Friday, November 21, 2008

IMF paper opposes tax competition, tax incentives

A new IMF Working paper has been looking at whether using tax incentives to promote growth is a good idea. It looks at the case from the Caribbean. The paper's preamble says this:

"This paper compares the costs of concessions in terms of revenues forgone with the benefits in terms of increased foreign direct investment. The costs are very large, while the benefits appear to be marginal at best. Forgone tax revenues range between 91⁄2 and 16 percent of GDP per year, whereas total foreign direct investment does not appear to depend on concessions. A rethinking of the use of concessions in the region is needed urgently."

This is what TJN has long argued: see pages 4-5 of a recent edition of our newsletter, Tax Justice Focus (TJF), also looking at tax incentives, which gives a pertinent example:

"Some countries are clearly giving up revenue that could be spent on schools, railways, nurses, and many other public goods. . . . Between 1992 and 2004, the copper industry’s total contribution to the Zambian treasury fell from more than $200m to just $8m – even though copper prices had climbed by more than 25% and copper production was roughly the same."


Zambia was earning in taxes jut 0.7% of the total value of the mineral produced. That is an astonishingly low figure. The editorial in the same edition of TJF quoted from a McKinsey's report:

“Popular incentives, tax holidays, subsidised financing or free land, serve only to detract value from those investments that would likely be made in any case.”

So the new IMF report is in good company. In general terms, it quotes cross-country research, concluding that:

"The emerging consensus from this research is that a country’s overall economic characteristics may be more important for attracting successful investments than any tax incentive; and even if tax incentives play a role in securing an investment, they are not generally cost effective. . . . A broad cross-country analysis shows that FDI is not related to incentives. "

More specifically in the case of the six Caribbean countries it is studying (Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines,) it noted:

"In a recent survey of 159 multinational firms operating in the Caribbean, tax concessions were not among the top 15 of the 40 areas that firms considered critical for their investments . . . it is generally considered much more effective for a country to attract investment by building genuine economic advantages and a conducive investment environment."

These studies are looking at "real" investment: that which has local economic substance, and it includes tourism facilities, light manufacturing. We like one of the conclusions:

"A development strategy based on increasing the amount of concessions to investors is unlikely to result in increased investment and growth. A re-evaluation of the strategy of using incentives to promote development is needed, possibly within a regional context. A regional approach to harmonizing concessions would help limit each country’s revenue losses, and avoid the tax competition that has produced a race to the bottom."

This is written almost as if the researchers had been in consultation with TJN. They recognise clearly, as we have done, that tax competition, when taken in overview, is unambiguously harmful.

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