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WEST AFRICAN UNION OF TAX
INSTITUTES (WAUTI)
*
3RD ANNUAL INTERNATIONAL
TAX CONFERENCE
*
Date: 26TH February 2014
*
by
Justice Margaret Welbourne
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TAX INCENTIVES:
An OUTMODED CATALYST
For REGIONAL INTEGRATION
- CHALLENGES
and
BENEFITS
2
NO
ONE
LIKES
TO
PAY TAXES
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OUTLINE
1. INTRODUCTION
2. DEFINITIONS
3. TYPICAL TAX INCENTIVES
4. TAX COMPETITION
5. COST AND BENEFITS OF INCENTIVES
6. ASSESSMENT OF TYPICAL TAX
INCENTIVES
7 REGIONAL INTEGRATION AND
INCENTIVES
8. SCOPE FOR COORDINATION
9. YOUR VERDICT: OUTMODED
CATALYST OR DEVELOPMENT TOOL?
10. WAY FORWARD
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INTRODUCTION
“In the past, such
exemption regimes have
been used as a tool for
attracting investors into
particular sectors of the
economy.
5
these largely depend
on government focus at
the time. These rules
are usually embedded
in investment and tax
laws.
6
it is worth noting that
some of these
exemptions continue to
be relevant as the sectors
they relate to still need
support to develop.”
- PwC 2013 Budget Highlights
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what is the relevance of
tax incentives in the
promotion of growth in
our local economies
and the fostering of
regional trade and
regional integration?
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DEFINITION OF TAX INCENTIVES
“Tax incentives are benefits that
are available to potential and
existing tax payers to serve as
motivation and encouragement
with the ultimate aim of reaping
some positive returns for the
state”. (Abdallah Ali Nakyea)
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ANOTHER DEFINITION
Tax incentives are defined as all
measures that provide for a more
favourable tax treatment of certain
activities or sectors compared to what
is granted to general industry. under
this definition, a general cut in the tax
rate or a generous depreciation
scheme applicable to all firms would
not be considered tax incentives.
- Alexander Klemm (IMF).
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RATIONALE
1.TO ATTRACT INVESTMENT
2. TO CREATE POSITIVE
EXTERNALITIES FOR THE
DOMESTIC MARKET E.G. SKILL
AND TECHNOLOGY TRANSFER
3. EMPLOYMENT CREATION AND
OTHER SOCIAL GOALS
4. TO INCREASE TAX REVENUES
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To ensure that tax incentives
lead to economic
transformation
Government Role
MONITOR IMPACT TO
PREVENT OR MINIMISE
ABUSE
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ASSUMPTIONS FOR ADOPTING TAX
INCENTIVES
1 . T H AT T H E C O N F E R R A L W I L L I N D U C E
D O M E S T I C O R F O R E I G N I N V E S TO R S TO
I N I T I AT E A C T I V I T I E S W H I C H T H E Y
WO U L D N OT OT H E RW I S E H AV E
U N D E R TA K E N
2 . T H AT T H E C O N F E R R A L W I L L I N D U C E
AN INCREASE IN INVESTMENT IN
EXISTING ENTERPRISES
13
The general merits of the
argument either for or
against the adoption of
particular incentives
would seem to turn
largely upon the validity of
this premise.
14
Support for this basic premise has in
turn rested largely upon two
assumptions:
1st Assumption. Tax considerations are
highly important in decisions to invest,
and taxes as such frequently operate
as an important impediment to
investment. thus, the removal or
minimization of tax obstacles to
investment will encourage investments
that would not otherwise be made.
15
Similarly, tax incentives make
otherwise unpromising
investments attractive because
they permit a rapid recovery of
capital and a higher rate of
return. Finally, they encourage
reinvestment by making
available to the taxpayer funds
that would not otherwise be at
his disposal for this purpose.
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2nd Assumption: Tax incentives are
valuable as an indirect stimulus to
investment because they publicize and
enhance the country’s investment
climate. In addition to their advertising
value in calling the country to the
attention of the foreign investor as a
desirable location for investment,
incentives improve the investment
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climate for both domestic and foreign
investors by indicating the favourable
disposition of the government toward
private investment. Also, insofar as the
country is competing with others for
scarce capital, failure to offer the same
advantages to investors as are provided
by other countries might result in a
serious diversion of capital to these
other countries.
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Typical Tax Incentives
Tax
holidays
Special zones
Investment tax credit
Investment allowance
Accelerated depreciation
Reduced tax rates
Exemptions from various taxes
Financing incentives
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While it is possible to find
circumstances under which certain tax
incentives are justifiable, the case for
most incentives remains doubtful.
Empirical research on tax incentives
shows that they sometimes work in
attracting foreign direct investment
(FDI), but it remains unclear whether
they are beneficial overall.
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Tax Competition
One of the forces shaping tax policy in many
countries is the need to maintain a competitive
tax system in an increasingly globalized
economy. Tax competition refers to a process
in which countries attempt to attract capital or
taxable profits by reducing taxes on capital.
An important result of the theoretical tax
competition literature is that small countries
should not levy source-based taxes on capital
income.
21
Tax incentives may be an explicit tool
of tax competition. A country may, for
example, wish to use taxes to attract
mobile capital, but also face a strong
revenue constraint and high tax collection
costs from taxes on factors other than
capital. In that case, an incentive that is
targeted at new and mobile investment may
appear an attractive solution, because it
allows both a competitive tax system where
needed, and provides revenue from existing
capital and immobile activities (as long as
leakages remain limited).
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

Even if incentives have a purely domestic intent,
they may have international repercussions and lead
to tax competition. A regional incentive, for example,
whose aim may be to achieve a more evenly distributed
development by supporting a backward part of a country,
will not only affect the domestic allocation of production
factors, but also change the relative benefits of producing
the affected good in this rather than other countries. An
even stronger example is the frequently used tax incentive
for Research and Development (R&D). The aim of these
incentives is to address the externality of this activity,
namely the spillovers of some of the created knowledge to
other firms. The presence of such an incentive is, however,
likely to attract activity from abroad in addition to boosting
domestic investment. And given the spillovers, this may
even be a particularly worthwhile field of tax competition.
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Costs and Benefits of
Incentives
Even if there is a case in principle for tax
incentives, this will not help a policy maker,
unless the costs and benefits of practicable
incentive schemes are known.
The cost of tax incentives are wide-ranging
and go beyond any immediate revenue loss.
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Even the pure revenue costs of
incentives are difficult to
quantify.
The benefits of tax incentives
are even harder to assess.
Any beneficial impact on
investment by firms benefiting
from tax incentives should be
analyzed in light of the effect
of aggregate investment.
25
Cost-benefit studies of tax
incentives are difficult to
make and may be misleading
if they systematically exclude
general equilibrium effects.
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Assessment of Typical Tax
Incentives
In evaluating the efficacy of tax incentives, one must
be mindful of not only apparent benefits but
fundamental game-changers. In this appraisal it is
necessary to assess each of the typical tax incentives
and look beyond what meets the eye particularly
their impact on Regional Integration and
Cooperation.
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TAX HOLIDAY
Despite their popularity, tax holidays
seem particularly harmful.


First, they are particularly attractive to short-term,
footloose and rapidly profitable investment, as the benefits
accrue only during the limited period of the tax holiday.
These are unlikely to match the authorities’ priorities.
Second, their costs are often not transparent, because
beneficiaries are either exempt from filing tax returns, or, if
there is an obligation, may not do so correctly. Given that
at most limited tax revenue is at stake, the tax
administration has no incentive to closely scrutinize such
returns. As a result policy makers may not have a good
idea about revenues forgone.
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
Third, they may cause rent-seeking behavior, with
investors trying to obtain extensions to remain
competitive with firms still covered by holidays. In
principle, it is possible to think of situations in
which a tax holiday could be a useful tool. If, for
example, a country is about to begin a major
reform towards a more business-friendly
environment, then a tax holiday could be used to
signal its commitment to the reform, as investors,
enticed into the country by the holiday, would
leave afterwards, if the planned reforms stall. This
appears, however, to be more of a theoretical
possibility than a strategy used in practice.
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INVESTMENT ALLOWANCES AND
TAX CREDITS
Investment allowances and tax credits have
both advantages and disadvantages.
ADVANTAGES
They can easily be implemented in a transparent and
automatic way, and they are directly contingent on
new investment, i.e., the objective of the incentive.
However, the advantage of not reducing taxes on
existing investments should not be overstated, as this
may lead to an efficient system in the long run.
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DISADVANTAGES
 If initially allowances are increased instead
of a tax cut, then future tax cuts will be
even harder to justify, because they would
benefit owners of capital who already
enjoyed the high allowances (though it
would reduce the value of those
allowances still outstanding).

31

As the argument would hold every time
cash is available for tax cuts, the system
would then evolve further towards a
problematic one with a narrow base. Instead
of specifying a tax holiday in numbers of
years, it can instead be specified as a
maximum amount of tax to be forgiven
within a limited timeframe. In addition to
imposing a maximum limit on revenue
forgone, this would improve transparency by
requiring better bookkeeping and auditing.
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ACCELERATED DEPRECIATION
Accelerated depreciation has similar,
though
much
more
limited,
implications
as
investment
allowances and tax credits.
 Given that accelerated depreciation does
not change total deductions, but only
brings them forward in time, the
maximum benefit to a company is the
time value of money. .
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REDUCED TAX RATES
Reduced tax rates may have merits, but this depends on
the details.
If they apply for a limited time only, then similar concerns as for
full tax holidays apply. Otherwise, it is important that the sectors
benefiting from the reduced rate can be easily and objectively
identified, to ensure transparency and avoid discretion on the
part of the authorities. If applied to the more mobile part of the
economy, then such a reduced rate could be well justified by
economic considerations, even if it led to a permanent split in
the tax system. One disadvantage of such a split rate is that
there could be repercussions on international tax cooperation,
because existing cooperation agreements often proscribe such
practice
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EXEMPTIONS FROM OTHER TAXES
Exemptions from other taxes,
particularly those assessed at the
border, can be important, but are
second-best solutions.
35
SPECIAL ZONES
Special zones can differ so much in their
characteristics that it is not possible to make
an assessment in general terms.
36
FINANCING INCENTIVES
Most financing incentives are likely to
have a limited impact, although it
depends on the details.
Effective tax rates allow a quick
assessment of the impact on
different tax incentives on tax
liabilities.
37
REGIONAL INTEGRATION AND INCENTIVES

In recent decades, the globalisation of markets and
the expansion of free-trade agreements have
prompted many areas of the world to consider
regional integration as a means to better compete
in the world economy. Countries that alone may
not have sufficiently large markets for production
and consumption join together with regional
neighbours in order to form areas where goods
and labour can flow relatively freely in response to
market demand.
38
 This
allows the region the
comparative advantage of many
countries into one unified block
of economic activity. As with
every complex political and
economic
venture,
regional
integration is not without its
risks.
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ADVANTAGES
 1. The formation of a common market
 2. Larger Markets
 3. Increased global competitiveness

DISADVANTAGES
 1. Loss of Sovereignty
 2. Loss of Flexibility.

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 It
seems clear that regional
integration ties member nations
together in both times of prosperity
and times of difficulty. The advantages
and disadvantages presented can
each be seen as beneficial, harmful or
neutral, depending on what is going
on in both the world economy and
the domestic situation of member
nations.
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
Theoretical reasoning suggests that
regional integration which involves
collaboration and coordination between
countries is difficult, although difficulties
may be overcome as shown by some
recent initiatives especially in the EU. The
main difficulty of coordination is that some
countries have more to gain than others, with
small countries whose current tax system is
very generous standing to lose most. Moreover,
the more countries in a region cooperate, the
more attractive it becomes to be an outsider
and maintain lower taxes..
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The Scope for Coordination
If the perspective shifts from one country’s
level to the global or regional level, the
availability and desirability of the policy
options change.
Any tax incentive that does not create new
investment at the regional level, but only shifts it from
one jurisdiction to another would then appear as a
needless loss of revenue
The desirability of regional cooperation rests
on the assumption that capital income should
be taxed.
43
Regional coordination may make
tax
competition more harmful, depending on how
coordination takes place.
Empirical work on the impact of economic
zones suggests that their impact is limited.
There is very little work specifically addressing
tax incentives for general investment,
particularly in developing countries.
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THE WAY FORWARD
IMPROVED SECURITY
 IMPROVED INFRASTRUCTURE WITHIN
THE SUB-REGION
 REMOVAL OF RESTRICTION TO FREE
MOVEMENT OF GOODS SERVICES
AND PEOPLE
 GOOD JUSTICE SYSTEM
 IMPROVED REGULATORY SYSTEMS
 BETTER SKILLED LABOUR

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BUREAUCRACY
 CORRUPTION
 NON-FUNCTIONING INSTITUTIONS
 SQUALOR DISEASE AND FILTH
 At the end of the day, Incentives tax or
otherwise will serve no useful purpose if
the Region cannot improve its efficiency
and eliminate corruption and develop its
infrastructure to create the enabling
environment for the attraction of
investments.

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CONCLUSION
In many cases, previous skepticism about tax
incentives seems warranted, and advice against
their rampant use appears appropriate.
Given the difficulty in assessing both the costs
and benefits of tax incentives, opinions about
their desirability may differ.
Even if a tax incentive can be useful in
principle, a country may be well advised to
refrain from introducing one.
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THANK YOU
AND GOD BLESS
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