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

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4-12 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION Exhibit 4-3 Foregone Revenue from an Investment Tax Incentive The usual method for estimating the “tax expenditure” cost of a given tax incentive uses a database of taxpayer records to compute the difference between (a) the actual tax due and (b) the tax that would have been due if the incentive were not available, for each filer who has claimed the tax break. Call this difference the Tax Benefit (TBi) for each beneficiary i. Summing over all beneficiaries gives the total tax expenditure: Tax Expenditure = Σ TBi (1) {i} Equation (1) accurately measures foregone revenue only if taxpayer behavior (and thus the tax base) is not altered by the incentive, and if there are no indirect revenue effects from the tax incentive program. In reality, the “ifs” are rarely valid. Recalling the discussion in chapter 3 of redundancy and indirect revenue effects, the actual revenue loss from a tax incentive measure can be expressed as follows: Revenue Loss = Σ (TBi x REDi ) + IRE1 + IRE2 + IRE3 + IRE4 (2) {i} Equation (2) says that the revenue loss depends on: • TB: The size of the tax benefit. The larger the tax break, the larger the direct revenue loss. • {i}: The size of the set of beneficiaries. A narrowly targeted benefit is less costly than a broad one. • RED: The redundancy ratio. If RED=1.0, then the incentive is superfluous and the investments would be undertaken anyway. The full tax benefit is a loss to the treasury. If RED=0.0, then there is no redundancy. The investments would not exist without the tax benefit, so there is no genuine revenue loss. When RED falls between 0 and 1, then the incentive is partially redundant and the effective revenue loss is a fraction of TB. • Four indirect revenue effects: • IRE1: Tax-favored investments may generate revenue by creating taxable jobs and stimulating other taxable enterprises through linkage effects and positive externalities. This indirect effect on revenue is positive. • IRE2: Expansion of the tax-favored activities may reduce taxable income for other entities by undercutting their market position, bidding away resources, or (in the case of EPZ incentives) providing new channels for smuggling. This indirect effect is negative. • IRE3: The tax incentive may create loopholes that provide new opportunities for tax planning, tax avoidance, and corrupt practices in tax administration. The third indirect effect is also negative, and often very large. • IRE4: The tax incentive may complicate the tax system and require administrative procedures that divert tax officers from their basic task of collecting revenue. This effect is also negative. Comparing equations (1) and (2), one can see that the tax expenditure is only a partial measure of revenue impact. It will be an overestimate if RED is low or IRE1 is large. Or it will be an underestimate if RED is high and IRE2-4 are large. The redundancy rate and the IREs are hard to measure, so the bias is difficult to determine. If only the tax expenditure can be compiled routinely, the question is whether it is better to have a partial estimate of the revenue loss, or none at all?
ECONOMIC TOOLKIT 4-13 4.3 Screening Criteria Selective tax incentives require screening criteria to determine which projects qualify. In some cases, the screening criteria also determine the nature of the benefits. 59 The determination may simply involve confirming objective criteria, such as establishing that a project is a manufacturing operation, or that safari vehicles are being purchased by a tourism company. In many other countries eligibility is limited to investments that are expected to have a favorable economic impact, or even more narrowly to projects that are deemed to be strategically important for the economy. In theory, the screening should be based on a careful cost−benefit analysis that includes an appraisal of both the economic and financial rates of return on a proposed investment project. Again in theory, special incentives should be limited to projects falling in cell 3 of the classification matrix shown in Table 4-3, that is, projects that have a high economic rate of return and—counter intuitively—a relatively low financial rate of return. The reason for the latter condition is to screen out projects where the tax incentives would be superfluous. As Usher (1990, 169) points out, offering incentives to “prize” projects is a waste of public resources. The program “seems to be a glowing success because [tax-]subsidized firms are in the forefront of economic progress,” but in reality the incentives do not affect prize investment decisions and simply sacrifice revenue. Table 4-3 Conceptual Basis for Screening Selective Tax Incentives High FRR project viable without incentives Low FRR project viable only with incentives High ERR large benefits to economy Cell 1 - Excellent project - Tax incentive redundant Cell 3 - Excellent project - Tax incentive effective Note: ERR = economic rate of return; FRR = financial rate of return Low ERR small benefits to economy Cell 2 - Poor project - Tax incentive redundant Cell 4 - Poor project - Tax incentive effective This classification may help to clarify the economic concepts, but it is less helpful in practice because the estimation of economic rates of return (ERR) is a difficult and imprecise exercise. In low-income countries where technical capacity is limited, the analysis may not be feasible 59 Even general incentives may involve discretion. For example, the deductibility of training costs or research expenses may require prior approval by the tax commissioner.
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TECHNICAL REPORT Effectiveness and
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Contents Executive Summary xi 1. In
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Contents (continued) ILLUSTRATIONS
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Glossary ACT additional company tax
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Preface The Scope of Work (SOW) for
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PREFACE IX Export Development & Inv
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XII EFFECTIVENESS AND IMPACT OF TAX
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XIV EFFECTIVENESS AND IMPACT OF TAX
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XVI EFFECTIVENESS AND IMPACT OF TAX
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XVIII EFFECTIVENESS AND IMPACT OF T
Page 25 and 26: 1. Introduction Why should schemes
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Page 31 and 32: 2. Taxation, Investment, and Growth
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TAX SYSTEMS AND INCENTIVES IN THE S
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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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