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

2-4 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
Exhibit 2-1
A Productivity Package
Steady gains in aggregate productivity emerge from
a complicated process of evolutionary changes at
the firm and industry level, as some firms grow and
others shrink or fold. Joseph Schumpeter long ago
identified this "creative destruction" as a central
feature of growth dynamics. The following policies
can make an important contribution:
• Allow resource allocation decisions to be
determined primarily by market mechanisms
that harness the power of personal initiative
and self-interest in response to price signals
reflecting resource costs and effective demand.
• Invest in human capital, including technical,
scientific, and managerial education,
particularly where linked to clusters of
national competitiveness.
• Expand the scope for specialization and scale
economies by improving transportation and
communications infrastructure (which also
reduces costs throughout the supply chain)
and facilitating production for the export
market.
• Strengthen competition throughout the
economy by reducing highly protective trade
barriers, eliminating legal and administrative
impediments to entry and exit of new
businesses, and reforming or privatizing
industries that have been operating as
inefficient state monopolies.
• Establish a welcoming environment to attract
and facilitate productive FDI as a major source
of technical and managerial innovation, along
with domestic investment and innovation.
• Develop policies to facilitate the introduction
and adaptation and development of more
productive technologies, including the
protection of property rights and the
enforcement of contracts.
Tax incentives may be a useful tool for stimulating
productive investment, research and development,
and training. But they must be carefully designed
and well administered so as to avoid side-effects
that diminish productivity by distorting resource
allocation, sustaining inefficient or unsustainable
activities, and losing revenue needed for other
components of the productivity package.
possible locations for a given investment project—then the investor will normally favor the
location offering the highest risk-adjusted rate of return.
Exhibit 2-2 shows that a variety of government policies affect risks and returns for investors.
The tax system, in particular, influences the viability of investment through several channels.
The rate of return depends clearly on the effective tax rates. In addition, the perceived risk is
affected by unpredictability of the tax code, the degree of transparency or arbitrariness in tax
administration, and technical factors such as investment allowances and loss carry-forward
provisions.
The tax system, however, is just one of many policy variables entering the risk/return
analysis. Furthermore, a host of non-policy variables have a strong effect on investment
decisions. These include the distance to major markets, proximity to raw materials, climate,