Finding ways to use incentives effectively yet responsibly is a global challenge. A report released last month by the International Monetary Fund (IMF) notes, “Countries often face pressures to attract investment by offering tax incentives, which then erode the countries’ tax bases with little demonstrable benefit in terms of increased investment.” This useful report provides the following advice on how to make better and more efficient use of tax incentives.
- Design tax incentives carefully. Target incentives toward export-oriented sectors and mobile capital, while avoiding sectors serving domestic markets and extractive industries. Cost-based tax incentives that lower the cost of investment are preferable to profit-based tax incentives.
- Good governance is critical for effectiveness and efficiency. The report suggests that tax incentives be subject to the legislative process, consolidated under the tax law, and their fiscal costs reviewed annually as part of a tax-expenditure review. Eligibility should be clearly defined and readily verifiable.
- Mitigate tax competition through regional coordination. The authors acknowledge that the political commitment and enforcement mechanism to make this happen are lacking, but still recommend common reporting standards and data collection as an important first step toward coordination and enhanced transparency.
- Conduct systematic evaluations to facilitate informed decision making. A lack of data and analytical tools hinders assessments of tax incentives. In response, the IMF has prepared “a simple conceptual framework” to consider the social benefits and costs of tax incentives. The framework places heavy emphasis on considering redundancy effects – that is, investments that would have occurred without the incentive – and calculating net impacts.
You can download the full report here: Options for Low Income Countries’ Effective and Efficient Use of Tax Incentives for Investment (October 2015).