Role of Tax Incentives in Investment Policy Investment Policy Conference Vienna June 15, 2011

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) However, its use as a policy tool should be determined by – Its ability to influence investment decisions in the first place – Then by its cost effectiveness (revenue and other costs v. the overall economic benefits the investments generate) Econometric evidence is hard due as most reforms are bundled together Tax Incentives have give up more than a quarter of the tax revenues in Sierra Leone, Rwanda and Bangladesh with little to show in impact 2

Incentives Framework 3 Revenue rise due to increased investment Social benefits from increased investment Indirect cost of incentives Lost revenue from investments that would have been made anyway > + + The Benefits and Costs of an Incentive Policy Social Benefits include cleaner environment, better skills, better health, etc. How can we measure the different components and provide policy advice to governments ?

Tax Incentives Tools 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 Simplification Tax Transparency

Incentives and Tax - Project scope This project studies incentives in 32 countries across 4 continents 5

The Effectiveness of Tax incentives in West/Central Africa 6

Source: James and Van Parys, Impact of Investment Code on FDI

Organization of Eastern Caribbean Countries 8 The Effectiveness of Tax incentives for Tourism Investment in the Caribbean

Finding in OECS Case Study 9 Tourism Incentives  Tourism Investment  Tourism FDI ( Thousand Eastern Caribbean dollars) Antigua ECCU6 Source: James and Van Parys, 2009

10 Almost no impact of lowering Effective Tax Rates on FDI in low IC countries Source: James and Van Parys, 2009

Results from Surveys Focus of surveyDid Incentives influence Investment level Jordan (2009)70%28% Mozambique (2009)78%13% Nicaragua (2009)15% (51% for non- exporting firms outside free zones) 17% Serbia (2009)71%6% Thailand (1999)81% Ghana (Agriculture, 2010)69% Vietnam85% 11

Thank You.

Investor Motivations to Invest 13 *: Open-ended question, multiple answers possible **: Number of businesses surveyed in respective countries; ***: Includes ease of import/export, employing labor, etc. Source: Investment Climate Department, 2009 Survey asked about three most critical factors for investment decisions* (Answer in Percent)

Cost of Incentives 15 Distortion costs Time and money spent by businesses to lobby the government for incentives Time and money spent by businesses to qualify for and receive tax incentives Revenue lost to illegal activity Additional costs for tax authorities responsible for administering tax incentives

Political Economy of Incentives 16 Discretionary Incentives popular with politicians Incentives have non- transparent costs Role of Governance Bargaining for Incentives

How to tackle Political Economy of Tax Incentives Increase Transparency – Measure the cost of Incentives (Tax Expenditure Statements) – This allows the costs to be scrutinized by the public – Place a budget on tax incentives Reduce Discretion – Replace discretionary Incentives with those that flows out of the Tax Code – This ensures the role of the legislature – Even if a ‘big’ deal has to be given tax incentives ensure that criteria is defined Tighten administration – Reduce leakage on the usage of Tax Incentives Periodically study the effectiveness – This allow the public to see for themselves if incentives work 17

Policy questions to ask 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 ? 18