How important are tax incentives for SEZs?

Tempo de leitura: 2 minutos

Most people consider tax incentives a fundamental competence of a special economic zone (SEZ) programme. Without them, is an SEZ even an SEZ? But research indicates tax incentives may not help SEZs much and can even harm the economy.

Tax incentives come in two types: “income-based”, which reward companies’ profit, and “cost-based”, which reward their activities or investments. SEZs, especially in developing countries, have typically relied heavily on income-based incentives by granting generously reduced corporate tax rates or tax holidays. This aims to lower costs for businesses to attract more investment. More investment will boost economic productivity and incomes, which should result in increased tax revenue.  

But let’s consider that the most transformative SEZs didn’t rely on tax incentives as their primary draw. They instead changed institutions that were in need of reform. For instance, the export processing zones of the 1960s and 1970s replaced protectionism with trade liberalisation, China’s SEZs introduced a free-market system, and Dubai’s free zones (such as the Dubai International Financial Centre) implemented new commercial laws and courts. At the national level, none of the economic transformation stories of the 20th century — Japan, Singapore, South Korea, Chile, Botswana, Rwanda or Vietnam — can credit lower taxes as a primary reason for increased investment. Why should we expect SEZs to be different? 

Research suggests that tax incentives are not the most important factor driving investment decisions. Instead, surveys indicate the quality of the overall business environment, the labour force, infrastructure, and political and regulatory stability matter much more to companies’ choice of where to locate. When these factors are not strong, tax incentives may have no impact. 

Globally, overreliance on tax incentives spurs tax competition, resulting in each country lowering their taxes more than others. Evidence also indicates that as tax incentives become more generous, corporate tax revenue declines as a share of GDP. This means fewer resources for public investments that promote growth, like education and infrastructure. 

There are cases in which tax incentives appear to be effective, of course. Tax holidays remove procedural burdens for companies, which can be particularly meaningful in countries with inefficient, opaque or unfair tax administrations. Incentives also matter more to “footloose” industries, such as garments and textiles. However, these companies tend to leave once the incentives expire or a better deal appears elsewhere. 

SEZs can offer other advantages that are much better for both investors and the nation, such as:

1. Piloting institutional reforms in SEZs, including improved tax administration. Making it easier to comply with procedures can attract companies, avoid public revenue losses, and initiate nationwide reforms. 
2. Relying more on cost- and performance-based incentives than income-based incentives. Cost-based incentives include tax deductions and credits to encourage socially beneficial expenditures, like on-site childcare or skills development programmes. Performance-based incentives include subsidies that effectively “purchase” positive outcomes, such as measurable pollution reduction.

So, before adopting another cookie-cutter tax incentive package for SEZs, policymakers should consider other tools for attracting investment. They may end up transforming the entire nation.

Fonte: FDI Intelligence | Foto: Pixabay