Fiscal Incentives for Investment and Innovation

Abstract

Developing countries continue to make widespread use of tax policy instruments to promote industrial and technological development. The actual effect of these instruments on business activity and government revenues, however, remains an open question. The studies presented in this volume take an important first step in quantifying the effect of investment incentives on business decisions related to production and investment. In addition, they suggest the consequences of such incentives for government revenues. The analyses presented in subsequent chapters attempt to answer a narrow set of questions. The most fundamental of these questions is: Do taxes matter for investment?

Related questions include:

- What have been the investment stimulation (direct and induced) effects of tax policy measures per dollar of forgone revenues?

- Do taxes matter for foreign direct investment (FDI) in developing countries? Do they influence foreign business decisions about location?

- What are the implications of the home (industrial) country tax regime for the host (developing) country tax system?

- How do taxes interact with other institutional features of a developing country, and what are the implications for the effectiveness of tax incentives? Are corporate taxes largely ineffective (nonmarginal) instruments because of the influence of other policy instruments?

- Do taxes matter for domestic investment? What is their effect on the structure of industrial production?

- What has been the effect of tax instruments on the employment of labor, physical capital, and research and development (R&D) capital?

- What has been the effect of business taxes and tax expenditures (forgone revenues) on technological change, expansion of private output, and after-tax profits?

- Are there tax-induced distortions that prevent firms from holding optimal levels of fixed factors?

- How does market power affect tax incentives?

- What is the role of expectations in investment decisions?

- Given empirical estimates on factor substitution, the nature of technical change, and economies of scale, what revenue-neutral alternative tax policy environment would best encourage investment and enhance productivity and growth?

The papers presented in this volume reflect on the above questions at both conceptual and empirical levels and in doing so pay close attention to the tax and nontax policy elements and the existing institutions (market imperfections) in developing and emerging market economies. In the next section the case for tax policy interventions in the marketplace is examined briefly.

Keywords: Tax policy, investment, R&D

JEL Classification: E22, H25