The centre for tax analysis in developing countries
The centre for tax analysis in developing countries
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This blog was originally published on odi.org on 23 October 2024 here, and is reproduced with kind permission.
Presentations from this year’s policy session at the 6th World Bank / IFS /ODI Public Finance Conference suggest fiscal incentives are set to remain a key part of many lower income countries’ plans for structural transformation, so effective design, governance and evaluation is vital.
With industrial policy finding renewed favour in many governments’ medium and long-term development plans for economic structural transformation, interest in fiscal incentives continue. These are often seen as a key instrument for leveraging private investment as well as a tool for incentivising activities with positive socio-economic spillovers, including investment in research and development and low carbon technologies, including strategic sectors in high-income countries, like the US CHIPS and FABS acts.
Evidence on the effectiveness of tax incentives is mixed, however, with surveys suggesting most investments are influenced more by other factors, such as enabling infrastructure, skills and the wider business environment. The revenue foregone from tax relief (referred to as tax ‘expenditure’) also risks undermining governments’ abilities to invest in crucial infrastructure and services, and there are ongoing calls for governments to rationalise tax incentives to meet revenue targets. Nonetheless, OECD (2022) found sector-based corporate tax incentives in all 48 lower income countries surveyed, including location-based incentives in 50% of them, and PwC has identified 88 countries with green taxes and incentives.
Attempts have been made to codify good practice into guidance on the use of tax incentives, emphasising the importance of effective design, governance, and monitoring and evaluation to ensure that potential distortions are minimised whilst policymakers remain focused on ensuring that the net benefits to the economy are maximised. A new global minimum tax on multinationals (the OECD/G20 Inclusive Framework “Pillar II” solution) may lead to changes in the nature of tax incentives, although its focus is on tackling corporate tax avoidance rather than discouraging the use of fiscal incentives more generally: substance-based carve outs and refundable tax credits still allow countries to compete for real investment.
In this context, the policy session at this year’s World Bank / IFS / ODI public finance conference on structural transformation provided insights on the use of sector- and location-specific tax incentives from 3 countries: Argentina, Philippines and Rwanda. Each country plans to continue offering tax incentives, but with a different perspective on how they can be improved: Argentina through public-private dialogue; in the Philippines through a structured governance framework; and in Rwanda through transparency and evaluation.
Argentina has under-performed economically for decades – with stagnant productivity and limited non-commodity exports. A contributing factor was a poorly targeted fiscal incentive regime, weakened by limited government capacity, which focused on protecting unproductive industries supplying the domestic market, rather than tackling market failures and creating competitive agglomerations of activity.
Between 2015-2019, significant efforts were made to reform incentives, to focus more on tackling market failures, the provision of public goods, and boosting international competitiveness. Initiatives focused on labour markets, deregulation and identifying economically important focal sectors with growth potential.
At the heart of the sector approach was a formal process of convening public-private sector dialogue, with the aim of identifying key barriers to growth – including market failures – and potential solutions. This approach had several advantages: It helped address information gaps and elicit ideas from a range of stakeholders while building consensus, strengthening relationships and improving coordination within and between the public and private sectors. It also improved transparency through clear roadmaps with actionable and measurable milestones that could be monitored.
This process was not without its challenges, however, particularly in resisting lobbying for tax and spending concessions, and resolving opposing views of business and unions on labour market issues. Fiscal incentives were still used but with reduced durations to free up resources for investment in infrastructure, skills and enabling public goods.
Changes in government have since seen further changes to Argentina’s fiscal incentives regime. For example, the Milei administration has legislated for a 30-year incentive regime for large investments in key sectors starting within the next 2 years. The short time horizon to take up these incentives and the focus on traditional heavy industries suggests that economic stimulus is at least as important a driver of the current plans as offsetting market failures.
The Philippines has seen strong economic growth over recent years, with its GDP per capita increasing by over 50% in real terms between 2009 and 2019. However, as of 2023, it remains a lower middle-income country, with a GDP per capita of just 13% of the level of the United States.
Despite a long history of using fiscal incentives as part of efforts to attract investment and grow the economy, it has recently undertaken significant reforms to the frameworks governing their granting and monitoring under the auspices of the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act.
The Act aims to ensure that tax incentives are granted according to the guidelines produced by the OECD, including providing a legal framework for all tax incentives, consolidated under a single government body, and ensuring incentives are monitored and reviewed systematically. In particular, it expands the role of the cross-governmental Fiscal Incentives Review Board (FIRB), supported by a secretariat provided by the National Tax Research Centre.
The CREATE Act gives the FIRB (among other responsibilities) the power to exercise policymaking and oversight functions on the administration and granting of fiscal incentives. It directly handles projects with investment capital of approximately $270 million (P15 billion) or more, while projects with an investment capital below this threshold are delegated to the regional Investment Promotion Agencies (IPA). The FIRB conducts periodic performance reviews of all IPAs and other government agencies administering tax incentives and requires the submission of data on incentives and beneficiary impact, as well as the publishing of estimates of foregone revenue as part of its monitoring function.
The CREATE act also stipulates that eligibility for incentives is contingent on alignment with a Strategic Investment Priority Plan (SIPP). The current SIPP is arranged around five objectives – creating jobs, providing for Filipinos’ basic needs, improving infrastructure, promoting innovation and technological transfer, and supporting the green transition.
Incentives on offer are set out in the SIPP according to sector, activities and location. For example, a 4-year income tax holiday may be granted to investors in the national capital region that are manufacturing for the domestic market. By contrast, more favourable incentives (a 7-year tax holiday) is offered to investors in manufacturing in rural areas targeted at export markets. The largest investments of over around $900 million or those that create more than 10,000 direct jobs are eligible for incentives for up to 40 years, subject to the President’s approval.
This new approach is still in its infancy. Building capacity and political will across all responsible government agencies to ensure effective implementation and monitoring will be challenging. The incentives offered to investors are relatively broad and generous in scope and – depending on take-up and approval rates – could forego significant tax revenues in future. Nonetheless, increased transparency and commitment to review effectiveness via the CREATE Act provides a clear process to support the FIRB in addressing these challenges.
Like the Philippines, Rwanda’s economy has seen strong growth in recent years, with GDP per capita increasing by over 50% during the 2010s, and a robust recovery from the COVID-19 pandemic. However, with a GDP per capita of less than 5% of the level of the United States, plans to achieve high-income status in the next 25 years are ambitious to say the least.
Rwanda’s fiscal incentive regime is designed to contribute to this goal, with a focus on promoting construction and investment, boosting productivity and supporting the green transition, as well as reducing the cost of living for Rwandan households.
Several incentives experienced challenges that required careful review. For example, Information and Communications Technology (ICT) equipment incentives were meant to be temporary, but have been repeatedly renewed and expanded in scope over time. Incentives for green vehicles may not meet their original objectives because they have largely encouraged the import of older hybrid vehicles, which may not significantly reduce fuel consumption and pollution. The VAT exemption for rice and maize flour revealed conflicting interests: it reduced prices for consumers in the face of high food-price inflation but disadvantaged domestic growers relative to imported produce; they would not be eligible for relief from VAT on supplies they use, but due to their small scale (often below the eligible threshold to register for VAT) neither would they benefit from the exemption on sales of their produce.
The Government of Rwanda sees transparency and evaluation as key to ensuring its fiscal incentives regime is beneficial. Tax Expenditure reporting is now firmly embedded, with an increasing emphasis on evaluating impacts against their intended objectives. The implications of such evidence may include replacing the incentives with alternative policies, such as considering whether high mobile phone penetration now means that targeted subsidies to lower-income households would be a more efficient measure than the long-standing VAT exemption for mobile phones.
While policymakers are faced with a delicate balance when designing fiscal incentives, the Rwanda experience suggests that tax expenditure reporting on the fiscal costs can start the process of evaluation to inform how to best to reform potentially ‘sticky’ or ineffective incentives.
Despite weak evidence on their effectiveness in supporting structural transformation, tax incentives are likely to remain popular with politicians. In this context, the experiences of Argentina, Philippines and Rwanda all have lessons for policymakers elsewhere. Establishing clear and structured principles and processes for developing, managing, monitoring and evaluating incentives does not guarantee that they will meet their objectives; but it increases the likelihood, and makes it easier to identify and address failure.
The authors would like to thank Paula Szenkman (CIPPEC – Argentina), Marry-Jean V. Yasol (National Tax Research Center - Philippines) and Denis Mukama (Rwanda Revenue Authority) for their contributions and allowing us to reference their presentation of recent country policy reforms based on the policy session at the 6th World Bank/IFS/ODI Public Finance Conference 2024.
Published on: 4th November 2024
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