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

5-2 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
•
•
•
•
•
•
•
Effectiveness in stimulating investment. The basic indicator of effectiveness is the extent to
which each tax tool improves investment incentives by reducing the marginal effective tax
rate (METR). This gives a rough approximation but not a pat ranking, since METR
differentials vary depending on the type of project and other characteristics of the tax
system. Effectiveness also depends heavily on whether the incentives accrue to marginal
investments or to projects that would be undertaken anyway. When tax benefits are
redundant, the beneficiary investments cannot properly be viewed as arising from the
incentive program.
Revenue foregone. To gauge the generosity of each instrument, one can calculate the
revenue foregone per beneficiary. But a larger consideration is the number of beneficiaries:
does the benefit accrue to every filer, to new investments only, or to a selective subset of
new investments? The smaller the set of beneficiaries, the lower the tax loss, other things
being equal. A second major factor is whether the incentive is carefully targeted to
investments that would otherwise be lost to the economy. If so, then the effective revenue
loss is zero. If the incentives are redundant, however, then the tax break is a straight loss to
the treasury. (See Exhibit 4-3.)
Economic efficiency. Various tax instruments introduce different kinds of economic
distortions, which bias investment decisions and reduce efficiency.
Tax administration. Tax incentives also differ in terms of administrative simplicity, the ease
of estimating the foregone revenue (tax expenditures), and the scope for abuse. The latter
should be a central consideration for the design of any tax incentive program.
Zee, et al. (2001) suggest combining these factors into an overall measure of cost-effectiveness
for each tool. This is a useful way to conceptualize the policy analysis, but in practice many
relevant factors are difficult to quantify consistently. Beyond these four broad criteria, several
other general considerations pertain to the design of a tax incentive program:
Incentives that create large tax differentials between favored and non-favored activities
provide the greatest opportunity and strongest incentive for abuse of the incentive as a tax
shelter.
The effectiveness and impact of an incentive depends on characteristics of the investor. In
the case of investments coming from countries that impose residence-based tax on
worldwide income, host-country tax incentives may be neutralized by tax obligations in the
home country (see chapter 3). Another important consideration is whether the investor has
ongoing operations generating tax obligations that can be offset by tax losses that arise in
early years of the new project.
The value of a tax incentive to the investor depends on technical features of the tax code
such as loss carry-forward provisions, ring-fencing of tax losses of incentive-eligible
activities, the taxation of capital gains, whether the basis for capital allowances and capital