United nations of tax incentives

Chapter II
Tax incentives: benefits and costs, design 
and administrative considerations *
I . Introduction
The present chapter examines the benefits and costs of using tax 
incentives and important considerations for designing, granting and 
monitoring the use of tax incentives to increase investment and growth. 
Tax incentives are often criticized on the grounds that they erode the 
tax base without any substantial effects on the level of investment. It 
is not easy to separate criticism of the tax incentive regimes that are 
currently in place from criticism of all tax incentives. Tax experts 
have recognized that certain well-designed tax incentives have been 
successful in increasing investment.
II . 
Benefits and costs of tax incentives
A . 
Benefits of tax incentives
If properly designed and implemented, tax incentives are a useful 
tool for attracting investments that would not have been made 
without the provision of tax benefits. Tax incentives are justified if 
they correct market inefficiencies or generate positive externalities. 
Scholars view such tax incentives as desirable, given that, without 
government intervention, the level of foreign direct investment would 
be suboptimal.
 16 
It is not surprising that Governments often choose tax 
incentives over other types of action. It is much easier to provide 
tax benefits than to correct deficiencies in the legal system or to 
dramatically improve the communications system in a country. In 
*
Prepared by Eric M. Zolt, Michael H. Schill Distinguished Professor of Law, 
UCLA School of Law.
16 
Yoram Y. Margalioth, “Tax competition, foreign direct investments and 
growth: using the tax system to promote developing countries”, 
Virginia Tax Review
, 
vol. 23, issue 1 (2003).

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Design and Assessment of Tax Incentives
addition, tax incentives do not require an expenditure of funds by the 
Government as do some alternatives, such as the provision of grants 
or cash subsidies to investors. Although tax incentives and cash grants 
may be similar in terms of their economic cost to Governments, for 
political and other reasons, it is easier to provide tax benefits than to 
actually provide funds to investors.
New foreign direct investment may bring substantial benefits, 
some of which are not easily quantifiable. A well-targeted tax 
incentive programme may be successful in attracting specific projects 
or specific types of investors at reasonable costs compared with the 
benefits received. The types of benefits from tax incentives for foreign 
investment are the benefits commonly associated with foreign direct 
investment, including increased capital, knowledge and technology 
transfers, increased employment and assistance in improving 
conditions in less developed areas.
Foreign direct investment may generate substantial spillover 
effects. For example, the choice of location for a large manufacturing 
facility will not only result in increased investment and employment 
in that facility but also in firms that supply and distribute the products 
emanating from it. Economic growth will increase the spending power 
of the country’s residents and that, in turn, will increase demand 
for new goods and services. Increased investment may also increase 
government tax revenue either directly from taxes paid by the investor, 
such as taxes paid after the expiration of the tax holiday period, or 
indirectly through increased tax revenue received from employees, 
suppliers and consumers.
The positive view of the benefits of foreign direct investment 
has recently been challenged by those who question whether tax 
incentives actually increase the level of foreign direct investment and 
whether foreign direct investment actually generates economic growth 
that is beneficial to development.
 17 
In this view, even if tax incentives 
succeed in attracting new investment, it is not clear, with many types 
of foreign investments, whether the developing country benefits.
17 
Yariv Brauner, “The future of tax incentives for developing countries”, in 
Tax, 
Law and Development
, Yariv Brauner and Miranda Stewart, eds. (Cheltenham, Unit-
ed Kingdom of Great Britain and Northern Ireland, Edward Elgar Publishing, 2014).

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