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

4-6 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
Table 4-1
International Comparisons of the Marginal Effective Tax Rate, circa 1985
Selected Countries
Ranked by Basic Tax Rate
Statutory Tax
Rate circa 1985
METR with all
Equity Financing
METR with 50%
Debt Financing
Ecuador 20.0 13.5 10.1
Colombia 30.0 28.5 36.9
Korea 30.0 33.3 32.8
Jamaica 33.3 40.6 35.3
Brazil 35.0 54.4 45.9
Thailand 35.0 24.9 20.0
Malaysia 40.0 31.7 24.2
Portugal 40.0 45.5 28.7
Guatemala 42.0 10.7 2.8
Ireland 50.0 5.8 5.5
Note: Calculations are based on the hypothetical project described in Exhibit 4-1. Calculations assume 5
percent inflation. The low METR figures for Ireland reflect full first-year expensing of capital outlays, with no
deduction for nominal interest expenses.
SOURCE: World Bank (1988), page 93, based on papers cited therein by Pellechio and others.
We have extended the Dunn and Pellechio (1990) model by adding a calculation of the present
value of taxes received by the government (PVtax) under each scenario. This allows one to
compare the reduction in the METR—which measures the incentive effect—against the
reduction in revenue, for each tax measure. One can express this relationship as ratio, with
both variables being measured as percentage changes from benchmark values reflecting the
standard tax regime. This ratio provides an index of the relative cost-effectiveness (RCE) of
various tax incentives. If the RCE index is greater than 1.00, then the incentive effect (reduction
in METR) is proportionally greater than the adverse revenue effect (reduction in PVtax). Table
4-2 shows the RCE index for 11 different tax incentive provisions, and four illustrative
investment projects. The specifications are explained in notes to the table.
The most striking feature of Table 4-2 is that the investment tax credit (ITC) delivers by far the
largest incentive effect relative to the revenue loss, with a RCE ratio in the range of 1.43 to 1.81
depending on the characteristics of the investment project. The least cost-efficient instruments
are the 10-year tax holiday and a reduction in the general company tax rate from 35 percent to
15 percent. For most instruments the RCE ratio lies between 0.95 and 1.05, indicating that the
incentive instrument reduces the METR and the revenue intake in approximately equal
proportions.
Insights from illustrative calculations must be used with caution, because the results depend
heavily on the parameters being used. This is not so much a weakness of the model as a
reflection of reality. That is, the impact of any particular tax measure depends on many
parameters of the tax system and the investment project. For this reason, it is very important
to customize the analysis to fit the circumstances in each country. The best way to do this is to