tax incentives; emerging tax issues in asia; the sixth imf ... · tax holiday/ exemption reduced...
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TAX INCENTIVES
Michael Keen
Sixth IMF-Japan High-Level Tax Conference For Asian Countries in Tokyo
April 7, 2015
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Context
• Request to IOs from G20 Development Working Group for a paper on “Options for low income countries’ effective and efficient use of tax incentives for investment”
• Professional consensus has been against incentives—but increasingly common!
– 1980: less than 40% of LICs in sub-Saharan Africa offered tax holidays , none had free zones
– 2005: over 80% offered tax holidays and 50% FZs
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Scope
• An ‘incentive’ is a departure, favorable to the taxpayer, from the general tax rules – Many forms and objectives
• Focus on those related to investment—and within that, on business income taxes – Though VAT, tariff and PIT incentives can be important
• And only on national level incentives
• Incentives are found in many other countries too – And many of the same lessons apply
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Prevalence
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Incentives are widespread
Countries
Surveyed
Tax holiday/
exemption
Reduced
Tax rate
Investment
allowance/
R&D Tax
Incentive
Super-
deductions
East Asia and Pacific 12 92 75 67 83 33
Eastern Europe and
Central Asia
16 88 38 25 31 0
Latin America and the
Caribbean
25 88 32 52 12 4
Middle East and
North Africa
15 80 40 13 0 0
OECD 33 21 36 64 76 21
South Asia 7 100 43 71 29 71
Sub-Saharan Africa 45 78 62 78 11 18
/1 Number of countries in percent of total in the group
Source: James (2014)
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When are incentives desirable?
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When the social benefits, from…
• Increased investment…
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Effects on Investment: Survey evidence
Source: UNIDO (2010)
2.94
3.05
3.05
3.22
3.32
3.46
3.50
3.51
3.63
3.65
3.81
3.82
0 1 2 3 4
Export market
Incentives package
Bilateral agreements and …
Availability of local …
Quality of life
Labour costs
Availability of skilled labour
Transparency of legal …
Local markets
Costs of raw materials
Political stability
Economic stability 0.31
0.28
0.24
0.15
0.12
0.10
0.09
0.06
0.00
- 0.01
- 0.22
- 0.26
- 0.3 0.0 0.3
Political stability
Local markets
Availability of …
Economic …
Quality of life
Transparency …
Availability of …
Bilateral …
Export market
Labour costs
Costs of raw …
Incentives …
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…and econometric evidence
• Is that taxes do affect FDI
– Mainly for location choices/greenfield
• But less marked for developing countries
• Host country tax systems matter
– Host taxation without deferral reduced value of incentives
– As does availability of other tax avoidance devices
• BEPS may make incentive issues more important
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When the social benefits, from…
• Increased investment, including displacement of other investments
• Impact on jobs
– But what is the counter factual?
• Spillover benefits
– Hard to quantify
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…exceed the social costs, from
• Lost tax revenue…
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Redundancy can be high
Burundi (2011) 77 Rwanda (2011) 98
El Salvador (2013) 37 Serbia (2009) 71
Guinea (2012) 92 Tanzania (2011) 91
Jordan (2009) 70 Tunisia (2012) 58
Kenya (2012) 61 Uganda (2011) 93
Malaysia (2014) 81 Vietnam (2004) 85
Nicaragua (2009) 15 Thailand (1999) 81
Nicaragua (2009) 51 for non-exporting
outside free zones
Mozambique (2009) 78
/1 Percent of affirmative answers to the question if an incentive was redundant
Source: James (2014)
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…exceed the social costs, from
• Lost tax revenue
– Which needs to be weighted by the marginal value of public spending
• Consequent distortion in rest of the economy
– Incentives lead to investments that have a lower pre-tax return than others
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PRINCIPLES FOR THE USE OF TAX INCENTIVES
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Design
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Types of incentive
• Cost-based, such as enhanced depreciation
Are generally to be preferred to
• Profit-based, such as holidays, reduced rate
because they:
– Target investment itself
– Have less risk of simply giving a windfall to profitable projects
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Economic zones
• Many types
– Export processing, SEZs fro domestic markets too
• Often non-tax benefits
• Widely seen as important in several countries in Asia
– E.g. Work on China
• But wider experience mixed
– No discernible impact on growth in India
– Much experience of risks to revenue
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Eligibility criteria
• Many types, each with their own risk. Eg
– For foreign investment: But round tripping?
– For large investments: But meet commitments?
• 'Strategic sectors’
– but is government good at guessing?
• Critical to:
– Target incentive closely today objectives
– Consider alternative means to those ends
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Governance
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Transparency
• Legal: – Clear legal basis, preferably in tax law
• Economic: – Clear, public rationale
– Ex post assessment; tax expenditure analysis a minimum
• Administrative: – Eligibility criteria clear and verifiable
– Clear, open decision-making process
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Authority to grant
• Often several agencies involved – Investment Promotion Agency, Ministry of
Economy, line ministries
• Coordination critical – Possibly through inter-departmental committee
• Ultimate authority to grant national-level incentives should be with Minister of Finance
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Administration
• Risk of complexity
• Importance of on-going monitoring – Including through filing
• Enforce termination
Country Average delay in days for granting of incentives Tax incentive largely
discretionary?
Serbia 6 No
Rwanda 10 No
Tanzania 15 No
Uganda 18 No
Jordan 21 Yes
Nicaragua 42 No
Burundi 47 Yes
Kenya 63 Yes
Guinea 80 Yes
Tunisia 95 Yes
Source: James (2014)
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Reform
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Why is it so hard?
• Have observers understated the benefits of incentives?
• Lack of transparency
– Costs often unclear – alleged benefits can be easy to point to, losses more nebulous
• Incentives create vested interests
– Easier or the few who gain a lot to lobby for than for the many who each lose a little to lobby against
• And they create precedents for more incentives
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Examples
• Jamaica: Removed many discretionary incentives in 2013
• Egypt: began phasing out holidays in 2005 – inward FDI doubled
• Mauritius: Aligned EPZ with rest of economy and removed incentives (except for small businesses)
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Regional coordination
• Some efforts (SADC, EAC, WAEMU, Central Am.)
• But not easy: to be effective, need to cover…
– Full range of instruments
• E.g. If agree to eliminate invectives, may compete on general CIT rate
– Wide enough range of countries
• …and incentive of each is to remain outside
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Practical tools
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Tax expenditure reviews
• Measure revenue foregone, usually without allowing for – Investment responses, implying overestimation of
revenue cost – Avoidance opportunities created, implying
underestimation
• A first step in evaluating incentives – Require company level data – Including for holiday firms (and, ideally, related
companies)
• Increasingly common (though often crude)? – India, Malaysia, Nepal, Pakistan,Philippines, Sri Lanka
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Quantifying effects on incentives to invest
• Impact depends on ‘effective’ tax rates, which reflect not just statutory rate, but details of base
• This impact can be complex… – E.g. Holiday firm may wish to delay investment
– Interest deductibility plus accelerated depart ion can already mean a subsidy at the margin
• But methods to estimate are now routine
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Concluding
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Questions
• How common are positive/negative experiences with incentives?
• Are some types more effective than others?
• What are the obstacles to reform?
• What might help to overcome them?