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

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ECONOMICS OF TAX INCENTIVES 3-17<br />

from Chapter 2 is that <strong>the</strong> tax system is not a major determ<strong>in</strong>ant <strong>of</strong> viability for most projects.<br />

Thus, <strong>the</strong> revenue foregone from <strong>of</strong>fer<strong>in</strong>g tax <strong>in</strong>centives would <strong>of</strong>ten be put to better use <strong>in</strong><br />

improv<strong>in</strong>g conditions that are more important to <strong>in</strong>vestors, <strong>and</strong> which contribute more<br />

broadly to growth, job creation, <strong>and</strong> development. Indeed, <strong>the</strong> provision <strong>of</strong> tax <strong>in</strong>centives may<br />

divert political attention from fix<strong>in</strong>g more critical problems. For example, tax breaks may be<br />

seen as a palliative that reduces pressure to deal with high <strong>in</strong>flation, overvalued exchange<br />

rates, high <strong>in</strong>terest rates, or weak <strong>in</strong>frastructure <strong>and</strong> public utilities. <strong>Incentives</strong> that are not<br />

cost-effective overall impact may end up deterr<strong>in</strong>g national development.<br />

On <strong>the</strong>se grounds, Porter (1998) dismisses <strong>the</strong> use <strong>of</strong> tax <strong>in</strong>centives, tariff protection, <strong>and</strong><br />

subsidies as tools for national development. He argues that tax <strong>in</strong>centives shelter companies<br />

from competitive pressures ra<strong>the</strong>r than promot<strong>in</strong>g <strong>in</strong>novation <strong>and</strong> productivity. It is better, <strong>in</strong><br />

his view, to emphasize policies that facilitate dynamic ga<strong>in</strong>s <strong>in</strong> productivity for prospective<br />

centers <strong>of</strong> excellence. Melo (2001) echoes this po<strong>in</strong>t <strong>in</strong> his survey <strong>of</strong> <strong>the</strong> “new approach” to<br />

<strong>in</strong>dustrial policy <strong>in</strong> Lat<strong>in</strong> America. He f<strong>in</strong>ds that most countries <strong>in</strong> that region are mov<strong>in</strong>g<br />

away from subsidies <strong>and</strong> protection, <strong>and</strong> <strong>in</strong>stead pursu<strong>in</strong>g programs to improve <strong>the</strong> economic<br />

fundamentals for strategic <strong>in</strong>dustries. The recommended policies <strong>in</strong>clude<br />

• Technical <strong>and</strong> pr<strong>of</strong>essional education,<br />

• Industrial <strong>in</strong>frastructure <strong>and</strong> services,<br />

• Establishment <strong>of</strong> quality st<strong>and</strong>ards,<br />

• Elim<strong>in</strong>ation <strong>of</strong> restrictive regulations,<br />

• Science <strong>and</strong> technology policies, <strong>and</strong><br />

• Export market<strong>in</strong>g support.<br />

10. Experience Shows That <strong>Tax</strong> <strong>Incentives</strong> Usually Don’t Work! Success <strong>in</strong> us<strong>in</strong>g tax<br />

<strong>in</strong>centives to spur efficient <strong>in</strong>vestment <strong>and</strong> rapid development is <strong>the</strong> exception ra<strong>the</strong>r than <strong>the</strong><br />

rule. Most develop<strong>in</strong>g countries have tried for many years to promote <strong>in</strong>vestment through tax<br />

<strong>in</strong>centives with disappo<strong>in</strong>t<strong>in</strong>g results. Even <strong>the</strong> <strong>in</strong>troduction <strong>of</strong> export process<strong>in</strong>g zones<br />

(EPZs) has failed more <strong>of</strong>ten than succeeded. 43 Observ<strong>in</strong>g that EPZs are <strong>of</strong>ten <strong>in</strong>effective <strong>and</strong><br />

commonly become conduits for smuggl<strong>in</strong>g <strong>in</strong>to <strong>the</strong> domestic market, Zee et al. (2001, 1507)<br />

conclude that “sett<strong>in</strong>g up <strong>and</strong>/or ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g export process<strong>in</strong>g zones are rarely advisable.”<br />

Fur<strong>the</strong>rmore, countries that are successful <strong>of</strong>fer many advantages to <strong>in</strong>vestors o<strong>the</strong>r than tax<br />

breaks. As expla<strong>in</strong>ed <strong>in</strong> Exhibit 3-1, Mauritius, Cost Rica, Irel<strong>and</strong>, <strong>and</strong> Malaysia used tax<br />

<strong>in</strong>centives <strong>in</strong> conjunction with stable economic <strong>and</strong> political conditions, a well educated labor<br />

force, good <strong>in</strong>frastructure, open trade for exporters, dependable rule <strong>of</strong> law, <strong>and</strong> effective<br />

<strong>in</strong>vestment promotion systems. Where <strong>the</strong>se conditions are lack<strong>in</strong>g, tax <strong>in</strong>centives are<br />

generally not sufficient to attract major flows <strong>of</strong> <strong>in</strong>vestment.<br />

43 For recent surveys <strong>of</strong> experience with EPZs, see UNCTAD (2002), Madani (1999),<strong>and</strong> Radelet (1999). Radelet<br />

po<strong>in</strong>ts out that every successful develop<strong>in</strong>g country has used some form <strong>of</strong> export promotion program<br />

effectively, but he also emphasizes that EPZs are <strong>of</strong>ten unsuccessful <strong>in</strong> stimulat<strong>in</strong>g <strong>in</strong>vestments, jobs, or<br />

l<strong>in</strong>kage effects.

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