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

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8-4 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION Countries facing serious revenue constraints should be especially cautious about offering incentives that create substantial revenue risks, either directly or indirectly. This principle is important not only to maintain macroeconomic stability, but also to prevent tax incentives from undercutting the state’s fiscal capacity to improve more basic elements of the investment climate. To ensure proper consideration of revenue objectives, the ministry responsible for finance must be centrally involved in formulating tax incentive policies. Furthermore, to preclude legal inconsistencies, tax incentives should be incorporated in or carefully coordinated with the relevant tax legislation. Another ministry or agency may have the authority to manage and administer the tax incentive program, but the finance ministry must control the budgetary consequences. One way to shift authority while retaining fiscal control is to set an explicit budgetary ceiling on the amount of tax breaks that can be granted in any fiscal year. 8.2 Structure of Investment Tax Incentives CHOICE OF TAX INCENTIVE INSTRUMENTS The advantages and disadvantages of each tax incentive instrument must be judged in light of local conditions and priorities, subject to systematic policy analysis to support well informed decisions. Nevertheless, our analysis suggests ten broad conclusions about the choice among tax incentive instruments: 1. The soundest tax incentive, overall, is to establish standard tax rates that are fair and moderate in comparison with rates prevailing elsewhere in the region and in the main capital-source countries. 2. Relieving exporters of indirect tax on their inputs should be a top priority, with due regard to the need for effective procedures to prevent abuse of tax and duty remissions. 3. The most cost-effective tax incentives are the investment tax credit (ITC) and the initial capital allowance. These tools yield a large reduction in the marginal effective tax rate (METR) relative to the revenue cost, with a minimum of administrative complexity. However, these incentives are not costless. They create moderate distortions by favoring capital-intensive projects and short-lived assets, and they can serve as avenues for tax evasion if not well administered. 4. Tax holidays with a full exemption are far less cost-effective. The revenue loss is large relative to the improvement in investment incentives via reduction of the METR. Tax holidays also favor transitory rather than sustainable investments, and they create glaring opportunities for aggressive tax avoidance.
CONCLUSIONS AND RECOMMENDATIONS 8-5 5. The worst form of tax incentive is the imposition of high protective tariffs on competing imports. This may stimulate investment oriented to the domestic market, but it usually turns out to have low productivity and poor development potential. 6. In states with serious revenue constraints, special tax benefits should be narrowly targeted to activities that are likely to deliver a high payoff in terms of the policy objectives, and which would not be undertaken in the absence of incentives. The broader the applicability of tax incentives, the more revenue is foregone. 7. Avoid zero tax rates. The vast majority of viable investment projects do not hinge on getting a total exemption from tax. Low or moderate tax rates, even during a tax holiday period, serve the purpose with a smaller revenue costs, less distortion of economic decisions, and lower incentives for tax avoidance. 8. Eliminating import duties on raw materials and intermediate goods is a poor approach to stimulating investment. This measure usually has a very high revenue cost and little effect on investment (because indirect taxes are usually passed along to consumers rather than being borne by the producers). 9. Location-dependent investments that are fundamentally viable, especially resource-based projects, should not receive special tax preferences. On the contrary, governments should negotiate carefully to capture a fair share of resource-extraction rents. 10. A low-rate alternative minimum tax can ensure that every company contributes at least minimally to the cost of basic public services. TAX ADMINISTRATION In designing or reforming tax incentive programs, SADC members should place a high priority on the administrative implications. Countries with weak tax administration should shun high-value tax breaks that invite aggressive tax planning and abusive tax avoidance. Programs that involve relatively few, easily controlled tax incentives are preferable to offering a panoply of benefits. AUTOMATIC VERSUS DISCRETIONARY INCENTIVES As with the choice among tax incentive instruments, member states must judge for themselves the scope for discretion in light of local conditions and priorities. In a country with highly disciplined administrative systems (e.g., Korea), discretionary programs can have advantages in targeting the use of incentives to enhance their effectiveness and impact, while minimizing the loss of revenue. In other circumstances, however, discretion usually creates more problems than it solves by increasing the administrative costs for both the authorities and the beneficiaries, politicizing decisions, and creating incentives for corrupt practices.
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TECHNICAL REPORT Effectiveness and
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Contents Executive Summary xi 1. In
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Contents (continued) ILLUSTRATIONS
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Glossary ACT additional company tax
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Preface The Scope of Work (SOW) for
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PREFACE IX Export Development & Inv
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XII EFFECTIVENESS AND IMPACT OF TAX
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XVI EFFECTIVENESS AND IMPACT OF TAX
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1. Introduction Why should schemes
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INTRODUCTION 1-3 well administered.
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INTRODUCTION 1-5 from selective to
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2. Taxation, Investment, and Growth
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TAXATION, INVESTMENT, AND GROWTH 2-
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3-10 EFFECTIVENESS AND IMPACT OF TA
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Effectiveness and Economic Impact of Tax Incentives in the SADC ...

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