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
• 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
3
Plan of the Presentation
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
• 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
6
Plan of the Presentation
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
• 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
13
Plan of the Presentation
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.
• The Incentives Framework • The econometric evidence
– Current literature– Investment Climate Department research
• The survey evidence– Previous surveys– Investment Climate Advisory’s surveys
• Incentives and Public Goods• Cost of Incentives• Political Economy• Policy advice
18
Plan of the Presentation
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
• The Incentives Framework • The econometric evidence
– Current literature– Investment Climate Department research
• The survey evidence– Previous surveys– Investment Climate Advisory’s surveys
• Incentives and Public Goods• Cost of Incentives• Political Economy• Policy advice
21
Plan of the Presentation
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
• The Incentives Framework • The econometric evidence
– Current literature– Investment Climate Department research
• The survey evidence– Previous surveys– Investment Climate Advisory’s surveys
• Incentives and Public Goods• Cost of Incentives• Political Economy• Policy advice
24
Plan of the Presentation
Political Economy of Incentives
25
Discretionary Incentives popular
with politicians
Incentives have non-transparent
costs
Role of Governance Bargaining for Incentives
• The Incentives Framework • The econometric evidence
– Current literature– Investment Climate Department research
• The survey evidence– Previous surveys– Investment Climate Advisory’s surveys
• Incentives and Public Goods• Cost of Incentives• Political Economy• Policy advice
26
Plan of the Presentation
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**
Chose another loca-tion
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 )
Chose another loca-tion
Tax incentives
Duty free imports
30
19
16
Serbia – 50 total respondents
Chose another loca-tion
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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