Page 3 - Working Paper (Tax Incentives: An Alternative to Revenue Enhancement)

DDTC Working Paper 1115
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1. Introduction and regional non-economic objectives; and (v) the
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effects on firm’s organization . A report prepared
The debaTe on The effecTiveness of by the World Bank in 2005 found that, as a result
Tax incenTives is always relaTed of foreign direct investment, foreign firms create
To how one counTry is able To important spillover effects. The present of export
leverage Their invesTmenT climaTe, oriented foreign firms is positively correlated with
labor producTiveness, as well as the likelihood of domestic firms making foreign
improve insTiTuTional condiTion sales.
and noT solely on governmenT
fiscal policies. Investors, on the other hand, consider
locating their investments based on several
factors such as cheap labor, currency exchange
The increasing mobility of international as well as fiscal policies related to tax incentives.
firms and the gradual elimination of barriers to Developing countries mostly classified of having
global capital flows have stimulated competition underdeveloped capital markets and depend
among governments to attract foreign direct on foreign markets to leverage their domestic
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investment, often through tax policies . Taxation production. Developing countries must find ways
is a government main fiscal policy to generate to attract foreign investment that is good enough
revenues to finance government spending on to outweigh the economic political or social
the goods and services. The ideal tax system in instabilities that can arise. Measures to reduce the
developing countries, in essence, face formidable negative influence of nontax issued are addressed
challenges. First, economy structures in these through the implementation of beneficial tax
particular developing and transient economies policies, which may include tax incentive, tax
still rely heavily on agriculture or informal sectors holidays, and tax sparing provisions . These
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where they are seldom paid a regular and fixed policies could also lead to harmful tax competition
wage. This creates a difficulty in calculating their that may cause negative economic consequences
taxes. Secondly, it is difficult to create an efficient for developing countries.
tax administration without a well-educated and
well-trained staff, when money is lacking to pay Similar to other policies, tax policies
good wages to tax officials and to computerize implemented in developing countries are based
the operation, and when taxpayers have limited on trial and error. The problem is that emerging
ability to keep account. As a result, governments economies do not have a model to rely on that
often take the path of least resistance, developing demonstrates the efficient use of their tax systems
tax systems that allow them to exploit whatever to provide the critical ingredients for development,
options are available rather than establishing including increasing and retaining investment and
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rational, modern, and efficient tax systems . Third, at the same time increasing tax revenue . Some
income distribution is unevenly distributed and notable experts mentioned that there are other
constant economic growth is not easily maintained. problems like poverty, corruption, inadequate
infrastructure, low employment, and limited
With regards to boosting investment and reasonable educated officials need to be solved
upgrading productivity, most transient economies before implementing tax incentives. Foreign direct
exercise tax incentives. These incentive include tax investment will surely have direct and indirect
credit for new foreign and domestic investment; effects to those problems alleviation; however, the
tax holidays for specific limited time frame for new question is whether tax incentives are the right
firms; exemptions from import duties particularly approach.
to capital good and establish special economic
zones for exporting companies. The debate on the This paper starts with exploring the rationale
effectiveness of tax incentives is always related behind providing tax incentives and empirical
to how one country is able to leverage their
3. Shah, Anwar and Robin Broadway, “How Tax Incentives Affect
investment climate, labor productiveness, as well
Decisions to Invest in Developing Countries”, Policies Research Working
as improve institutional condition. Other factors Paper, WPS 1011, The World Bank, November 1992.
to be considered in designing tax incentives are 4. Pisani, Andres E. Bazo,”Do Developing Countries’ Tax Incentives
Attract Investment or Create Disaster”, Tax Notes International, October
(i) inflation – where incentives should offset the
2008. Tax sparing provision is a devise used both by countries taxing
effects of inflation; (ii) tax evasion; (iii) technology worldwide income, which allow a foreign tax credit as well as exemption
transfer; iv) the fulfillment of social, environmental countries which allow a foreign tax credit for certain kinds of income
(like dividends) that are not exempt. The object is to permit developing
countries to reduce their income taxes under an incentive scheme for
foreign taxpayers without having the residence country collect the spared
1. Morriset, Jacques,”Using Tax Incentives to Attract FDI”, The World tax (William B. Barker, 2007)
Bank Note Number 253, February 2003 5. Baker, William B,” An International Tax System for Emerging
2. Tanzi, Vito and Howell Zee, “Tax Policy for Developing Countries”, IMF Economies, Tax Sparing, and Development: It is All About Source” 29 Pa.
Working Paper, IMF, March 2001. J. Int’l L. 349 (Winter 2007).