted that the experience of carrying out activities in Georgia has had an influence on the investors' answers. This may explain why they gave more importance to tax administration than statutory declared tax rates. This result is in accordance with the OECD model regarding the fact that statutory tax rates frequently do not fully reflect the tax burden in a particular country.
21 For the period before 2008, discussion on the investment environment of Georgia see: F. Gürsoy, O. Kursun, "Investment Climate of Georgia," IBSU Scientific Journal, No. 2 (1), 2008.
22 See: "TAX Effects on Foreign Direct Investment," pp. 28-34.
Main Institutional Factors of Decision Making for Investment in Georgia
Transportation Costs Business Licensing and Operating Permits Cost of Finance (interest rate) Skills and Education of Available Workers Economic and Regulatory Policy Certainty
Tax Rates Labor Regulations Tax Administration Macroeconomic Stability (inflation, exchange rate)
Property Rights
As for the basic factors of investment, I have chosen to compare basic natural and institutional factors in the questionnaire (see Table 1). Most investors answered that market size is the most important factor for them (the so-called empty market effect, which is characteristic of transition economy countries). In this case, market size and macroeconomic stability were given an average score of 3.33 and 3.00, respectively. Tax policy ranked only third among the basic five factors of investment. According to one of the investor's comments, tax policy is like an additional factor to basic factors such as market characteristic and macroeconomic stability. Thus we can assume that, according to our results, tax policy is only a marginal factor in addition to other basic factors.
Table 1
Main Factors on Investment in Georgia: Natural and Institutional Factors
Main Factors Mean Score
Natural resources 1,67
Market size 3,33
Geographic location 2,67
Macroeconomic stability 4,67
Tax policy 3,00
Figure 6
Most Important Aspects of Tax Policy
Tax Depreciation Tax
Rates Rates Administration
| Number of Respondents
When listing the specific aspects of tax policy, the respondents ranked tax administration and deprecation rates at the top and tax rates at the bottom. Out of the 25 surveyed investors only 6 ranked tax rates in first place (see Fig. 6). As for the direct question: "Does tax policy matter when deciding whether or not to invest in Georgia," the respondents gave it moderate importance (see Fig. 7). Fourteen of the 25 respondents stated that tax policy is somewhat important in making the decision to invest. Most of the investors made the interesting comment that the tax policy reforms in Georgia have created overall image of the country, which in turn had an influence on the decision to invest in Georgia. This result can be compared to those international rankings and reports of international organizations that posited Georgia as a country with a tax-friendly investment environment.
Figure 7
How Important is Tax Policy in Making the Decision to Invest in Georgia
Number of Respondents
It is obvious that making a decision to invest in other countries involves certain risks, especially in a transition or less developed country. Some of these risks are tax policy risks, since higher taxation makes business unprofitable and in certain cases tax administration is a tool used in government policy. Thus beneficial and generous tax policies in the opinion of the government offer significant incentives for foreign investors. In response to our research survey question asking whether a generous tax policy can compensate for other obstacles in the investment environment, the polled investors said that tax policy is only an additional factor (16 out of the 25). Only 8 respondents answered that a generous tax policy cannot compensate for other obstacles in the investment environment in Georgia (see Fig. 8).
Figure 8
Do You Think Tax Policy in Georgia (if it is very important) Can Compensate for the Other Obstacles in Georgia's Investment Environment?
18 H 16 -14 -
12--
10 -8 6 4
21 0
Yes
I Number of Respondents
The number of respondents who said that tax administration did have an impact on the investment environment and that tax administration is far more important than statutory tax rates was the same (see Table 2).
Table 2
Cross Tabulation of Q1
(How Important is Tax Policy in Making the Decision to Invest in Georgia?) and Q2 (Can Tax Policy in Georgia Compensate for the Other Obstacles in Georgia's Investment
Environment?)
Q 1
Q2 Not important Not so important Somewhat important Grand Total
No 3 5 8
Tax policy is only an additional factor 6 3 7 16
Yes 1 1
Grand Total 6 6 13 25
16
8
Tax Policy is Only Additional Factor
Difficult to Answer
No
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The respondents who said that tax policy is "somewhat important" reckon that tax policy is "only an additional factor". Cross tabulation showed that if tax policy matters it matters only marginally.
From an analysis of the survey data, we see that tax policy is very important when ranking it among the institutional factors of investment. As for basic factors (natural resources, market Size, geographic location, and macroeconomic stability), tax policy is less important (third and sixth places, respectively). As some respondents stated, the tax policy changes and reforms in the taxation sphere have created a positive image of Georgia as a tax-friendly country for foreign investors. I conducted this survey among the main investors in Georgia who have experience in doing business in Georgia. Based on this perception, most of the foreign investors consider tax administration to be far more important than statutory tax rates. In light of the basic investment factors, Georgia's overall tax policy is only of marginal importance. However, I would like to make a disclaimer and say that the data I collected is limited and that this research is relatively new for Georgia at this stage, making it difficult to account for the differences that exist in different industry spheres. In general, these results apply more to the service industry (in our case, 52 percent of investors were from this sphere). The effects of tax policy depending on the special features of different industry spheres will be the subject of future research.
Conclusion
In the case of small countries that do not have rich natural resources, so-called institutional factors matter. This perception assumes that the country has reached macroeconomic stability. One of these institutional factors is taxation, since taxes determine a company's net profit. Under tax factors, we have analyzed not only statutory tax rates but also tax policy, which covers tax rates and related provisions of the tax code, as well as tax exemptions and special tax free industrial zones. Thus, from the theoretical perspective and taking into account the special features of the Georgian economy, tax factors matter in the investment process.
Since 2005, tax administration has been undergoing liberalization. At the same time, FDI inflows into Georgia have grown. The positive correlation of tax rate reduction and FDI inflows suggests that the liberal reforms have triggered inflows of FDI into Georgia. However it is important to determine how important tax policy factors are compared to other factors.
The survey of investors shows that tax policy factors occupy a moderate position (5th and 6th) among the ten basic factors, while among the five basic investment factors, tax policy ranks even lower. When investors were asked about the importance of tax policy factors, most of them answered that the reforms and changes in tax policy indicate that Georgia has a friendly environment for foreign investors. This conclusion is reinforced by the fact that Georgia's tax policy reforms are positively assessed in the reports of international organizations, as well as in international business journals. These publications are generally the source of information for foreign investors.
Georgia has enhanced its image as a country friendly to foreign investors by signing double taxation agreements, which have created a legal basis for protecting foreign investors. These agreements have become a direct source of information about Georgia's liberal tax policy in foreign investor resident countries.
In conclusion, foreign investors in Georgia consider tax policy issues to be a marginal factor among basic factors such as macroeconomic stability and property rights. Tax policy factors act through indirect channels, giving the impression that Georgia has a friendly environment for foreign investors wishing to invest in its economy.
