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

5-12 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
for promoting productive investment and stimulating economic growth. Consequently, most
countries have moved in recent years towards lower tariff barriers in order to reduce the
economic distortions and foster efficient investment.
The revenue effect of reducing duty rates is non-linear. Highly protective duty rates may
impair revenue collection because they diminish import volume and create enormous
incentives for smuggling and “negotiation” with customs officers. When rates are especially
high, say above 40 percent, it is often possible to increase revenue by lowering the customs
duties (as Kenya did in the mid-1990s). Further reduction in the maximum duty rate normally
entails a substantial revenue loss. To avoid fiscal problems, duty reductions can be phased in
and packaged with other measures to enhance revenue (including closing off loopholes by
eliminating special exemptions).
5.3 Summary
Table 5-1 summarizes the advantages and disadvantages for each tax incentive discussed in
this chapter. A simple ranking of the instruments would be inappropriate because the
effectiveness and impact of each one is highly dependent on local circumstances, the
characteristics of a particular investments, and technical details of the tax code. In addition,
every tool has drawbacks as well as virtues, so any ranking involves policy judgments, not
just technical analysis. Nevertheless, one may draw a few tentative conclusions about the
relative merits of the various instruments:
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The soundest tax incentive is a reduction in the overall statutory tax rate to levels that are
competitive with most other countries in the region and with rates applying in the main
capital-exporting countries.
Relieving exporters of indirect tax on inputs is a must, in order to remove a serious
disincentive for export production. The problem lies in devising a practical way to
implement and control this export promotion measure in countries with weak tax
administration.
Moderate investment tax credits, initial allowances, and accelerated depreciation serve the
signaling effect of tax incentives at low cost in terms of the fiscal, economic, and
administrative impact. Even these incentives, however, can be abused if not well
administered.
The worst form of tax incentive is the imposition of high protective tariffs on competing
imports. This may stimulate investment for the domestic market, but it usually turns out to
be investment with low productivity and poor development potential.
Eliminating import duties on raw materials and intermediate goods is another poor way to
stimulate investment. The measure has a high revenue cost, impairs backward linkages,
and has little positive effect on investment for the domestic market since indirect taxes are