Chapter 2: The future of tax incentives for developing countries
Governments of all kinds routinely use their tax systems to implement policies beyond the mere collection of general revenue. These uses, coined as ‘tax expenditures’, have advantages and disadvantages that are by now well-known and widely discussed in academic discourse. In many developing countries, governments use tax expenditures specifically in their quest for economic development. These tax expenditures targeted at economic development, often called ‘tax incentives’ in this context, almost universally stem from the desire of developing countries to attract investment – particularly foreign direct investment. Underpinning this desire is the theory that such tax incentives increase foreign direct investment, and foreign direct investment in turn generates economic growth that is essential for development. These tax incentives, like all tax expenditures, result in lost revenue. Yet the traditional theory suggests that such loss is minor in comparison to the benefits because tax incentives result in investment that would not otherwise be made, and hence there is no significant net loss of revenue. This chapter challenges the traditional theory and claims that none of the components of the theory can be strongly supported in reality, i.e., that tax incentives do not necessarily result in more foreign direct investment; that foreign direct investment does not always generate economic growth; and that the relationship between economic growth and development is more complex than the general theory of tax incentives implies. Consequently, this chapter questions the logic behind the widespread use of tax incentives in the search for development
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