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

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3-4 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION financial service centers. The government also provided financial grants tailored to each project. Still, manufactured exports did not take off until the 1980s, after the government adopted major reforms due to “sheer necessity for economic survival” (Emmons, et al., 1999, 9). The reforms included tight monetary and fiscal policy to achieve macroeconomic stability, a social compact with business and labor, and low overall tax rates. The World Investment Report 1998 (105) states that investment “has been visibly influenced by this policy,” attracting thousands of flourishing new enterprises and creating “new comparative advantage” in sectors such as chemicals, office machinery, electrical engineering and computer software. Since 1987, Ireland has been the fastest growing economy in Europe. By the late 1990s, foreign-owned manufacturing firms accounted for nearly 60 percent of gross output and 45 percent of manufacturing employment, up from a zero base in the late 1950s. COSTA RICA Thirty years ago the economy in Costa Rica was dominated by coffee and banana exports. Today the country is a dynamic export manufacturer boasting a showcase Intel semiconductor factory. In the 1970s, the government introduced EPZs and investment tax incentives, after previous efforts to stimulate development by protecting infant industries failed to deliver material benefits. Initially, the export promotion effort failed, too, because the export zones were poorly located and overly bureaucratic, and the economy was afflicted by debt crisis and macroeconomic instability. The export boom only gained traction in the mid-1980s after the government stabilized the economy, devalued the currency to improve competitiveness, and liberalized the EPZ laws. By 2000, export earnings reached US$7.5 billion, a six-fold increase (in constant dollars) compared to 1970. Key factors in the transformation included solid democratic institutions, a highly educated and healthy workforce, stable macroeconomic policies, a supportive investment environment, and expanded transportation links to the North American market. To woo the Intel factory, Costa Rica had to compete with Mexico, Brazil, Chile, Indonesia, and Thailand. Intel looked first at factors such as economic and politically stability, human resources, openness to trade, a pro-business environment, cost conditions, the logistics of manufacturing (including air transport links), and a fast track permit process. Taxes entered the picture as an element of the cost evaluation. Though the government did not offer Intel special tax breaks or grants, the standard EPZ package was attractive enough. It included a 12-year tax holiday followed by a 50 percent exemption for 6 more years, a “job bonus” ranging from 7 percent to 15 percent of the payroll for 5 years, and a subsidized on-site training program covering every new direct worker for 3 months. Spar (1998) contends that even with these advantages, Costa Rica made the short-list only because the investment agency had been “assiduously courting” the electronics industry since 1993. MAURITIUS Mauritius, too, has undergone an economic transformation over the last 30 years, from a low-income mono- crop (sugar) economy to an outward-oriented middle-income country with strength in manufacturing, tourism, and financial services, and an emerging ICT sector (in addition to sugar). EPZs were introduced in the early 1970s. Thereafter, through 1999, economic growth averaged 5.9 percent per annum, accompanied by large improvements in health and education and an extraordinary reduction in income inequality and poverty. Important ingredients in the Mauritius success story include a commitment to economic and political stability, a well educated labor force, reasonably efficient infrastructure, effective rule of law and
ECONOMICS OF TAX INCENTIVES 3-5 respect for property rights, and flexible labor market regulations in the EPZs, combined with preferential access to the European and American markets. Mauritius retained a highly protectionist tariff structure, but the export sector was largely insulated from the adverse effects of high tariffs through the EPZ system and various subsidies, including a 10-year tax holiday for most EPZ companies and preferential interest rates on loans. In the late 1990s, most of the tax was replaced by a 15 percent company tax rate as the main fiscal benefit for incentive companies. (See Chapter 7 and the Appendix for details.) A recent IMF study (Subramanian and Roy, 2001) emphasizes that many countries have offered similar fiscal incentives without matching Mauritius’ success. They point out that Mauritius benefited from a well paid and disciplined civil service, which minimized the abuse and leakage that come from weak administration of EPZ privileges and tax incentives. Thus, the authors caution that “attempting to replicate the Mauritius experiment might be hazardous for other countries.” The common theme is that some highly successful developing countries have used investment tax incentives with impressively good effects—but always in conjunction with a broad and consistent framework of other supportive policies and institutions. SOURCES: UNCTAD (1998 and 2002); Shaw (1995); Emmons, et al. (1999); Spar (1998); Fox (2003); Subramanian and Roy (2001). 3.2 Ten Arguments against Investment Tax Incentives This section discusses ten main arguments about costs and problems associated with tax incentives, particularly selective incentives. Most of these arguments are familiar to tax specialists and public finance economists, but they are less well understood by other stakeholders. For that reason, they merit a detailed explanation. 1. Revenue Loss. As explained earlier, the central purpose of tax policy is revenue mobilization. The claim that tax incentives have no adverse impact on revenue assumes that the investments that benefit from tax incentives are additional to what would take place in the absence of the incentives. Full additionality may indeed occur in two cases. The first is where an investment is fundamentally viable in the host country but could earn a higher risk- adjusted rate of return in another location, and the profit differential is small enough that a tax break reverses the location advantage. The second is where an investment is not viable under the normal tax code, but becomes so due to the tax break. Investments in this category are inherently those of low productivity. Aside from these special cases, tax incentives do cause a loss of revenue. There are four ways in which this can occur: • Redundancy: A tax incentive is redundant, or superfluous, when it does not materially affect the investment decision. This situation arises if the investment has a sufficient rate of return to be viable under the normal tax code, and cannot relocate easily to another jurisdiction. If the investment makes sense anyway, then the tax incentive simply transfers resources to the investor at the expense of the treasury. If redundancy is widespread, then the incentive program generates little additional investment and the revenue cost is high. An important
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.
Page 29 and 30: INTRODUCTION 1-5 from selective to
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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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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