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

TAXATION, INVESTMENT, AND GROWTH 2-9
and equipment increases the user cost of capital and renders some investments non-viable,
especially for capital-intensive projects. Conversely, reducing tK lowers the user cost of capital
and encourages additional investment and higher capital intensity.
SUMMARY
In summary, the standard economic theory indicates that lower tax rates or higher tax
benefits can be a significant factor in stimulating investment, even though the fundamental
risks and returns are determined largely by non-tax considerations. For some investments, tax
considerations can tip the balance in deciding where to locate, if non-tax fundamentals are
similar in several alternative host countries. Still, for many projects, the tax system has no
effect on the go/no-go decision. Tax breaks can even have a negative effect on investment if
they lead to a revenue loss that adversely affects macroeconomic stability or the provision of
public services which are critical to the investment climate. Thus, one cannot conclude from
the theory whether tax effects on investment are large, small, or even negative. The effect
depends on the context, and the outcome can only be determined from empirical analyses, to
which we turn.
2.3 Empirical Evidence for Taxation as a Determinant of
Investment
Three types of empirical studies provide information on the importance of taxation as a
determinant of investment: econometric studies, surveys of investors and businesses, and case
studies. This section summarizes some of the main findings. 18
ECONOMETRIC STUDIES
Most econometric analyses of investment behavior have been based on data for the United
States and other OECD countries. One must be very cautious in applying these results to the
SADC region. Moreover, research in this field has inherent problems due to the use of
simplified measures of investment flows, financing costs, and tax effects, in addition to
technical problems in controlling fully for other factors that influence investment decisions.
Empirical research using data for developing and emerging economies is less extensive and
suffers from even more serious data problems. 19
18 This section draws on reviews of the empirical literature provided in Chirinko (1993), OECD (2001), Morisset
and Pirnia (2001), and Zee, Stotsky and Ley (2002), and other studies listed in the bibliography.
19 For example, the study by Wilhems (1998) on determinants of FDI in 67 emerging economies (1978-1995)
found a highly significant negative effect of taxes on FDI. But the tax variable is simply the ratio of tax
revenue to GDP. One cannot say whether the negative effect of a high tax ratio is due to the tax burden on