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

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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: • • • 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.
ECONOMICS OF TAX INCENTIVES 3-11 5. Economic Distortions. Economists are very concerned about economic distortions that arise from tax incentive programs. These are not well understood by most stakeholders, yet they can be decisive in determining whether investment tax incentives foster growth and development. Tax incentives reduce efficiency and productivity in two main ways: • Fostering low productivity. Figure 3-1 shows the normal case where tax incentives reduce the effective user cost of capital from UCC0 to UCC1 and therefore increase investment from I0 to I1. The issue at hand is that capital investments to the left of I0 are viable even without the tax break; the investments that are affected by the tax break (in the range I0-I1) are the ones with relatively low productivity. Hence, tax incentive programs tend systematically to foster investments with a low or marginal rate of return. One clear case of adverse impact on efficiency is the use of protective tariffs to stimulate investment in high-cost production activities, so as to shield uncompetitive domestic producers from import competition. Exhibit 3-3 explains how this policy works. Figure 3-1 Tax Incentives and the User Cost of Capital User cost of capital UCC 0 UCC 1 Tax benefit Value of marginal product of capital I 0 I 1 Investment
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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
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Page 25 and 26: 1. Introduction Why should schemes
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ECONOMICS OF HARMFUL TAX COMPETITIO
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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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