Page 6 - Working Paper (Tax Incentives: An Alternative to Revenue Enhancement)
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DDTC Working Paper 1115

                                                 Table 2 - Main Categories of Tax Incentives

                    Category        Specifications
                    Profit/income-based  Reduction of the standard corporate income tax rate; tax holidays, loss carry forward or carry back to be
                                    written off against profits earned later (or earlier)
                    Capital investment-  Accelerated depreciation; investment and reinvestment allowance
                    Labor-based     Reduction in social security contributions; deductions from taxable earnings based on the number of
                                    employees or on other labor-related expenditure
                    Sales -based    Income-tax reductions based on total sales
                    Value added-based  Income tax reductions or credits based on the net local content of outputs, granting income-tax credits based
                                    on net value earned
                    Based on other   Income-tax deduction based on, for example, expenditures relating to marketing and promotional activities
                    particular expenses
                    Import-based    Exemption from import duties on capital goods, equipment or raw materials, parts and inputs related to the
                                    production process
                    Export-based    •   Output-related (e.g. exemptions from export duties; preferential tax treatment for income from exports;
                                       income tax reduction for special foreign exchange-earning activities or from manufacturing exports; tax
                                       credits on domestic sales in return for export performance)
                                    •  Input-related (e.g. duty drawbacks; tax credits for duties paid on imported materials or supplies; income-
                                       tax credits on net local content of exports; deductions of overseas expenditures and capital allowance for
                                       export industries)
                    Source: UNCTAD, 2000

                   rather than follow-up capital injections.        through the accelerated depreciation program.
                                                                    Providing  accelerated  depreciation has  the least
                      Compared  with  tax  holidays,  tax  credits
                                                                    of  the shortcomings  associated  with tax  holidays
                   and investment allowances have a  number of
                                                                    and all of the virtues of tax credits and investment
                   advantages.  They are much better targeted than
                                                                    allowances and overcomes the latter’s weakness to
                   tax  holidays for promoting particular  types of
                                                                    boot. Since merely accelerating the depreciation of
                   investment and their revenue cost is much more
                                                                    an asset does not increase the depreciation of the
                   transparent  and  easier  to control.  A  simple and
                                                                    asset beyond its original cost, little  distortion in
                   effective way of administering a tax credit system is
                                                                    favor of short-term assets is generated. Moreover,
                   to determine the amount of the credit to a qualified
                                                                    accelerated depreciation has two additional merits.
                   enterprise  and to “deposit” this  amount  into a
                                                                    First,  it  is generally least  costly,  as the  forgone
                   special tax account in the form of a bookkeeping
                                                                    revenue (relative to no acceleration)  in the early
                   entry . Investment tax  credit may be claimed
                                                                    years is at least partially recovered in subsequent
                   as a  percentage of investment  expenditures
                                                                    years of the asset’s life. Second, if the acceleration
                   incurred  in  a  year  on  qualifying  capital.  Similar
                                                                    is made available only temporarily, it could induce
                   to tax holidays, investment tax allowance focuses
                                                                    a significant short-run surge in investment .
                   on new investments. Investment allowances are
                   deductions  from taxable  income  based on some     The mechanism  by which tax  incentives can
                   percentage  of new  investment.  There are two   be triggered can  be either  automatic or fully
                   notable  weaknesses  associated with  tax  credits   discretionary of the authorities. An automatic
                   and investment allowances. First, these incentives   triggering mechanism allows the investment to
                   tend to distort choice in favor of short-lived capital   receive the incentives automatically once it satisfies
                   assets since further credit or allowance becomes   clearly specified objective qualifying criteria, such
                   available  each  time  an  asset  is  replaced.  Second,   as a minimum amount  of investment in certain
                   qualified multinationals may attempt to abuse the   sectors  of the economy or  inside  the proposed
                   system by selling and purchasing the same assets   economic  zones.  The  relevant  authorities  have
                   to claim multiple credits or allowances or by acting   merely to ensure that  the qualifying criteria are
                   as a purchasing agent for enterprises not qualified   met. A discretionary triggering mechanism involves
                   to receive the incentive.                        approving or denying an application for incentives
                                                                    on  the  basis of subjective  value judgment by the
                      Moreover,  multinationals  are  also  allowed  to
                                                                    incentive-granting  authorities, without  formally
                   write off  capital  costs  in a shorter  time period
                                                                    stated  qualifying criteria.  Or in other  words,  this
                   than is  dictated  by the capital’s  economic  life
                                                                    regime relies on case-by-case evaluations that are
                   15. Tanzi and Zee, Op.Cit., page 14              16 Ibid.
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