Effectiveness of Tax Incentives in Attracting Investment; Evidence and Policy Implications

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1 Effectiveness of Tax Incentives in Attracting Investment; Evidence and Policy Implications Edward Mwachinga Global Tax Simplification Team, World Bank Group February 12 Lusaka, Zambia

2 WBG Tax Simplification in Africa East African Community Tax admin procedures harmoniza2on Incen2ves regime harmoniza2on Alignment of SME tax regimes Guinea: Program design Guinea- Bissau: Investment code and incen2ves review Liberia: Admin streamlining SME tax design Reform communica2on Computeriza2on Mali: Legal Codifica2on of advanced rulings Sierra Leone: Admin streamlining (mobile payments) SME tax design Incen2ves 2 reform Pipeline: Botswana (Transparency) Burkina Faso Central African Republic Congo- Brazzaville Ethiopia Togo Burundi Admin streamlining SME tax design Incen2ves review Kenya Transfer pricing Transparency Tanzania Admin streamlining Rwanda Admin streamlining Tax Appeals SME tax design Uganda SME tax design Incen2ves review

3 Tax Incentives and Investment Policy Tax Incentives are used by most governments to attract investment There have been some spectacular successes and notable failures. UNCTAD, 2000 Governments tend to place high reliance on this as a tool of investment policy (for several reasons including political economy); Qn is are tax incentives effective at attracting investment However, its use as a policy tool needs to be determined by Its ability to influence investment decisions Its cost effectiveness (revenue and other costs v. the overall economic benefits the investments generate) Econometric evidence is hard to get as most reforms are bundled together Tax Incentives have given up more than a quarter of the tax revenues in Sierra Leone, Rwanda and Bangladesh with little to show in impact 3

4 Tax Incentives Tools Policy Support Research on The effectiveness of incentives in attracting investments Sector specific approaches Cost-benefit analysis on revenue loss and jobs gained Investor Motivation surveys To understand the salience of Incentives to the investment decision To gauge investment climate barriers for existing investors Cost-Benefit Analysis Jobs/Revenue cost Compilation of Tax Incentives in various laws and identify elements of discretions Tax Expenditures Measuring the revenue cost of tax incentives and direct cost of subsidizing investments Reform of Procedures to administer Tax Incentives Investment Policy Tax Simplifica2on

5 Incen2ves and Tax - Project scope This project studies incengves in 32 countries across 4 congnents (not including EAC) 5

6 The Effectiveness of Tax incentives in West/Central Africa

7 Impact of Investment Code on FDI BEN BFA CAF CIV CMR COG GAB MLI NER SEN TCD TGO year FDI flow current USD change inv climate Graphs by country_code

8 The Effec2veness of Tax incen2ves for Tourism Investment in the Caribbean OrganizaGon of Eastern Caribbean Countries

9 Finding in OECS Case Study Tourism IncenGves ñ Tourism Investment ñ 800 Tourism FDI (Thousand Eastern Caribbean dollars) 700 An2gua ECCU Source: James and Van Parys, 2009

10 Effectiveness and Investment Climate Fiscal Policy Effectiveness and the Investment Climate SRB BEL HKG BGR HUN GEO NLD SGP ISL MDG CHEJOR HRVIRLVNMKAZ LVA EGYCHL ZMB FJI AUT CAN JAM LSO TCD UKR CRI GBR ROM GHA FRA MUS POLCZE SLE SVK MYS FIN PER AUS DNK THA ESP KEN NGA UGA TUR MARTZA TUN PAK RUS RWA ZAF MEXPRT NZL SWE NOR DEU USA BGD BOL IND BRA GRC ETH IDN ITA UZB ECU BWAIRN JPNKOR Almost no impact of lowering Effec2ve Tax Rates on FDI in low IC countries CHN ARG METR Source: James and Van Parys, 2009 High IC countries Trend High IC countries Low IC Countries Trend Low IC Countries

11 When are tax incentives recommended Investment incentives are recommended when: a) Investments give rise to public goods b) Generate positive externalities Encourage Green Technologies Infrastructure projects Upgrade skills of workers The new investment is an anchor investment (a rigorous assessment is required to determine this type of investment and it benefits) c) International tax competition? *: First bet is to tackle the tax compe22on issue

12 Policy questions to ask before providing incentives Would the investment come in anyway? Does the country have any special advantages that are important to the investor? Does the Investment provide benefits beyond the direct investment (positive externalities)? Will the Investment generate additional tax revenue? Would Incentives put existing investments at a disadvantage? Does it cause leakage in tax revenue? Does it undermine the investment environment by encouraging other investors to ask for similar incentives?

13 Tackling the Political Economy of Tax Incentives Increase Transparency Measure the cost of Incentives (Tax Expenditure Statements) - allows the costs to be scrutinized by the public Place a budget on tax incentives Reduce Discretion Replace discretionary Incentives with those that flow out of the Tax Law This ensures the role of the legislature Even if a big deal has to be given ensure that criteria is defined Tighten administration - reduce leakage in the usage of Tax Incentives Periodically study the effectiveness - allow the public to see for themselves if incentives work 13

14 Thank you Ahsante sana