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TAX INCENTIVES AND EXEMPTIONS: CHALLENGES FORTAX POLICY AND REVENUE ADMINISTRATION
Presentation at International Workshop on“Building The Domestic Revenue Base: TaxMorale And Taxation Of Natural Resources”held in Lusaka, April 18-19, 2012
by Adolf H. Ndunguru
Manager, Public Finance
Tanzania Revenue Authority
April 19th , 2012
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TAX INCENTIVES AND EXEMPTIONS: CHALLENGES FOR TAXPOLICY AND REVENUE ADMINISTRATION
OUTLINE
Introduction
Evidence on Effectiveness of tax incentives
Political Economy of Tax Incentives
The Achilles heel of Tax Incentives
Challenges
Strategies for the future
conclusion
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Introduction
Many governments in LDCs have been subjected tointensive pressure to sweeten their tax programmes toattract both FDIs and DDIs
High reliance is placed on tax incentives, as a tool ofinvestment (economic) policy (for several reasonsincluding political economy)
However, the ability of this tool to influence investmentdecisions remains a moot point
In Tanzania Tax Incentives have given up around 3% ofGDP in tax revenues on average with little to show inexchange
In most countries, tax incentives and exemptions needmajor tax policy reforms
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Effectiveness Of Tax Incentives
Various methodologies have been toemployed to study the effectiveness of taxincentive:
Research on cost-benefits analysis, sectorspecific approaches etc
Investor Motivation surveys
Tax Expenditures
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Effectiveness Of Tax Incentives (cont’d)
In LDCs experience with tax incentives has produced amixed results,
countries such as Mauritius and Malaysia with tangiblesuccess from their incentive scheme
Most countries however have had little to show inexchange for the incentives they have offered
still, despite suffering sizable revenue loss, havemaintained generous tax incentive schemes.
Mauritius has undergone a significant turnaround inreforming its tax incentive structure cutting taxexpenditure as a percentage of from 3.23% in 2006 to1.46% in 2010. Outcome: revenue growing at 15-20%rates, sound real GDP growth at 5% on average
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Effectiveness Of Tax Incentives (cont’d)
Econometric studies on investment incentives indeveloping countries are scanty, mainly due lack of goodfirm level data on investment in these countries.
To mitigate this problem, several approaches, includinginvestors motivation survey methods, have been used todetermine whether incentives are effective inencouraging investments
The balance of evidence suggests that, for manydeveloping countries, fiscal incentives do not effectivelycounterbalance unattractive investment climateconditions such as poor infrastructure, macroeconomicinstability, and weak governance and markets.
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Effectiveness Of Tax Incentives (cont’d)
investors have confirmed that while incentives were notan important factor in their decisions to invest, theywould ask for them anyway because incentives improvedtheir bottom lines
Asked whether incentives are important a US investor responded:
"Tax exemption is like a dessert; it is good to have, but it does not helpvery much if the meal is not there.“
An Investor Motivation Survey 2012 (Sebastian, Jamesand Mikra Krasniqi, 2012) in Burundi, Rwanda andTanzania found out that only 7.9% (39 out of 450 cases)of all respondents in all three countries said that theywould not have invested without tax and fiscal incentivesthey received.
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Effectiveness Of Tax Incentives (cont’d)
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Political Economy of Tax Incentives
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DiscretionaryIncentives popularwith politicians
Incentives havenon-transparentcosts
Role of Governance
Bargaining forIncentives
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Achilles heel of Exemptions
Although the case against tax incentives is not widelyappreciated among policy makers, it is a criticallyimportant parameter of sustainable revenue policydesign.
tax incentives
lead to revenue losses,
create loopholes for tax avoidance and further erode the taxbase,
complicate tax administration and make revenue collection lessefficient,
introduce distortions in resource allocation,
impair transparency and accountability, and rarely deliverfavourable results
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Selected Challenges
Assessing their effectiveness
Controlling ‘exemptions creep’ pressure fromlobby powers
Agreeing on the proper incentives recipe-balancing economic vs political interest
Combating the race to the bottom effects ofincentives
Putting in place effective administrativemonitoring machineries
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Selected Challenges (cont’d)
Achieving simplicity in the tax system
Building data base for informed analysis
Ensuring predictability of tax revenues
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Strategies for the Future
Increase Transparency
Undertake Tax Expenditure Analysis- allows the costs to bescrutinized by the public
Place a budget on tax incentives
Reduce Discretion
ensuring that incentives are granted transparently, throughlegislation.
This ensures the role of the legislature
Even if a ‘big’ deal has to be given ensure that criteria isdefined
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Strategies for the Future
Action should be coordinated among neighboring countries.Avoidance of tax Competition –Race to the Bottom
Selectivity in tax incentive recipe. Avoid period holidays infavour of other investment-linked or performance-basedincentives,
investment tax credit,
Investment allowance
accelerated depreciation
Tighten administration - reduce leakage in the usage of TaxIncentives by periodically study their effectiveness - allow thepublic to see for themselves if incentives work.
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Conclusion
The benefits of tax incentives on investment are widelyexaggerated
costs are widely underestimated.
Exemptions have significant proximity with of illicit capital flightwith the application of tax incentives
This bias in favour of incentives arises partly from weaknessesin tax policy analysis, and partly from political pressures thatinherently favour special interest groups.
Revenue mobilization is the central purpose of the tax system,countries should agree in principle that the existing taxincentive programmes are not sustainable and therefore theyshould be re-designed to ensure prudent tax revenuemanagement.
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Conclusion (cont’d)
Countries should be cautious about offering incentives thatcreate substantial revenue risks, either directly or indirectly.
All tax incentives should be incorporated in or carefullycoordinated with the relevant tax legislations, shunning asmuch as it possible from discretionary tax incentive.
effective monitoring machinery in the implementation of projectsthat receive discretionary fiscal benefits contingent onperformance criteria are required
Learning from successful reforms in implementing andmanaging tax incentives.
Limit the granting of incentives to location specific investments
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THANK YOU FOR YOUR ATTENTION