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

2. Taxation, Investment, and
Growth
Although many development practitioners and researchers continue to target capital
accumulation as the driving force in economic growth, ‘something else’ besides capital
accumulation is critical for understanding differences in economic growth and income across
countries. -- Easterly and Levine (2001)
… tax incentives do affect the decisions of some investors some of the time. —Morisset and
Pirnia (2001)
In this chapter we examine two fundamental premises that underlie the justification for
offering investment tax incentives in developing countries: first, that additional investment
leads to faster economic growth and higher standards of living; and second, that tax breaks
stimulate additional investment. These statements may seem self-evident, but both of them
are subject to important qualifications that are directly relevant to understanding the
effectiveness and impact of investment tax incentives.
2.1 Capital Investment and Economic Growth
A standard tool used by economists to study economic growth is an empirical framework
called “growth accounting.” Given the rate of population growth, the growth of per capita
income is driven by
• Investment in physical capital
• Investment in human capital, and
• Productivity growth.
If productivity and the quality of labor were constant then investment in physical capital
would directly determine the growth of per capita income. Empirically, however, changes in
productivity and investment in human capital are central to the growth process.
Virtually every analysis of economic growth highlights the importance of investing in human
capital—through education, technical training, preventive and primary health care, and