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

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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.
EXECUTIVE SUMMARY XIII 6. Tax preferences create inequities by favoring some taxpayers over others. This can undermine general compliance. 7. As a development tool, tax incentives score poorly in terms of transparency and accountability. 8. The cash value of tax incentives stimulates political manipulation and corrupt practices. 9. Alternative instruments for promoting investment can have much more favorable and lasting effects on productivity, growth, and development. 10. International experience shows that tax incentives most often do not deliver favorable results! In short, there are arguments both for and against the use of investment tax incentives that must be taken seriously. The applicable balance will vary according to circumstances. The danger is that in the political discourse the benefits are usually exaggerated, while the costs are downplayed or ignored. This creates a strong bias toward the implementation of poor tax incentive policies. Tools for Analyzing Tax Incentives Three important tools for analyzing tax incentive policies are the marginal effective tax rate (METR) model, tax expenditure budgeting, and the specification of screening criteria for applying selective incentives. The METR model provides a gauge for evaluating the extent to which various tax incentive packages improve the rate of return for representative investment projects, at the margin. Tax expenditure budgeting is a valuable method for monitoring the amount of foregone revenue from tax incentives. Every member country of SADC should be taking steps to adopt these two tools for policy analysis. In screening projects that will benefit from selective incentives, the goal should be avoid forgoing tax revenue for investments that would be undertaken anyway. In general, projects that are efficient and sustainable are likely to materialize even without special tax breaks. The exception is “footloose” investment that can easily locate in other countries. Incentives can also be effective in stimulating investments that are not viable without a tax break. However, these are projects with low productivity, by definition. The criteria used to target investment incentives often fail to pick projects that will deliver large benefits relative to the revenue cost. Furthermore, any selective screening process can be subverted by political maneuvering. Design of Tax Incentives Common incentives include low overall tax rates, preferential tax rates for certain investments, tax holidays, capital recovery allowances, investment tax credits, the treatment of dividends, excess deductions for designated expenses, special export incentives, reduced
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Page 5 and 6: Contents Executive Summary xi 1. In
Page 7 and 8: Contents (continued) ILLUSTRATIONS
Page 9 and 10: Glossary ACT additional company tax
Page 11 and 12: Preface The Scope of Work (SOW) for
Page 13: PREFACE IX Export Development & Inv
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Page 25 and 26: 1. Introduction Why should schemes
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6. Economics of Harmful Tax Competi
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ECONOMICS OF HARMFUL TAX COMPETITIO
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7. Tax Systems and Tax Incentives i
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TAX SYSTEMS AND INCENTIVES IN THE S
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Table 7-5 Elements of Tax Structure
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Table 7-5 (continued) Sheet 3 of 4
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Notes a Mozambique information Coun
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8. Conclusions and Recommendations
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CONCLUSIONS AND RECOMMENDATIONS 8-3
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A-2 APPENDIX The present investment
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A-6 APPENDIX Government revenue in
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A-12 APPENDIX • • • Asset All
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A-14 APPENDIX also get zero import
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A-16 APPENDIX EPZ measure was motiv
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