A Case for and Against Tax Incentives

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TAX INCENTIVES
Alex Easson and Eric M. Zolt*
OVERVIEW........................................................................................................................1 I. THE CASE FOR AND AGAINST TAX INCENTIVES..........................................6 A. Convention Wisdom ............................................................................................6 B. Advantages of Tax Incentives..............................................................................9 C. Disadvantages of Tax Incentives.......................................................................10 1. Different types of costs associated with tax incentives ..............................10 2. Estimating the costs of tax incentives.........................................................13 D. Sunset provisions and evaluation of success of specific tax incentive initiatives .................................................................................................................14 II. TYPES OF TAX INCENTIVES .............................................................................15 A. Objectives of Tax Incentives..............................................................................15 B. Targeting of Incentives......................................................................................15 C. Forms of Tax Incentives ....................................................................................18 D. Economic Effects of Tax Incentives...................................................................24 III. COMMON DESIGN ISSUES.................................................................................25 A. Eligibility Criteria.............................................................................................25 B. Operational Features of Incentive Provisions ..................................................27 1. Depreciation Rules .....................................................................................28 2. Loss Rules ..................................................................................................29 3. Relevance to Investment Credits and Allowances......................................29 C. Matching the Tax Incentive to the Target Investment .......................................30 IV. IMPLEMENTATION AND COMPLIANCE ISSUES...........................................30 A. Monitoring Compliance ....................................................................................30 B. Common Abuses ................................................................................................31 V. CONCLUSION .......................................................................................................34 VI. APPENDIX .............................................................................................................35

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OVERVIEW

This module examines the use of tax incentives to encourage investment and growth in developing countries. The conventional wisdom is that tax incentives, particularly for foreign direct investment, are both bad in theory and bad in practice. Tax incentives are bad in theory because they distort investment decisions. Tax incentives are bad in practice because they are often ineffective, inefficient and prone to abuse and corruption. ____________________________________________________________

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Alex Easson is a Professor of Law, Queens University, Kingston, Canada and Eric M. Zolt is the Director of the International Tax Program, Harvard Law School and a Professor of Law, UCLA School of Law. *

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WORLD BANK INSTITUTE

Yet almost all countries use tax incentives. In developed countries, tax incentives often take the form of investment tax credits, accelerated depreciation, and favorable tax treatment for expenditures on research and development. To the extent possible in the post-WTO world, developed countries also adopt tax regimes that favor export activities and seek to afford their...
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