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

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3-14 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION • to extrapolate from East Asian cases to recommend selective interventions as a tool for industrial policy in countries with weaker public administration and highly politicized procedures for deciding who qualifies for benefits. The main conclusion from decades of experience is that developing countries have largely failed in repeated efforts to nurture infant industries by subsidizing and protecting inefficient operations. The statement that incentives foster low-productivity investment is mitigated by the importance of “footloose” projects that can just as well locate elsewhere. Such projects may be highly efficient, and they can make a large contribution to knowledge transfer, job creation, and development. This argument applies mainly to footloose export-oriented projects. 34 Another consideration is that tax preferences may lead to social benefits that counterbalance the economic efficiency costs. For example, Zambia has a 15 percent income tax rate for farm operations and a 35 percent rate for most other companies. This tax structure may draw resources into agricultural investments that have a low rate of return. Yet the policy reflects a political consensus to support farm enterprises, irrespective of productivity considerations. The important thing is that such political decisions should be based on a clear understanding of the economic consequences. Distorted Technical Decisions. In addition to favoring certain sectors, tax incentives also distort technical decisions. Poorly designed programs have unintended consequences that may operate at cross purposes with other objectives of government policy. For example, ⎯ Tax preferences that reduce the cost of capital systematically favor capital-intensive over labor-intensive investments, which reduces the impact of investment on job creation. ⎯ Tax holidays will favor short-term over long-term investments. 35 ⎯ Exemptions from import duty on capital goods will favor production activities that depend on imported capital, reducing the incentive to develop local capital goods industries. ⎯ Exemptions from duty on imported raw materials and intermediate goods favor activities that use imported inputs, impairing the development of backward linkages. 36 to experiment and innovate is suppressed. What appears to be a low-return activity for the entrepreneur can have a high rate of return for the economy overall. 34 To be sure, not all export projects are equal. Some enclave export activities generate few benefits for the host economy, even though they may be efficient in their production technology. 35 UNCTAD (2002), p. 219 cites studies showing that investment tax incentives in Brazil, Indonesia, Malaysia, Mexico, Pakistan, Thailand, and Turkey “led to distorted investment decisions, partly because they discriminated between firms that showed losses in early years and those that did not, and between relatively capital-intensive and relatively labour-intensive activities.” 36 Moran (2001) finds that linkage requirements tend to backfire by making down-stream activities less profitable, which reduces investment and slows growth. He concludes that linkage effects develop more strongly when producers are given the freedom to pursue market incentives.
ECONOMICS OF TAX INCENTIVES 3-15 These serious distortions need to be well understood, particularly in countries that place a high priority on job creation and the promotion of backward linkages to the domestic economy. On balance, investment tax incentives will reduce efficiency and productivity unless they are carefully designed, well targeted, and impartially implemented. 37 Recall from Chapter 2 that the quality of investment is at least as important as the quantity in determining the prospects for economic growth and development. 6. Equity. Equity issues usually take a back seat in discussions about tax incentives, or else they are finessed by simply presuming that these programs benefit the general population by generating jobs and promoting growth. In some cases significant job creation does occur, as in Mauritius and Ireland. However, favorable impacts on equity are not a sure thing. In some cases foreign corporations or business elites obtain large benefits at the expense of the general taxpayer. This can occur where tax incentives lead to a revenue loss that is financed by higher taxes on other producers and consumers, 38 or slower progress in expanding and improving social services, or government borrowing that pushes up interest rates and crowds out financing for other users. Also, selective tax incentives that are badly designed or carelessly implemented may create inequities by giving tax-preferred producers an unfair advantage in competing with companies that pay full tax. When this occurs, the unfairness undoubtedly affects tax compliance, as well. The equity effects are often difficult to trace, but in some cases they are clear-cut. For example, Mozambique imposes a high surtax on sugar imports to stimulate investment in rehabilitating the domestic sugar industry. The surtax also led to the creation of jobs for thousands of Mozambicans. But who bears the cost? It is essentially a transfer from domestic consumers to company owners, because the surtax supports a high domestic price of sugar. This raises the question of whether other investment promotion instruments might create jobs more equitably. 39 The claim that incentives are needed to foster job creation is less compelling than one would believe from investment promotion brochures. Recall that some investments that benefit from incentives would be implemented anyway. Jobs arising from such investments cannot be attributed to the program as such. Also, if tax-favored producers displace others, jobs are lost 37 A third form of economic inefficiency arises if tax benefits are financed by imposing higher tax rates elsewhere in the economy. Virtually any tax causes an efficiency loss – called the Deadweight Loss (DWL) – by altering prices and costs faced by households and businesses. The DWL rises with the square of the tax rate. Therefore, offering preferential tax rates to activity A at the expense of imposing higher rates on activity B increases the overall DWL compared to a situation that generates the same revenue with equal tax rates on both activities. 38 Warren Buffet, one of the richest men in the world, and a major beneficiary of the recent reduction in tax on dividends in the United States, objected to this tax cut on equity grounds: “Remember that giving one class of taxpayer a ‘break’ requires – now or down the line—that an equivalent burden be imposed on other parties. In other words, if I get a break, someone else pays.” Washington Post, May 20, 2003, p.A19. 39 A corollary issue is whether the surtax is larger than necessary to stimulate investment in the sugar industry. To the extent that this is so, the redundant tax is an unmitigated burden on consumers.
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TECHNICAL REPORT Effectiveness and
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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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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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Effectiveness and Economic Impact of Tax Incentives in the SADC ...

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