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

INTRODUCTION 1-3
well administered. 6 The introduction of special investment incentives inherently complicates
tax administration and creates loopholes through which companies and wealthy taxpayers
avoid or evade other tax obligations. These are serious problems worldwide, but the costs are
especially high in countries with weak tax administration and critical revenue constraints.
Under these conditions, simplicity is a cardinal principal.
Many SADC countries face a critical need to enhance tax collections (relative to GDP) in order
to finance urgent demands for public services, including those essential to economic growth
and social welfare, such as education, health, public security, legal and judicial systems, and
economic infrastructure. Therefore, the revenue effect of tax incentives is a central concern. In
countries with adequate fiscal resources, revenue risks may not be a major issue; but in
countries where revenue performance is precarious, such policies may be highly imprudent.
EFFICIENCY
An efficient tax system is one that minimizes the loss of economic welfare and growth due to
tax-induced distortions in the incentives that guide private decisions on investment,
production, technology, consumption, saving, work effort, financing, and even the legality of
activities. Efficiency is especially important for poor countries that can least afford economic
losses due to avoidable resource misallocation. To minimize efficiency losses, most tax reform
programs in developing countries aim to apply a moderate tax rate to a broad tax base. To the
extent that special incentives shrink the tax base, revenue targets can only be achieved with
higher tax rates on other activities or persons that remain chargeable. This may magnify the
efficiency costs that inevitably accompany taxation. 7
Yet the intent of any tax incentive policy is precisely to alter economic incentives in a direction
that enhances growth potential and improves national welfare. Depending on the prevailing
economic and political conditions and the design of the incentives, the actual impact can go
either way -- as discussed in depth in the rest of the report.
EQUITY
The concept of tax equity is endlessly debated. Yet there is widespread agreement that an
equitable tax system
6 As famously claimed by Casanegra de Jantscher (1990, p. 179): “Tax administration is tax policy.”
7 As a rule, the welfare cost of any tax rises with the square of the tax rate. Thus, the welfare loss from a 40
percent tax rate is four times higher than that of a 20 percent tax rate. An exception is the case of an excise duty
on goods with highly inelastic supply or demand. Rate differentials can also be rigorously justified by
optimal tax theory (Newbury and Stern, 1987; Burgess and Stern, 1993). But the theoretical advantages are
vastly outweighed in practice by administrative considerations. The efficiency cost of distortionary tax policy
can be astonishingly high. For example in the World Development Report 1988 (85) the World Bank cites a
general equilibrium study of the Philippines which found that the marginal economic cost of imposing a 25
percent import tariff exceeds 2 pesos per peso of revenue collected.