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

3-2 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
private decisions based on free-market signals lead to an inefficient undersupply of
investment and innovation. There is then a logical justification for government intervention to
enhance the market incentive for investment, research and development, and training. Tax
breaks can be useful for this purpose.
3. Practicality. Although the fundamental purpose of taxation is to raise revenue, the tax
system inherently and invariably affects economic incentives. It is therefore a convenient,
practical, and flexible instrument for influencing incentives in a direction that contributes to
other policy objectives such as investment promotion, job creation, development of
disadvantaged regions, or upgrading of the labor force.
4. Signaling. In conjunction with other measures to create a welcoming investment climate,
introducing tax breaks for investors can signal a country’s commitment to facilitating
investment. It also provides a headline banner for marketing the country as a desirable
investment destination.
5. Capital Mobility. In a global economy with high mobility capital, the effective tax rate on
capital has to be low to attract inward flows of foreign investment and keep domestic savings
at home to finance productive investment.
6. Tax Competition. When other countries vie for the same investments by offering special tax
breaks, the stark choice may be to match the tax breaks or lose the benefits that may come
from the investments, including growth-enhancing spillover effects.
7. Compensating for Other Deficiencies in the Investment Climate. A common argument in
less developed countries is that attractive fiscal benefits are essential to gain the interest of
investors who would otherwise not consider investing because of problems, such as
unreliable or high cost infrastructure, macroeconomic instability, or a weak legal and judicial
system.
8. Revenue Gains. If it is so that investors would go elsewhere in the absence of getting special
tax breaks, then the direct revenue loss from offering such incentives is nil. And the indirect
revenue impact can be favorable, because the new investments that materialize through the
tax incentive program will create jobs and linkage effects that generate tax revenue.
9. Political Cover. The cost of tax incentives is less visible than that of investment promotion
policies that involve explicit budget outlays. This argument is rarely uttered out loud, but it
undoubtedly contributes to the political attraction of tax incentives, compared to alternatives
that have a direct budgetary impact, such as subsidies or infrastructure development for
industrial zones.
10. Experience Shows that Incentives Can Work! Above all, the main argument for investment
tax incentives is that they have worked well in a number of countries. Exhibit 3-1 provides a