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

1-4 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
• Minimizes the tax burden on the poor;
• Collects more from the rich than from those with lower incomes (vertical equity);
• Avoids excessive tax rates and arbitrary impositions all around; and
•
Provides relatively uniform and non-discriminatory treatment of taxpayers with similar
economic circumstances in terms of ability to pay (horizontal equity).
Equity issues are often neglected in deliberations about tax incentives, but they surely bear
consideration as a matter of principle, and also because perceptions of unfairness can
undermine the political sustainability of an incentive program. Investment incentives directly
reduce the tax burden on income earned by relatively wealthy investors. As a result other
taxpayers may bear a greater tax burden. For example, if investment incentives reduce
company tax revenue, then governments may depend more heavily on indirect taxes which
impose a greater burden on poorer segments of society. In addition, most programs are
designed to favor certain taxpayers over others in similar economic conditions. To
compensate for these inequities there must be a clear expectation that the tax incentives will
truly and substantially foster equitable growth and job creation.
From these three basic principles, one can see why many public finance specialists ask hard
questions about the advisability of tax incentive programs. Yet most governments deviate
from the pure principles of taxation to pursue other public policy objectives. There is no a
priori reason not to do so because the tax code is an obvious tool for social and economic
engineering. The primary question, then, is whether tax incentives stimulate the intended
behavior and whether their overall impact is beneficial or detrimental to ultimate policy
objectives. The secondary question is how best to design investment tax incentives to achieve
the objectives at minimum cost.
1.2 What are Tax Incentives?
The SADC MOU on taxation (2002) defines “tax incentives” as “fiscal measures that are used
to attract local or foreign investment capital to certain economic activities or particular areas
in a country.” 8 Zee, Stotsky and Ley (2002) adopt a similar definition in a recent review of this
topic. They claim that “any tax provision that is applicable to all investment projects does not
constitute a tax incentive.” This definition excludes “general tax incentives,” such as
accelerated depreciation that applies to all investments. Such general tax provisions deserve
to be called incentives for three reasons. First, they are designed as such and function as such.
Second, it makes sense for a government to broadcast that it is offering attractive tax
incentives for investment even if they take the form of general rather than selective provisions
of the tax code. And third, a number of countries, such as Indonesia and Uganda, have shifted
8 Essentially the same definition is used by the International Bureau for Fiscal Documentation. While the
definition covers both direct and indirect taxes, the MOU focuses largely on the former category.