Effectiveness and Economic Impact of Tax Incentives in the SADC ...

ECONOMICS OF HARMFUL TAX COMPETITION 6-11
that the country’s important garment sector has paid little tax because of income-shifting
strategies rather than fundamentally weak profits. Where such practices are rampant, the
domestic tax rate matters little.
Few of the SADC countries have strong statutory measures and administrative capacity to
deal with abusive transfer pricing, thin capitalization schemes, tax dodges through controlled
foreign entities (CFEs), or other forms of aggressive avoidance through international channels.
On CFEs, only 5 Member States—Lesotho, Mauritius, Namibia, South Africa and Tanzania—
have adopted residence-based tax systems that could bring this income into the domestic tax
net. Regional and international cooperation could be very useful in strengthening both the
legal provisions and audit systems that are needed to fight potentially huge revenue losses
through international tax planning.
COMPETITION WITHIN SADC
Within the SADC region, a few cases of head-to-head tax competition have been widely
reported, such as the Ramatex example in Exhibit 6-2. 88 Undoubtedly many other
investments, which do not make the headlines, have crossed borders to take advantage of
lower taxes or weaker tax administration. At the policy level, some tax incentive programs
have explicitly been introduced as a response to tax competition from other countries in the
region and elsewhere. For example, the recent introduction of full tax exemptions for EPZ
enterprises in Zambia was motivated in part by a concern to match incentives available in
other AGOA-eligible countries. 89 In some instances, tax incentives may even have been
motivated by a desire to undercut tax rates in a neighboring country. Nonetheless, most tax
incentive programs in the SADC region appear to be driven by a legitimate desire to create an
attractive investment environment, rather than a deliberate intent to deprive other Member
States of investment and revenue.
Whatever the motivation for tax competition in SADC, the most important question is
whether the effects on regional development are positive or negative. In theory, tax
competition could promote development of the entire region—despite the adverse side-effects
of tax incentives—if the incentives attract a large amount of new investment. In this scenario
there is little reason to pursue restraints on tax competition. But this is not a realistic scenario.
The preponderance of evidence (as reviewed in chapters 2 and 3) indicates that tax incentives
rarely induce a strong investment response, whereas they do impair revenue mobilization and
reduce economic efficiency. Hence, the operational premise is that unrestrained tax
88 Another widely cited example is the case of the Hyundai factory in Botswana, which went into liquidation in
2000. The basic cause was mismanagement and probable fraud, but the company’s demise was precipitated
by a decision by South Africa to get tough on what it viewed as tax abuse. Sources: James (2003) and
Kebonang (2001).
89 According to a well-informed source in Zambia (in private communication) the initial beneficiaries of the
new EPZ regime in Zambia have been companies that were already in existence and paying taxes.