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

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.