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

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2-10 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION A major review of the literature on investment behavior a decade ago, by Chirinko (1993), reported that variables reflecting the UCC, which includes tax effects, had only a small effect on investment. In contrast, output variables had a large effect, in line with the accelerator model discussed above. But Chirinko also concluded that investment models in general produced weak results. Most of the studies examined in this survey used macroeconomic data for estimating investment functions. Perhaps the most important lesson from this early work is that one does not get strong and consistent results about investment behavior from macroeconomic models. To overcome this problem many researchers have begun to use microeconomic data, which produces a far larger sample size and more discerning statistical tests. These papers generally find that variables reflecting the UCC, including tax effects, are statistically significant and quantitatively important as determinants of investment. Zee et al. (2002) cite several estimates of the elasticity of investment with respect to the UCC in the range of -0.5 to -1.0. This means that a 10 per cent reduction in the UCC, due to lower financing costs or tax benefits, tends to increase investment by 5-10 per cent. This is a large impact. 20 Looking more specifically at evidence for developing countries, however, the same paper reaches the following conclusion: The main messages of this research are that tax incentives can stimulate investment, but that a country’s overall economic characteristics may be more important for the success or the failure of industries than any tax incentives package; and even if tax incentives stimulate investment, they are not generally cost effective. 21 Here the statement that incentives are not “cost effective” means that the amount of additional investment is less than the estimated revenue loss. In this sense, cost-effectiveness appears to vary widely by the type of investment and by the tax instrument used (Shah 1995). General tax reductions appear to be less cost-effective than incentives tied directly to new investment because a large part of the revenue loss in the former case benefits existing capital. Also, R&D investment appears to be more sensitive to tax incentives than other types of investment. Numerous studies focus on the determinants of FDI, in particular, using firm-level data or international cross-section and time-series data. Much of this research finds significant effects of both host-country and home-country tax parameters. Also, FDI seems to be getting more tax-sensitive over time as capital has become more mobile and production more global. Bear in mind, though, that the data and the results are dominated by FDI flows between industrial countries. As OECD countries have become more homogenous in infrastructure, returns from investment, or high trade taxes that distort the trade regime, or simply the presence of a large and intrusive government sector. 20 In a widely cited study of FDI determinants, which focuses on corruption, Wei (2000) finds highly significant effects of both the statutory tax rate and the average effective tax rate. His famous conclusion: “An increase in corruption from the Singapore level to the Mexico level would have the same negative effect on inward FDI as raising the corporate income tax rate by eighteen percentage points.” 21 Zee et al., 2002, p.1508
TAXATION, INVESTMENT, AND GROWTH 2-11 labor force skills, macroeconomic performance, regulations, and so forth, it is no surprise to find that tax differences have gained in significance. It is plausible to think that tax factors have also become increasingly important in developing countries for investment projects that can readily operate in other locations with similar non-tax characteristics, but there is no clear evidence to this effect. A review of econometric studies of FDI into Africa, by Basu and Srinivasan (2002), does not even mention tax effects. 22 SURVEY EVIDENCE Surveys of business decision makers are often used as a source of information on determinants of investment in developing countries. The quality of such information is often difficult to judge since the samples may not be representative, survey responses involve subjective judgments, and respondents may interpret the questions in different ways. In addition, surveys often include a bewildering list of pertinent factors. As one example, McMillan, Pandolfi and Salinger (1999) report on a survey of American electronics companies that invest in labor-intensive operations in developing countries. Asked to list their top five concerns for an investment decision, only 10 percent of the respondents listed tax incentives—ranking well below infrastructure, political stability, skilled labor, and proximity to customers and suppliers. The study also asked respondents to rank 95 “investment factors” in terms of importance for location decisions. On a scale of 1 (low) to 5 (high), tax holidays obtained a score of 4.0. Yet 18 other factors scored higher, including the overall corporate tax rate (with a score of 4.26). Topping the list were power, telecommunications, intellectual property rights, and skilled labor. International reports on competitiveness have become a virtual industry in recent years, based on a combination of business survey responses and statistical data. Perhaps the best known is the annual Global Competitiveness Report (GCR) of the World Economic Forum. 23 The GCR for 2002 offers two composite indices. The first, called the Growth Competitiveness Index (GCI), is based on established academic research on the determinants of economic growth. It entails a weighted average of 32 indicators falling into three broad categories: technology, public institutions, and macroeconomic environment. Tax variables do not enter the analysis. The second, called the Microeconomic Competitiveness Index (MICI), is based on Michael Porter’s theory of competitiveness. It consists of 16 indicators of company operations and strategy, and 49 indicators of the National Business Environment. The latter set includes data or scores on physical and administrative infrastructure, human resources, technology infrastructure, capital markets, demand conditions, supporting industries, incentives, and competition. Taxes enter the MICI analysis as an element of the incentive variable labeled 22 Nor does an earlier IMF study of investment in Africa by Hadjimichael et al. (1995). 23 The WEF also published an African Competitiveness Report. This will be discussed in Chapter 7, which reviews investment conditions in the SADC region.
Page 1: TECHNICAL REPORT Effectiveness and
Page 5 and 6: Contents Executive Summary xi 1. In
Page 7 and 8: Contents (continued) ILLUSTRATIONS
Page 9 and 10: Glossary ACT additional company tax
Page 11 and 12: Preface The Scope of Work (SOW) for
Page 13: PREFACE IX Export Development & Inv
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Page 25 and 26: 1. Introduction Why should schemes
Page 27 and 28: INTRODUCTION 1-3 well administered.
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Page 31 and 32: 2. Taxation, Investment, and Growth
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5-12 EFFECTIVENESS AND IMPACT OF TA
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5-14 EFFECTIVENESS AND IMPACT OF TA
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6. Economics of Harmful Tax Competi
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ECONOMICS OF HARMFUL TAX COMPETITIO
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7. Tax Systems and Tax Incentives i
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TAX SYSTEMS AND INCENTIVES IN THE S
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Table 7-5 Elements of Tax Structure
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Table 7-5 (continued) Sheet 3 of 4
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Notes a Mozambique information Coun
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8. Conclusions and Recommendations
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CONCLUSIONS AND RECOMMENDATIONS 8-3
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R-2 EFFECTIVENESS AND IMPACT OF TAX
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A-2 APPENDIX The present investment
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A-4 APPENDIX Democratic Republic of
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A-6 APPENDIX Government revenue in
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A-8 APPENDIX income tax payable by
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A-10 APPENDIX (though they are obli
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A-12 APPENDIX • • • Asset All
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A-14 APPENDIX also get zero import
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A-16 APPENDIX EPZ measure was motiv
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