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

XII EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
seem self-evident, yet they are subject to important qualifications that are highly pertinent to
understanding the effectiveness and impact of investment tax incentives in the SADC region.
On the first proposition, the key issue is that investment productivity is at least as important as
the quantity of investment in determining growth. Even if tax incentives do stimulate
investment, their net impact on growth could be adverse if the incentives reduce productivity.
Regarding the second proposition, taxation undoubtedly affects some investments—
particularly “footloose” projects that are viable in several competing locations. But non-tax
factors are far more important in determining most investment decisions. Moreover, if tax
breaks cause fiscal problems that worsen other elements of the investment climate, the net
effect of incentives on the volume of investment can be negative rather than positive.
Advantages and Disadvantages of Tax Incentives
Arguments in favor of investment tax incentives are widely known. According to proponents,
tax incentives clearly enhance returns on investment; they may be justified by positive
externalities stemming from investments; they are relatively easy to target and fine tune; they
signal openness to private investment; they are useful in a world of capital mobility; they are
necessary for responding to tax competition from other jurisdictions; and they compensate for
other deficiencies in the investment climate. Another common argument is that incentives can
actually enhance revenue by stimulating investments that generate other taxable income via
employment and linkage effects. Tax incentives also offer political advantages over direct
expenditure programs to stimulate investment. Finally, proponents point out that tax
incentives have been successfully used in well known cases like Malaysia, Ireland, and
Mauritius.
The case against tax incentives is less widely understood, but essential to any careful policy
analysis. Those who advise against tax incentives argue that:
1. The actual revenue cost can be high if the investments would have been viable anyway;
the incentives are offset by source-country tax laws; or tax-favored investors take
business away from taxable producers.
2. Abusive tax avoidance schemes, made possible by tax preferences, further erode the
revenue base.
3. Tax incentives also divert administrative resources from revenue collection.
4. Such revenue losses require painful fiscal adjustments in the form of higher taxes on other
entities, cuts in expenditure, or greater dependence on other costly forms of financing.
5. Tax differentials can introduce serious economic distortions that reduce efficiency and
productivity.