effectiveness of investment incentives in developing countries evidence and policy implications...

Effectiveness of Investment Incentives in Developing countries

Evidence and Policy Implications

Investment Policy WorkshopVienna

May 14, 2012

Plan of the Presentation

• The Incentives Framework • The econometric evidence

– Current literature– Investment Climate Department research

• The survey evidence– Previous surveys– Investment Climate Advisory’s surveys

• Incentives for Public Goods• Cost of Incentives• Political Economy• Policy advice

2





3


Typical IncentivesNon-Tax Incentives

• Grants (Training)• Loan Guarantees• Free Land/Electricity, etc• Pricing (Feed-in-Tariffs)

4

Tax Incentives

• Tax holidays• Special zones• Investment tax credit• Investment allowance• Accelerated depreciation• Reduced tax rates• Exemptions from various taxes• Financing incentives

The Benefits and Costs of an Incentive Policy

Revenue rise due to increased investment

Social benefits from increased investment

Indirect cost of incentives

Lost revenue from investments that would have been made anyway

>+ +

Benefits

5

Social Benefits include cleaner environment,

better skills, better health, etc.

Costs





6


7

The Effectiveness of Tax incentives in West/Central Africa

0.2

.4.6

.81

0.2

.4.6

.81

0.2

.4.6

.81

-500

05

001

000

-500

05

001

000

-500

05

001

000

1995 2000 2005 1995 2000 2005 1995 2000 2005 1995 2000 2005

BEN BFA CAF CIV

CMR COG GAB MLI

NER SEN TCD TGO

FDI flow current USD change inv climate

FD

I flo

w c

urre

nt U

SD

year

Graphs by country_code

Source: James and Van Parys, 2009 8

Impact of Investment Code on FDI

Finding in UMEOA/CEMAC Case Study

General Tax Holiday Investment

Export Tax Holiday Investment

Complexity Incentives Investment

Legal Guarantees Investment

9

10

The Effectiveness of Tax incentives for Tourism Investment in the Caribbean

Organization of Eastern Caribbean Countries

Finding in OECS Case Study

Tourism Incentives

Tourism Investment

0

100

200

300

400

500

600

700

800

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Tourism FDI (Thousand Eastern Caribbean dollars)

Antigua

ECCU6

11Source: James and Van Parys, 2009

AUS

AUT

BEL

BWA

BGR

CANCHL

DNK

FJ I

FINFRA

GEO

DEU

HKG HUN

ISL

IRL

JAM

JPNKOR

LVA

MYSMUS

MEX

NLD

NZLNOR

PER

PRT

ROM

SGP

SVK

ZAF

ESPSWE

CHE

THATUR

GBR

USA ARGBGD BOL

BRA

TCD

CHN

CRI

HRV

CZE

ECU ETH

GHA

GRCINDIDN

IRNITA

KAZJOR

KEN

LSO

MDG

MARNGA PAKPOL

RUS

RWA

SRB

SLE

VNM

TUNUGA

UKREGY

TZA

UZB

ZMB

010

2030

FDI a

s %

of G

DP

-20 0 20 40 60METR

High IC countries Low IC CountriesTrend High IC countries Trend Low IC Countries

Fiscal Policy Effectiveness and the Investment Climate

Almost no impact of lowering Effective Tax Rates on FDI in low IC countries

12Source: James and Van Parys, 2009





13


Tax incentives are one of the least important factors in investment decisions

Results from SurveysAuthor Focus of survey Redundancy ratio for

incentivesDid Incentives influence Investment level

Investment Climate Advisory (FIAS)—Investor motivation surveys and incentives

Jordan (2009) 70% 28%Mozambique (2009) 78% 13%Nicaragua (2009) 15% (51% for non-

exporting firms outside free zones)

17%

Serbia (2009) 71% 6%Thailand (1999) 81%Ghana (Agriculture, 2010) 69%Tanzania (2012) 91.2% 30%Rwanda (2012) 97.7%Burundi (2012) 77.4%

Uganda (2012) 92.7%

Phu et. Al. (2004) Vietnam 85%

15

Investor responses do not depend on foreign ownership or size

Would your company have invested without tax incentives?

Tanzania: Marginal investors only created 16% of all new, national permanent jobs

Category Conventions Comm.Telecom

Transport Water supplies Industry/Manifact

Other sectors cumulative

Total jobs created – selected sectors

Total jobs created – All

sectors

MI(Raw count)

1,200 695 676 150 371 2,096 3,092 5,188

MI (Percentage)

62% 14% 43% 100% 6% 11% 21% 16%

NMI (Raw Count)

716 4,215 883 0 5,803 17,190 11,617 28,807

NMI (Percentage)

38% 86% 57% 0% 94% 89% 79% 84%

Total 1,916 4,910 1,559 150 6,174 19,286 14,709 33,996

*Sectors are selected based on the highest number of representation in the survey

Investors who said “would not have invested without incentives” created more jobs in sectors of conventions, exhibitions and water supply than investors who said that they did not need incentives to invest.




• Incentives and Public Goods• Cost of Incentives• Political Economy• Policy advice

18


Incentives and Public Goods

• Investment incentives are recommended when– Investment assets available to general public (eg road,

school)• This is just another way to pay for public goods

– Investments generate positive externalities• Encouraging Green Technologies• Upgrading skills of workers• Anchor investments (but have to be justified)• Infrastructure

19*: First best is to tackle the tax competition issue

Tax competition• Race to the bottom

– Evidence shows that countries compete • by lowering tax rates• by providing more attractive tax holidays (Klemm and Van Parys, 2009)

– Thought this cannot be extended to other kinds of tax incentives

– Fighting off one country with the other is part of a strategy followed by some private sector

• However, in many cases the final choice is already made

– ‘Winning’ countries in many cases suffer from the winners curse/buyers remorse, having given up too much

– Only a coordinated response could avoid such a race to the bottom (Ex. agree on common minimum criteria)

• There is also evidence of a race to the top !

20





21


Cost of Incentives

22

Distortion costsTime and money spent by

businesses to lobby the government for incentives

Time and money spent by businesses to qualify for and

receive tax incentivesRevenue lost to illegal activity

Additional costs for tax authorities responsible for

administering tax incentives

PercentMozambique (60 respondents)

Jordan (61 respondents)

Serbia(50 respondents)

Nicaragua(71 respondents)

Did obtaining incentives delay project implementation? 20% by 2–12 months1% by more than 1 year

Did obtaining incentives add to project costs?

What were the main additional costs?Additional senior management time: 18%Loss of business: 15%

Not an issue Additional senior management time : 6% Additional consulting fees: 12%

Additional senior management time: 26%Legal fees: 24% Loss of business: 17%

23

Response

78

22%

10% by 1–3 months8% by 3–6 months

Response

82

18

8% by 3–6 months2% by 18 months or more

Response

72

27

Response

98

2

Response

72

28%

Response

98

5

Response

80

20

Response

87

13

Costs of obtaining incentives





24


Political Economy of Incentives

25

Discretionary Incentives popular

with politicians

Incentives have non-transparent

costs

Role of Governance Bargaining for Incentives





26


27

Tax Policy

Generous Tax Holidays

Partial Tax Holidays

Investment linked Tax Incentives (Investment Credits, Investment

Allowances, etc)

Only indirect tax incentives for capital inputs

Tax Incentives only for Anchor Investments

Uniform low tax rate over a broad base

Tax Administration

Discretionary/Non-Transparent Tax Incentives

Tax Incentives in Individual Agreements

Improve Transparency (Publish list of investors benefiting from

incentives)

Tax Incentives in Tax Laws

Tax Incentives are available without additional permission

No Tax Incentives

Non Fiscal Incentives

Define Investment Policy

Investor Aftercare

Removing Regulatory Barriers

Invest in Infrastructure

Policy Coordination

Reform Path for Investment Incentives PolicyReform Path for Investment Incentives Policy

Key Reforms

• Increase Transparency– Measure the cost of Incentives (Tax Expenditure Statements)– This allows the costs to be scrutinized by the public– Place a budget on tax incentives

• Reduce Discretion– Replace discretionary Incentives with those that flows out of the Tax

Code– This ensures the role of the legislature– Even if a ‘big’ deal has to be given tax incentives ensure that criteria is

defined

• Tighten administration– Reduce leakage on the usage of Tax Incentives

• Periodically study the effectiveness – This allow the public to see for themselves if incentives work

28

Typical Reform Program• Compile an Inventory of Incentives• Determine how they are administered• Measure their Costs (Tax Expenditures)• Conduct Investor Motivation Survey – Look at the

Investment side - Political Economy• Do a Cost-Benefit analysis• Advise on Policy to improve transparency

– Define an Investment Policy to drive Incentive Policy– On Tax Policy– On Tax Administration

Questions

30

Fiscal Policy and Investment Climate (Western Europe and North America excluded)

31

AUS

BWA

BGR

CHLFJ I

GEO

HKG HUN

JAM

JPNKOR

LVA

MYSMUS

MEX NZL

PERROM

SGP

SVK

ZAFTHATUR

ARGBGD BOL

BRA

TCD

CHN

CRI

CZE

ECU ETH

GHA

INDIDNIRN

KAZ

JOR

KEN

LSO

MDG

MARNGA PAKPOL

RUS

RWA

SRB

SLE

VNM

TUNUGA

UKR

EGY

TZA

UZB

ZMB

010

20

30

FD

I as %

of G

DP

-20 0 20 40 60METR

High IC countries Low IC CountriesTrend High IC countries Trend Low IC Countries

Thank [email protected]

Policy questions to ask• Would the Investment come in anyway ? Does the country

have any special advantages that are important to the investor ?

• Does the Investment provide benefits beyond the direct investment (positive externalities) ?

• Will the Investment generate additional tax revenue ?• Would Incentives put existing investments at a disadvantage?• Does it cause leakage in tax revenue ?• Does it undermine the investment environment by

encouraging other investors to ask for similar incentives ?

33

Incentives and Tax - Project scope

This project studies incentives in 38 countries across 5 continents using,- Econometric studies- Survey of Investors

34

Investor Motivations to Invest

35 *: Grading from 1 to 5 in order of importance for 25 different factors, with 5 defined as “critical”; **: Number of businesses surveyed in respective countries

Source: Investment Climate Department, 2009

Chose another loca-tion

Tax incentives

Duty free imports

12

17

27

Mozambique – 60 total respondents**


Tax incentives

Duty free import

33

38

36

Jordan – 61 respondents

Survey asked how critical were several factors to the investment decisions*(Answers in Percent )


Tax incentives

Duty free imports

30

19

16

Serbia – 50 total respondents


Tax incentives

Duty free imports

40

76

93

Nicaragua – 71 respondents

Finding of India Case StudyExport Tax Incentive Investment

-30

-10

10

30

50

70

90

Investm

ent in

fix

ed A

ssets

year

1998 1999 2000 2001 2002 2003 2004year

Control Treatment

Investment in f ixed Assets 1998-2004

Export Tax Incentive

Reported Profits

-10

-50

510

15

20

25

30

Net P

rofit (%

of S

ale

s)

1998 1999 2000 2001 2002 2003 2004year

Control Treatment

Figure-5: Net Profit (% of Sales) 1998-2004

Source: James, 200936

37

(1) (2) (3) (4) (5) (6) (7) (8) (9)Dependent variable: FDI FDI FDI FDI FDI FDI FDI FDI FDIIC variable: DB10 DB6 REGQUA RULAW LEGPROP INVFREE BASREQ ELECT CELL

METR -0.166*** -0.183*** -0.161*** -0.184*** -0.202*** -0.144** -0.185*** -0.203*** -0.117*(-2.86) (-3.15) (-2.79) (-3.22) (-3.51) (-2.44) (-3.09) (-3.29) (-1.98)

IC 4.136*** 3.504** 5.235*** 4.768*** 4.396*** 4.816*** 3.550* 3.409** 5.119***(2.74) (2.54) (3.43) (2.79) (2.67) (3.58) (1.79) (2.05) (3.48)

METR*IC -0.140*** -0.127** -0.166*** -0.156*** -0.173*** -0.180*** -0.155** -0.127* -0.223***(-2.67) (-2.37) (-3.14) (-2.94) (-3.10) (-3.19) (-2.65) (-1.82) (-3.71)

GDPPC -0.024 -0.021 -0.050 -0.052 -0.014 -0.026 0.008 -0.029 0.006(-0.51) (-0.44) (-0.92) (-0.82) (-0.25) (-0.60) (0.14) (-0.40) (0.13)

POP -0.003 -0.003 -0.003 -0.003 -0.002 -0.005 -0.002 -0.003 -0.006*(-0.91) (-1.04) (-1.08) (-1.02) (-0.72) (-1.39) (-0.74) (-0.96) (-1.92)

INFL 3.067 -6.641 16.743 10.995 10.757 -2.162 18.826 0.825 20.465(0.11) (-0.25) (0.60) (0.39) (0.39) (-0.08) (0.57) (0.03) (0.74)

OPEN 0.343* 0.377** 0.381** 0.432** 0.456*** 0.317* 0.455** 0.576*** 0.447***(1.84) (2.05) (2.24) (2.53) (2.65) (1.79) (2.37) (3.21) (2.66)

Cst 9.387*** 10.063*** 9.028*** 9.826*** 9.619*** 9.287*** 8.665*** 9.934*** 7.011***(4.34) (4.62) (4.29) (4.58) (4.41) (4.38) (3.71) (3.94) (3.15)

Observations 78 78 78 78 77 77 73 70 77R-squared 0.34 0.33 0.38 0.36 0.36 0.38 0.34 0.36 0.39t-statistics in parentheses, *** p<0.01, ** p<0.05, * p<0.1

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (12) VARIABLES FDI as % of

GDPFDI as % of GDP

FDI as % of GDP FDI as % of GDP

FDI as % of GDP

FDI as % ofGDP

FDI as % of GDP

FDI as % of GDP

FDI as % of GDP

FDI as % of GDP

FDI as % of GDP

ic_start ic_lic ic_emwo ic_prop ic_gecr ic_prot ic_tax_norate ic_trade ic_foco ic_clobu ic_dbrank08

METR _ -0.078 -0.175** -0.142** -0.184*** -0.043 -0.156** -0.174** -0.138** -0.078 -0.203*** -0.397***

(-1.18) (-2.62) (-2.18) (-2.79) (-0.50) (-2.28) (-2.64) (-2.07) (-1.00) (-2.95) (-3.38)

IC 3.068*** -0.935 0.279 1.040 1.055 0.491 0.811 0.692* 1.992* 1.893 -0.089***

(3.54) (-1.02) (0.37) (1.51) (1.61) (0.75) (1.02) (1.98) (1.90) (0.95) (-2.74)

metr_IC -0.087*** 0.018 0.008 -0.034 -0.055** -0.025 -0.027 -0.028** -0.077* 0.002 0.003**

(-3.04) (0.58) (0.24) (-1.00) (-2.10) (-0.77) (-0.94) (-2.25) (-1.95) (0.02) (2.55)

L._GDPpc_cUSD -0.000 0.000 -0.000 -0.000 0.000 0.000 -0.000 -0.000 -0.000 -0.000 -0.000

(-1.07) (0.19) (-0.46) (-0.35) (0.06) (0.02) (-0.18) (-0.11) (-0.35) (-0.18) (-0.63)

L.openness2 0.420** 0.589*** 0.544** 0.541*** 0.532*** 0.443* 0.527*** 0.466** 0.389* 0.528*** 0.402**

(2.32) (3.00) (2.43) (2.85) (2.81) (1.76) (2.70) (2.43) (1.83) (2.80) (2.11)

inflation -18.936 -22.304 -15.599 -12.674 -8.929 -16.985 -7.166 -5.540 -12.951 -20.853 -9.972

(-0.66) (-0.68) (-0.51) (-0.41) (-0.29) (-0.54) (-0.22) (-0.18) (-0.42) (-0.68) (-0.34)

L._GDP_cbnUSD -0.000 -0.001 -0.001 -0.000 -0.000 -0.000 -0.001 -0.000 -0.000 -0.001 -0.000

(-0.90) (-1.55) (-1.65) (-1.07) (-1.00) (-0.66) (-1.22) (-0.82) (-0.74) (-1.26) (-0.49)

Constant 7.330*** 10.121*** 9.791*** 10.144*** 7.060** 9.595*** 9.667*** 8.575*** 7.672*** 10.731*** 16.340***

(3.06) (3.92) (4.01) (4.08) (2.55) (3.82) (3.88) (3.44) (2.89) (4.35) (4.86) Observations 69 69 69 69 69 69 69 69 69 69 69

R-squared 0.41 0.31 0.33 0.31 0.34 0.29 0.30 0.34 0.33 0.33 0.37 *** p<0.01, ** p<0.05, * p<0.1 t statistics in parentheses

38

Support of Government

Proximity to Export Markets

Investor Friendly

Existing Investments

Water availability

Land availability

Good Climate, Fertile Land

Political stability

Availability of Raw Material

Peaceful, safe

Personal Ties

0% 5% 10% 15% 20% 25%

Investors' motivation to Invest in Agriculture in Ghana

Econometric Analysis

Research Conclusion Policy implication

Mooij and Enderveen (2003), Desai, Foley, and Hines (2004)

Investments in developed countries respond strongly to incentives

Tax incentives are likely to work in developed countries

Klemm and Van Parys (2009) Investments in some developing countries did respond to incentives, but the elasticity was lower than that seen for developed countries.

Incentives have a small impact on investments in developing countries

Grubert and Mutti (2003), Rolfe and White (1991), Wells (1986)

Export-oriented investments are more sensitive to tax incentives

Targeted incentives are more cost effective for such businesses

Investment Climate Advisory research

Investments are poorly influenced by lower tax rates in countries with weak investment climates

Incentive policy should take into account the readiness of the environment to encourage business

40

Would your company have invested without tax incentives? (by capital ownership)

11.43

88.57

4.63

95.37

12.82

87.18

18.18

81.82

05

01

00

05

01

00

Yes No Yes No

Foreign capital Domestic capital

Mixed capital, majority domestic Mixed capital, majority foreign

Pe

rcen

t

Tanzania

Would your company have invested without tax incentives? (by investment amount in $US)

10

90

6.25

93.75

6.897

93.1

11.48

88.52

11.11

88.89

05

01

00

05

01

00

Yes No

Yes No Yes No

<$50K b/t $50K - $500K b/t $500K - $5M

b/t $5M - $50M >$50MPe

rcen

t

Tanzania

43

Jordan Mozambique Nicaragua Serbia0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Importance of investment incentives*

Domestic Market

Export Market

Would not have invested but for the investment incentives

Would your company have invested without duty relief? (by country)

Yes

No

0 10 20 30 40 50 60 70 80 90 100

94.3

5.6

88.5

11.4

66.2

33.8

BurundiTanzaniaRwanda

Investor Motivations to Invest

45

*: Open-ended question, multiple answers possible **: Number of businesses surveyed in respective countries; ***: Includes ease of import/export, employing labor , etc.

Source: Investment Climate Department, 2009

Political stability

Little competition

Domestic market

14

16

38

Mozambique – 60 total respondents**

Domestic market

Political stability and security

Investment climate***

23

25

31

Jordan – 61 respondents

Survey asked about three most critical factors for investment decisions* (Answer in Percent)

Personal resons

Skilled and competititvely priced labor

Investment climate

18

33

37

Serbia – 50 total respondents

Attractiveness of incentives

Labor cost

Investment climate

32

35

77

Nicaragua – 71 respondents

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