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

5-8 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
cost. In this respect, rapid depreciation (up to a point) serves as a corrective measure rather
than an incentive.
Investment Tax Credits
Zee, et al. (2001, p.1504) advocate investment tax credits (ITCs) as the preferred form of tax
incentive. They note that an ITC is equivalent to an initial allowance (IA) if there is a single
company tax rate. 69 Hence, the two approaches generally “share the same advantages and
shortcomings,” as outlined above. If there are multiple company tax rates, then the ITC is
more even-handed than the investment allowance. This is because the IA has greater value to
companies that face the higher tax rate, companies that the tax system is designed not to
favor.
The OECD (2001) cautions that generous up-front incentives, such as investment tax credits or
large initial allowances, can endanger revenue by placing the beneficiaries in a large tax-loss
position. This makes them attractive candidates for sale to companies with tax obligations, for
the purpose of sheltering the latter income from tax. 70
Treatment of Dividends
To understand how tax policy affects investment decisions, the analysis should examine rates
of return from the point of view of the enterprise owners. This requires taking into account
the tax treatment of dividend remittances as well as the company tax. 71 With a classical tax
system, business income is taxed once at the company level and again when remitted to
shareholders. The double taxation sharply increases the effective tax rate. It also creates a bias
in favor of debt instead of equity financing, and diminishes the incentive to invest. For
example, suppose that the company tax rate and the individual income tax rate are both 35
percent. Then the effective tax on company income, after remittance to shareholders, is 58
percent. 72 Integrating the company tax and the dividend tax is therefore an important way to
improve investment incentives and reduce the tax bias favoring debt. 73
The revenue effect of moving to an integrated tax system depends on how much revenue is
collected on dividend income. In most SADC countries, this is probably not a major source of
revenue. In any case, most economists view the integrated tax system as a normative
standard. From this perspective, elimination of the double tax on dividends is an objective of
tax reform, not an “incentive” that should be counted as a tax expenditure.
69 The equivalence is: ITC = IA x t, where t is the tax rate.
70 When the United States expanded investment tax credits in the 1981 Economic Recovery Tax Act, one result
was unexpectedly large revenue losses due to this type of tax-loss transaction.
71 The treatment of capital gains also enters the equation here. See the essay on this topic by John King in
Shome (1995, 155-157).
72 Given a pre-tax level of income, I, the double stage tax creates an overall obligation of .35 I + .35 x (.65 I) =
.58 I.
73 Shome (1995, 149-155) contains excellent essays on the arguments for integrating the tax system and methods
for doing so.