The Tax System of Jamaica Allowance) of 20% of the investment with normal depreciation for the remaining 80% of the historical cost of the asset.18 There is also a more favorable Special Capital Allowance for purchases of machinery in Basic Industry (part of manufacturing and construction) that may be depreciated in two years. But the most important tax break is an investment tax credit that goes from 20% for Basic Industry to 40% for the Sugar Industry of the cost of the capital good which is named Investment Allowance. This is a huge benefit because all the historical cost of the asset can be depreciated normally. This tax policy can be analyzed from the following angles: Distortions in the allocation of capital The taxation on income in the Jamaica Tax Code has several flaws. For example, it creates differences in the marginal productivity of capital among economic activities, and it favors debt-financed investments in relation to equity-financed investments because in the first case the opportunity cost of capital is allowed to be fully deducted. As individuals are not fully taxed on the interest accrued on their savings it follows that debt-financed investments are taxed at a lower rate than equity-financed investments. When there is inflation the Law establishes that firms may deduct the nominal interest paid on their debt, but can only deduct the nominal depreciation on their assets. It can be proved, following Atkinson and Stiglitz,19 that firms get a tax break when there is inflation. Assume than for one peso of marginal investment in a no tax world the firm will invest if the value of the marginal productivity of capital is equal to the real opportunity cost of capital and the real value of depreciation.20 That is, (1) PFk = (i-M) + d(1+M) where PFk = Value of the marginal product of capital i = Nominal interest rate M = Inflation rate d = Economic depreciation rate An income tax usually taxes the value of the marginal productivity of capital but allows for some expenditures. Defining, t = Income tax rate
18
Expensing allows firms to deduct automatically a fraction or the total amount invested. When there is 100% expensing the CIT becomes a tax on consumption because capital income is deducted from the tax base like labor income and like any other expense of the firm. Anything that can be deducted up front is not taxed at the firm level. 19
Atkinson, A. and Stiglitz, J. (1980).
20
This assumes that the depreciation pattern is exponential.
21