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

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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
ECONOMICS OF TAX INCENTIVES 3-3 snapshot of four widely known success stories that have been an inspiration for many developing countries – Malaysia, Ireland, Costa Rica, and Mauritius. Taken together, these ten arguments offer impressive justification for investment tax incentives. But a proper analysis must balance these considerations by examining the other side of the story. Exhibit 3-1 Success Stories in Malaysia, Ireland, Costa Rica, and Mauritius One strong argument for granting tax incentives is the evidence from countries that have used such policies effectively to stimulate investment and growth. This exhibit outlines the experience in four highly successful small countries: Malaysia, Ireland, Costa Rica, and Mauritius. MALAYSIA As a charter-member of the Asian Tigers club, Malaysia has been seen as a prototype for countries that wish to make the leap from being poor, resource-dependent economies to prosperous newly-industrializing states. In 1958 Malaysia began offering tax holidays of up to 5 years aimed at import-substitution pioneering industries. By the early 1970s the government recognized that sustained growth would not be achieved through import substitution, and established export processing zones (EPZs) offering subsidized infrastructure, zero import duties, and zero export taxes. The incentive programs were amended several times over the years, including a 1986 Promotion of Investments Act that extended tax holidays of up to 10 years for export-oriented foreign investments with “pioneer” status. Other incentives included an investment tax allowance, export allowance, reinvestment allowance, special deductions for training and R&D, and direct grants for high-tech activities. Aside from financial incentives, the government pursued programs to maintain economic and political stability, improve the infrastructure and upgrade the labor force. These investment promotion programs have been famously successful. In early years they attracted labor-intensive investment in electronic assembly and textiles. As wages and skill levels rose, the investment pattern shifted towards high-tech strategic projects. According to the World Investment Report 2002 (207), “The actual impact of the incentives offered is hard to assess, although it appears that incentives have been an important element in attracting TNCs to Malaysia.” The Report notes, however, that the foregone revenue may be as high as 1.7 percent of GDP, and some of the incentives may have been overly generous or redundant. IRELAND Over the last 20 years, Ireland has been transformed from a poor backwater of Europe to the continent’s most dynamic economy. Progress was earned through aggressive improvements in economic fundamentals, strengthening the education system, and promoting Ireland as an investment destination, with EU membership and attractive tax incentives as lures. Until the late 1950s, Ireland discouraged foreign investment, and reaped stagnation. In 1959, the government created the Shannon Free Zone to stimulate investment for export. Initially, export profits were entirely untaxed. In 1981 a 10 percent tax rate was established for manufacturing, EPZ operations, and certain service industries, including international
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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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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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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