iii
Preface
Tax incentives have traditionally been used by governments as tools
to promote a particular economic goal. They are preferential tax
treatments that are offered to a selected
group of taxpayers and take
the form of exemptions, tax holidays, credits, investment allowances,
preferential tax rates and import tariffs (or customs duties), and
deferral of tax liability.
The generalized use of tax incentives has been justified by the
need to: (i) correct market inefficiencies associated with the externalities
of certain economic activities; (ii) target new industries and mobile
investments that are subject to tax competition; (iii) generate a form
of agglomeration economies, or concentration externalities; and (iv)
subsidize companies during their sector’s downturn. As a matter of
fact, developed countries normally use tax incentives to promote
research
and development activities, export activities, and support
the competitiveness of their enterprises in the global market; while
developing countries use them to attract foreign investment and foster
national industries.
Although at first, tax incentives appear to be costless because
they do not seem
to affect the current budget, they may entail significant
costs, such as revenue loss, low economic efficiency, increased
administrative and compliance costs, and excessive tax planning and
tax evasion, which may exceed their benefits
and considerably erode
the general tax base.
Given that costs and benefits of tax incentives vary from
country to country, the impact of tax incentives on the economic
growth and expansion of the overall tax base is not uniform. While
in some cases, tax incentives may clearly play an important role in
attracting new investments that contribute to substantial economic
growth
and development of the country, in others, a particular tax
incentive scheme may result in little new investments, with a significant
cost to the government.
iv
Design and Assessment of Tax Incentives
For this reason, the theoretical positive
effect of tax incentives
has been questioned and thus some governments have used different
models, such as the computable general equilibrium (CGE) model,
to conduct a cost-benefit analysis focused on their economic and
revenue impact. This could ensure that a tax incentive program is
worth pursuing and clear policies and laws delineating its scope,
requirements and administration might be elaborated. Unfortunately,
such a sophisticated model is often not an option for developing
countries due to budget and resource constraints. However, in such
cases micro-simulation models can be built.
They are more easily
accessible, since they are based on companies’ financial statements
and tax returns submitted to the tax authorities.
The purpose of this publication is to provide tax policy makers
and administrations with a reasonable methodology that allows them
to estimate the net benefit of a tax incentive program, in order to
improve the design, assessment and administration
of such a program,
thereby supporting possible administrative reforms and improving tax
procedures, with a view to fostering greater tax efficiency, economic
growth and equity.
Alexander Trepelkov
Márcio Verdi
Director
Executive Secretary
Financing for Development Office
Inter-American Center of
UN-DESA
Tax Administrations