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

3-10 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
inherently complicates the system. Second, preventing and controlling the abuse of loopholes
absorbs highly skilled administrative resources. Third, senior tax administrators should be
and generally do participate in designing tax incentives, screening applicants, and monitoring
performance. Highly trained officers are thus diverted from raising revenue to managing
programs designed for other social and economic purposes. As emphasized by Zee, et al.
(2002, 1501): “The more scarce resources are devoted to administering tax incentives, the more
other important administrative tasks would be impaired—thus jeopardizing tax collection as
a whole.”
4. Economic Cost of Fiscal Adjustment. The previous subsections show that investment tax
incentives can cause revenue losses through diverse channels, most of which are indirect,
obscure, and difficult to measure. To the extent of these revenue losses, other fiscal
adjustments are needed to cover the concomitant budget gap. The adjustments take three
forms:
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Curtailing government expenditure. The government can curtail the growth of spending or
reduce the provision of public goods and services. In this case the impact takes the form of
less funding for education, health, roads, water systems, rural development, the legal
system, social safety nets, public administration, and so on. If the spending cuts impair
progress in fixing other serious impediments to investment, then the overall effect of the tax
incentives may be the opposite of those intended.
Increasing the tax burden on other activities and persons. The revenue loss can be financed with
higher tax collections on other fronts, through increasing tax rates, broadening the tax base,
or improving tax administration. If investment incentives are financed this way, then the
economic gains in tax-favored sectors come at the expense of a greater tax burden on others,
which may impair growth in other areas of the economy.
Resorting to other sources of financing. Instead of taking politically painful steps to close the
budget gap, the government can seek instead to finance the gap. Each source of financing,
however, imposes a cost on the economy. Compensating for lost revenue by borrowing
from the central bank amounts to “printing money,” which contributes to inflationary
pressure and economic instability. Issuing additional domestic debt tends to increase real
interest rates and divert financial resources from the private sector, thus impairing
investment. External borrowing contributes to the build-up of foreign debt, with well
known disadvantages. Finally, foreign aid grants come with conditionality constraints and
high administrative costs.
Put simply, foregone revenue has an economic opportunity cost. The cost may be easy to bear
if the revenue loss is small, or if the country has a strong fiscal system and ample financial
resources. But the cost can be exceedingly high if the revenue loss is large, or if the country
has a weak fiscal position and very scarce resources. Under such circumstances the revenue
risk from introducing tax incentives should be a paramount concern in the policy
deliberations.