Developing countries and tax incentives: OECD says it like it is

Updated with U.S. data, at the bottom, complementing the blog on developing countries.

It has long been recognised by people who have studied in this rarefied field that tax incentives are a terrible way to promote development in developing countries (and others). The OECD has a document entitled Draft Principles to Enhance the Transparency and Governance of Tax Incentives for Investment in Developing Countries.

It says, by way of introduction:

Many countries, developed and developing alike, offer various incentives in the hope of attracting investors and fostering economic growth. Yet there is strong evidence that calls into question the effectiveness of some tax incentives for investment, including in particular tax free zones and tax holidays. Indeed, ineffective tax incentives are no compensation for or alternative to a poor investment climate and may actually damage a developing country’s revenue base, eroding resources for the real drivers of investment decisions - infrastructure, education and security. There is a significant regional competitiveness dimension too, as governments may perceive a threat of investors choosing neighbouring countries, triggering ‘a race to the bottom’ that make countries in a region collectively worse off.

Quite so. Now here is a cut and paste from their Key Facts section: the reader is encouraged to read the rest too. We wouldn't necessarily disagree with any of the recommendations here.

Key Facts:

• According to investors, tax incentives are never a top three motivation factor for investment decisions in West and Central Africa (WB 2009). In only four of 15 countries in the Latin America and Caribbean region are they regarded as one of the top three concerns (IDB 2010).

• In South East Europe investors indicate that rather than encouraging FDI, special tax incentives either were not taken into account or operated to discourage investment – provisions were difficult to track, understand or comply with and/or invited corrupt behaviour on the part of tax officials, tending to increase project costs and uncertainty (OECD 2003).

• In 1980 no low-income Sub-Saharan African countries had tax free zones, 50 percent did so by 2005; in 1980 40 percent offered tax holidays, by 2005 about 80 percent did so (IMF, 2009).

• Eleven of 15 member states of the Southern African Development Community offer tax holidays to certain types of investors, nine of which offer a full exemption from company tax during the holiday period (Nathan MSI 2004).

• Harmful tax practices in East Africa include the widespread use of tax holidays, other zero or low effective tax rates, and a lack of publicly-available data on the extent of incentives, which can contribute to tax competition and ever-declining rates and revenues (TJN-Africa & Action Aid International 2012).

• The practices of Exporting Processing Zone (EPZ) have been identified as particularly problematic in East Africa. EPZs have become a micro-economy, with poor linkages and transfer of technology to other parts of the economy, and also encouraged practices such as transfer pricing and declaration of losses (TJN-Africa & Action Aid International 2012).

• Morocco is the only MENA country to elaborate a Tax Expenditure Report, which has been integrated into the government’s budget process (OECD 2008).

• Dramatic turnarounds are possible. For example, prior to 2006 Mauritius had an extensive set of tax incentives. A major tax reform was undertaken in 2006 which included the removal of most tax holidays, exemptions and investment tax credits. FDI and Corporate Income Tax revenue experienced strong growth since the reforms.

Although this list isn't entirely new, it's important for people to understand these kinds of messages.   And there are three particularly interesting bullet points at the bottom.

And this isn't just about developing countries either. Take a look at this new report from Citizens for Tax Justice, looking at a particular research credit in the United States.  It notes, among many other things:

"Created in 1981, the credit immediately became the subject of scandals when it was claimed by businesses that no ordinary American would consider deserving of a tax subsidy (or any government subsidy) for research — like fast food restaurants, fashion designers and hair stylists."

Or take a look at this new report, also looking at the U.S, entitled The Corporate Tax Rate Debate:Lower Taxes on Corporate Profits Not Linked to Job Creation.

The whole issue of tax subsidies needs to be reconsidered, worldwide.

Update 2014: For more information on corporate tax, see here.