Effectiveness of Tax and Non-Tax Incentives and Investments: Evidence and Policy Implications

Abstract

This paper is an update of an earlier 2009 paper and analyzes the role of Tax Incentives in promoting investment, their effectiveness and their revenue and other costs and political economy. The paper consolidates econometric work on the topic done by the authors covering the Caribbean, Francophone Africa and India; surveys of Investors in Jordan, Mozambique, Nicaragua and Serbia; and literature review. Building on existing literature on the subject and country experience with Incentives, the paper then examines the role of Investment Climate on the effectiveness of Incentives. Using cross-country data the paper finds that fiscal Incentives are particularly ineffective in attracting Investment in countries with poor Investment Climate. This is striking because it broadly supports country experience with incentives having been used successfully to encourage investment in some countries while failing in others. Very recent evidence suggests that governance has a similar effect with low tax rates being more effective in attracting foreign investments in better governed countries. Both these point to the importance a strong Investment Climate as well as strong institutions as a pre-requisite for the effectiveness of any investment promotion scheme using Incentives. The policy implications for a sound Incentive policy as well as the management and administration of Incentives are discussed.

Keywords: Tax Incentives, Tax Policy, Investment Policy

JEL Classification: H2, E62