Page 6 - Working Paper (Tax Incentives: An Alternative to Revenue Enhancement)

DDTC Working Paper 1115
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Table 2 - Main Categories of Tax Incentives

Category Specifications
Profit/income-based Reduction of the standard corporate income tax rate; tax holidays, loss carry forward or carry back to be
written off against profits earned later (or earlier)
Capital investment- Accelerated depreciation; investment and reinvestment allowance
based
Labor-based Reduction in social security contributions; deductions from taxable earnings based on the number of
employees or on other labor-related expenditure
Sales -based Income-tax reductions based on total sales
Value added-based Income tax reductions or credits based on the net local content of outputs, granting income-tax credits based
on net value earned
Based on other Income-tax deduction based on, for example, expenditures relating to marketing and promotional activities
particular expenses
Import-based Exemption from import duties on capital goods, equipment or raw materials, parts and inputs related to the
production process
Export-based • Output-related (e.g. exemptions from export duties; preferential tax treatment for income from exports;
income tax reduction for special foreign exchange-earning activities or from manufacturing exports; tax
credits on domestic sales in return for export performance)
• Input-related (e.g. duty drawbacks; tax credits for duties paid on imported materials or supplies; income-
tax credits on net local content of exports; deductions of overseas expenditures and capital allowance for
export industries)
Source: UNCTAD, 2000

rather than follow-up capital injections. through the accelerated depreciation program.
Providing accelerated depreciation has the least
Compared with tax holidays, tax credits
of the shortcomings associated with tax holidays
and investment allowances have a number of
and all of the virtues of tax credits and investment
advantages. They are much better targeted than
allowances and overcomes the latter’s weakness to
tax holidays for promoting particular types of
boot. Since merely accelerating the depreciation of
investment and their revenue cost is much more
an asset does not increase the depreciation of the
transparent and easier to control. A simple and
asset beyond its original cost, little distortion in
effective way of administering a tax credit system is
favor of short-term assets is generated. Moreover,
to determine the amount of the credit to a qualified
accelerated depreciation has two additional merits.
enterprise and to “deposit” this amount into a
First, it is generally least costly, as the forgone
special tax account in the form of a bookkeeping
revenue (relative to no acceleration) in the early
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entry . Investment tax credit may be claimed
years is at least partially recovered in subsequent
as a percentage of investment expenditures
years of the asset’s life. Second, if the acceleration
incurred in a year on qualifying capital. Similar
is made available only temporarily, it could induce
to tax holidays, investment tax allowance focuses
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a significant short-run surge in investment .
on new investments. Investment allowances are
deductions from taxable income based on some The mechanism by which tax incentives can
percentage of new investment. There are two be triggered can be either automatic or fully
notable weaknesses associated with tax credits discretionary of the authorities. An automatic
and investment allowances. First, these incentives triggering mechanism allows the investment to
tend to distort choice in favor of short-lived capital receive the incentives automatically once it satisfies
assets since further credit or allowance becomes clearly specified objective qualifying criteria, such
available each time an asset is replaced. Second, as a minimum amount of investment in certain
qualified multinationals may attempt to abuse the sectors of the economy or inside the proposed
system by selling and purchasing the same assets economic zones. The relevant authorities have
to claim multiple credits or allowances or by acting merely to ensure that the qualifying criteria are
as a purchasing agent for enterprises not qualified met. A discretionary triggering mechanism involves
to receive the incentive. approving or denying an application for incentives
on the basis of subjective value judgment by the
Moreover, multinationals are also allowed to
incentive-granting authorities, without formally
write off capital costs in a shorter time period
stated qualifying criteria. Or in other words, this
than is dictated by the capital’s economic life
regime relies on case-by-case evaluations that are
15. Tanzi and Zee, Op.Cit., page 14 16 Ibid.