How Tax Policy and Incentives Affect Foreign Direct Investment : A Review
With an increasing number of governments competing to attract multinational companies, fiscal incentives have become a global trend that has grown considerably in the 1990s. Poor African countries rely on tax holidays, and import duty exemptions, w...
| Main Authors: | , |
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2000/12/828317/tax-policy-incentives-affect-foreign-direct-investment-review http://hdl.handle.net/10986/19742 |
| Summary: | With an increasing number of governments
competing to attract multinational companies, fiscal
incentives have become a global trend that has grown
considerably in the 1990s. Poor African countries rely on
tax holidays, and import duty exemptions, while industrial
Western European countries allow investment allowances, or
accelerated depreciation. Have governments offered
unreasonably large incentives to entice firms to invest in
their countries? The authors review the literature on tax
policy, and foreign direct investment, and explore
possibilities for research. They observe that tax incentives
neither make up for serious deficiencies in a country's
investment environment, nor generate the desired
externalities. Long-term strategies to improve human, and
physical infrastructure - and, where necessary, to
streamline government policies and procedures - are more
likely than incentives to attract genuine long-term
investment. But more recent evidence has shown that when
other factors - such as infrastructure, transport costs, and
political and economic stability - are more or less equal,
the taxes in one location may have a significant effect on
investors' choices. This effect is not straightforward,
however. It may depend on the tax instrument used by the
authorities, the characteristics of the multinational
company, and the relationships between the tax systems in
the home country, and recipient countries. For example, tax
rebates are more important for mobile firms, for firms that
operate in multiple markets, and for firms whose home
country exempts any profit earned abroad (Canada, France)
rather than using tax credit systems (Japan, the United
Kingdom, the United States). Even if tax incentives were
quite effective in increasing investment flows, the costs
might well outweigh the benefits. Tax incentives are not
only likely to have a negative direct effect on fiscal
revenues, but also frequently create significant
opportunities for illicit behavior by tax administrators,
and companies. This issue has become crucial in emerging
economies, which face more severe budgetary constraints, and
corruption than industrial countries do. The authors suggest
research in five areas: 1) The eventual non-linear impact of
tax rates on the investment decisions of multinational
companies. 2) the effect of tax policy on the composition of
foreign direct investment (for example, green-field,
reinvested earnings, and mergers and acquisitions). 3) The
development of new technologies, and global companies that
are likely to be more sensitive to, and able to exploit
incentives. 4) The need for a global approach to the
taxation of multinational companies. 5) The question of
whether tax incentives should be directed only at (foreign)
investors that make the "right things" (such as
environmentally safe products) or more broadly at those that
bring jobs, technology transfers, and marketing skills. |
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