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

3-8 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
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promotion statistics, it looks as if the program has stimulated activity B, but in reality the
result is a straight revenue loss for the host-country treasury and a windfall for the
company. A common variation on this theme occurs when the tax holiday for B comes to an
end. The owners may then shut down B and open a “new” company C, which continues the
operations under a new name with an additional tax holiday.
Income shifting. A corporate group has a strong incentive to manipulate transactions within
the group to reduce revenue and increase expenses in a tax-laden unit (A), to augment the
reported income of a related tax-favored unit (B). Company B could be getting a tax
holiday, or it could operating in a sector that receives a special low tax rate, such as
agriculture in Zambia or manufacturing in Botswana. There are innumerable ways that this
can occur, including transfer pricing on purchases and sales, loans at above-market interest
rates, management fees and royalty charges, or sale and leaseback of depreciated
equipment.
“Interest pump.” Gillis (1989) describes a large revenue drain in Indonesia operating through
a tax incentive meant to encourage saving. Prior to tax reforms introduced in 1984, the
system exempted income from interest on deposit accounts, but allowed an unlimited
deduction for interest on debt. Companies could easily arrange a borrow-and-redeposit
scheme with their banks, yielding a deductible interest expense and tax-free interest
income. The net effect is a risk-free gain at the expense of the treasury.
False export declarations. In many parts of the world, tax incentives or subsidy schemes that
target export performance have triggered false declarations that can be extremely costly.
The best known example in recent years is the “Goldenberg affair” in Kenya, in which false
export declarations were used to extract hundreds of millions of dollars in export
subsidies. 32
Tailor-made loopholes. Exhibit 3-2 provides an intriguing example of how a seemingly small
tax incentive turned into a giant loophole because of special features in its technical design.
That this happens even in a country with enormous resources for tax administration, such
as the United States, means that problems can be far worse in countries with weaker tax
administration and less transparent processes.
32 This scheme has been widely reported in the local and international press when it became a central issue in
the loss of IMF and World Bank funding for Kenya in the late 1990s.