THE IMPACT OF GLOBALISATION ON TAX POLICY AND THE USE OF TAX INCENTIVES
PAPER PRESENTED TO THE PORTFOLIO COMMITTEE ON FINANCE
25 OCTOBER, 2000
Tax Policy Chief Directorate:
The Budget Office
NATIONAL TREASURY – SOUTH AFRICA
PRETORIA
REPUBLIC OF SOUTH AFRICA
Globalisation has exerted a profound influence on the economies of both developed and developing countries over the past 50 years. Reducing barriers to trade and the free movement of capital and other factors of production have fundamentally changed the economic relations between nations and regions of the world. The benefits of globalisation are manifold. However, these benefits do not come without costs that must be managed, including the limitations imposed on the freedom of governments to develop and apply fiscal and other macroeconomic policies. Differently put, it brings an element of fiscal competition with it, leading in the final analysis to a certain convergence of tax policies.
Globalisation and regionalism has fundamentally changed the framework within which governments formulate their policies, including fiscal policies in general and tax policy in particular. This paper explores the scope for government’s to use tax policy as a tool for economic policy, with particular emphasis on the effectiveness of tax incentives.
The paper is structured as follows:
In recent decades, the pace at which the economies of the world have become more integrated has been overwhelming. Capital accounts have been liberalised and barriers to trade have been reduced or eliminated in some instances. Factors of production, especially capital and highly skilled workers have become more able to scour the globe for opportunities to maximise wealth creation.
These simple statistics speak volumes for the impact of globalisation, which can be seen and felt in all facets of economic activity. Rapid advances in technology, especially telecommunications and information technology, have made an enormous contribution to this process. The benefits have been tangible, including:
Notwithstanding these benefits, globalisation is not without its difficulties or challenges for policymakers. These include the potential for global negative externalities to become more significant, such as the negative impact that the increase in trade has had on the global environment, or the spread of diseases (e.g. AIDS). One must also consider how the free movement of goods and services has enabled easier penetration of unwanted products (e.g. illicit drugs and weapons), which has placed an enormous burden government resources to detect and prevent this. It indeed highlights the need to introduce highly effective and intelligent management information systems for the use of border control or customs authorities in their task of monitoring cross-border shopping and trading activities.
The income gap between rich and poor nations (including those of the SADC regions) has increased in recent decades. While the percentage of the world’s population living on $1 a day has fallen (from 28.3% in 1987 to 24% in 1998), the absolute number (1.2 billion) has not changed over that time. The number of people living on $2 a day is alarming at 2.8 billion, or just under half of the world population of 6 billion people!
The primary challenge facing policymakers is to ensure that the benefits of globalisation are maximised, while the structural challenges it presents are managed and minimised. This will include utilising opportunities for regional groupings to engage with each other, yielding net social benefits, as well as utilising the strength of a union in the global marketplace. In addition, countries will need to ensure domestic fiscal policy, especially tax policy, is consistent with international best practice and that tax policy changes take cognisance of the new structural character of the economy. Similarly, regional country groupings aiming for increased economic integration need to consider the most appropriate path towards tax co-ordination and/or a certain degree of tax harmonisation.
Globalisation has also exerted a profound influence on the freedom of government to develop and implement fiscal policies in general and tax policy in particular. Global capital markets impose strict discipline on governments to maintain stable and consistent deficit policies. Expenditure policy is necessarily limited by the ability of government to raise taxes and finance expenditure through debt. Tax policies itself is limited by the integration of the world’s trade, financial and factor markets. Hence, there appears to be a growing need for macro-economic stability and the need to implement common monetary and fiscal policies in this regard.
In general, the tax systems of the world were developed before the globalisation was a reality and governments were able to design fiscal and other policies in relative isolation from the activities of other countries. In short, governments were able to fully exercise their respective fiscal sovereignty. In this context, countries relied heavily (almost exclusively) on source-based taxes. In other words, taxes were levied on income earned and consumption taking place within the jurisdiction’s borders, without considering the potential spillover effects of these policies.
Globalisation and the integration of all markets have rendered it impossible for countries to make tax policy without considering the broader international context. Tax policy has truly become an instrument to compete for foreign direct investment. This has opened up opportunities for some countries, e.g. small tax-haven countries that compete for highly-mobile financial capital, but in the main has presented significant challenges to tax policymakers. This is particularly acute in small, open economies, such as South Africa and many of the other countries in the SADC region.
Tanzi (1998) introduces some of the areas in which international dimensions have impacted considerably on tax policy. Drawing on the themes presented there, it is clear that such international considerations cannot be ignored in designing appropriate tax policy in the countries of the SADC region. It is also clear that there must at least be some degree of co-operation and co-ordination within the SADC region to avoid the negative externalities that can easily arise. The remainder of this section considers how globalisation has affected particular aspects of tax policy.
Traditionally, consumption taxes comprise destination-based taxes on the consumption of goods and services. These include broad-based sales taxes such as the General Sales Tax (GST) and the Value-added Tax, which are levied on the consumption of goods and services (though often many services, e.g. financial services are excluded from the base) within a jurisdiction. In addition to this, jurisdictions often impose selective custom and excise duties, which have a multitude of objectives, besides raising revenue. For instance:
The integration of global markets for consumption goods and improvements in technology have limited the scope for countries to set consumption tax policy independent of other countries policy stance. Improved information, reduced transport costs, Internet shopping, and enhanced international mobility of individuals have increased the opportunities for cross-border shopping, especially for high-value, low-volume products. In this context, countries cannot afford to set tax rates that are far out of line with international norms to avoid an erosion of the tax base, as individuals seek to acquire the same consumption goods from other jurisdictions at a lower cost. In principle, the scope for differing tax rates is limited by the transaction costs of cross-border shopping, which are falling all the time.
These trends have far-reaching implications for revenue authorities, which are required to protect their respective jurisdictions’ tax bases against avoidance and evasion. To counter these tax base eroding effects, jurisdictions in both the developed and developing world need to invest heavily in state-of-the-art customs or advance cargo information systems in order to track consignment of goods across borders, to expedite the legal processing of customs clearance procedures but also to arrest the ongoing smuggling activities.
The impact of globalisation on corporate income tax is multi-faceted. Of particular interest are issues such as transfer pricing and the impact of taxation on direct investment into a jurisdiction. Tanzi notes that trade between different parts of multinational groups accounts for a significant part of the growth in world trade. It has been estimated that intra-firm trade has grown from 20 per cent of total world trade in the 1970s to about one-third in the early 1990s – a trend that has undoubtedly continued throughout the decade.
The increasing mobility of investment capital has brought about downward pressure on and a degree of convergence of effective and statutory tax rates on corporations across the globe. As countries compete with each other for investment capital, Governments have been forced to reduce the effective tax rates on corporate profits. This has been achieved in two ways. First, countries have generally been reducing the statutory tax rates on corporate profits, while broadening the tax base by reducing / eliminating tax incentives for corporate investment (i.e. a broad base/low rate approach). Other countries have achieved lower effective tax rates by maintaining higher rates and introducing a number of selective tax incentives. Table 1 outlines a survey of statutory corporate tax rates undertaken by the accounting firm KPMG in 1999.
Table 1: KPMG Corporate Tax Rates Survey – January 1999
Country |
1 Jan 1998 (%) |
1 Jan1999 (%) |
|
Argentina |
33 |
35 |
|
Australia |
36 |
36 |
|
Austria |
34 |
34 |
|
Bangladesh |
35 |
35 |
|
Belgium |
40.17 |
40.17 |
|
Belize |
35 |
N/A |
|
Bolivia |
25 |
25 |
|
Brazil |
33 |
33 |
|
Canada |
44.6 |
44.6 |
* |
Chile |
15 |
15 |
|
China |
33 |
33 |
|
Colombia |
35 |
35 |
|
Costa Rica |
30 |
30 |
|
Czech Republic |
35 |
35 |
|
Denmark |
34 |
32 |
¯ |
Dominican Republic |
25 |
25 |
|
Ecuador |
25 |
15 |
¯ |
EI Salvador |
25 |
25 |
|
Fiji |
35 |
35 |
|
Finland |
28 |
28 |
|
France |
41.66 |
40 |
¯ |
Germany |
56.66/43.60 |
52.31/43.60 |
¯ * |
Greece |
35/40 |
35/40 |
|
Guatemala |
30 |
27.5 |
¯ |
Honduras |
40.25/30 |
25 |
¯ |
Hong Kong |
16.5 |
16.5 |
|
Hungary |
18 |
18 |
|
Iceland |
30 |
30 |
|
India |
35 |
35 |
|
Indonesia |
30 |
30 |
|
Ireland |
32 |
28 |
¯ |
Israel |
36 |
36 |
|
Italy |
41.25 |
41.35 |
|
Japan |
51.6 |
48.0 |
¯ |
Korea, South |
30.8 |
30.8 |
|
Luxembourg |
37.45 |
37.45 |
* |
Malaysia |
28 |
28 |
|
Mexico |
34 |
35 |
|
Netherlands |
35 |
35 |
|
New Zealand |
33 |
33 |
|
Norway |
28 |
28 |
|
Pakistan |
30 |
35 |
|
Panama |
37 |
37 |
|
Papua New Guinea |
25 |
25 |
|
Paraguay |
30 |
30 |
|
Peru |
30 |
30 |
|
Philippines |
34 |
33 |
¯ |
Poland |
36 |
34 |
¯ |
Portugal |
37.4 |
37.4 |
|
Singapore |
26 |
26 |
|
Spain |
35 |
35 |
|
Sri Lanka |
35 |
35 |
|
Sweden |
28 |
28 |
|
Switzerland |
27.8 |
25.1 |
¯ |
Taiwan |
25 |
25 |
|
Thailand |
30 |
30 |
|
Turkey |
44 |
33 |
¯ |
Uruguay |
30 |
30 |
|
United Kingdom |
31 |
31 |
|
United States |
40 |
40 |
* |
Venezuela |
34 |
34 |
|
Vietnam |
30 - 35 |
30 – 35 |
|
Note:
* = approximate rate
Although it must be noted that statutory corporate tax rate comparisons are insufficient to determine the effective tax rate on corporate profit, it is clear that the broad trend in corporate tax policy has been to reduce tax rates in recent years. This is confirmed in the case of South Africa where the basic corporate tax rate has been reduced from 35 per cent to 30 per cent in 1999. Table 2 outlines the statutory tax rates in Southern African countries.
Table 2: Corporate tax rates in SADC
Country |
Corporate tax |
Angola |
N/A |
Botswana |
15% plus ACT of 10% |
DRC |
45%a 7.84% subcontractors of oil companies |
Lesotho |
15% (manufacturing p )35%(other p ) |
Malawi |
38% 0% (EPZ) 24% (Life assurer) |
Mauritius |
35% |
Mozambique |
N/A |
Namibia |
40% |
Seychelles |
0 – 40% |
South Africa |
30% |
Swaziland |
37.5% |
Tanzania |
30% |
Zambia |
35% (general rate) 30% (listed on ZSE) 35%, 45% banks |
Zimbabwe |
35/% (normal) 10% (manufacturing companies in ‘growth point areas) 15% (EPZ licensees) 35% (holders of special mining leases) |
Throughout the Southern African Development Community, there has also been downward pressure on corporate tax rates. In the SADC region, there has also been a tendency to introduce special tax incentives to stimulate economic activity. The efficacy of such measures will be discussed further in section 4.
A second issue, which has been a primary influence on the convergence of statutory corporate tax rates, is "transfer pricing". Transfer prices are the prices that different parts of multinational groups charge each other for goods and services provided within the group. By manipulating these prices, groups of companies seek to channel taxable income into the part of the group of companies located in the lowest tax jurisdiction. This shifting of accounting profits within a group of companies is influenced by the statutory tax rate (i.e. not the effective tax rate on investment). As multinational companies have become more influential in the global arena, the incentive for countries to reduce their corporate tax rates has been compounded to protect the corporate tax base. These practices have also been influential in encouraging tax authorities in different jurisdictions to co-operate more with each other to ensure that the global corporate tax base is distributed effectively and fairly. However, often transfer pricing issues are wider than between two taxing jurisdictions, requiring co-operation on a broader scale. In this context, the transition to a residence-based income tax system provides additional protection against diversionary transactions that potentially involve transfer pricing and underpin the existing transfer pricing rules.
In recent years, individuals have been presented with great scope to diversify their investment portfolios internationally. With the liberalisation of capital accounts, the relaxation of exchange controls and the improvements in technology, international investment portfolios have become a reality for many. There has been a noticeable increase in the proportion of investment income accruing to individuals from sources outside their countries of residence. This has created numerous problems for tax authorities as such income is often underreported, or not reported at all, which erodes the income tax base and fundamentally alters the distribution of the tax burden.
Jurisdictions have sought to protect themselves by reinforcing their residence-based income tax systems with rules dealing specifically with passive income and by engaging with each other through exchange of information provisions in tax treaties. However, this has not always been successful, especially given the proliferation of tax havens that have their own motives for assisting individuals to conceal income from their domestic tax authorities. However, as shall be explored further below, multilateral organisations such as the OECD and the European Union are actively seeking co-ordinated solutions to the problems created by tax havens in the international community, with special reference to highly mobile financial service activities.
The sophistication of global financial markets and the ease with which financial capital can be reallocated around the globe renders it exceedingly difficult for jurisdictions to tax capital income. In particular, interest income is difficult to tax, especially for small, open economies as in the SADC region. In many instances, developing countries have not sought to tax interest income accruing to foreigners, as is the general case in South Africa. This is motivated by fears of capital flight that could occur, as investors disinvest seeking a higher after-tax real return on their investment. Given that the primary issuer of debt in developing countries tends to be Government, such capital flight would only result in higher borrowing costs for the public sector, which would largely offset the increase in tax revenue.
Such fears are not unfounded, if one considers the experience of Germany when it posited a withholding tax on interest in 1989. Haufler (1999: 137) reports that in 1989 Germany introduced a 10 per cent withholding tax on interest, which applied to residents and non-residents. In anticipation of the tax, German long-term capital exports reached a record level of DM85 billion in 1989 – almost four times the level of 1987. The German government was forced to withdraw the tax.
A further complication for tax authorities in the new global environment is the ease with which derivative and other exotic/synthetic financial instruments can be used to avoid taxes. Tax authorities do not deal with these products on a daily basis and often lag behind financial institutions and investors that are developing new products, often tailored to the specific requirements of clients. These instruments are used to circumvent tax laws by recharacterising income into a lower-taxed or untaxed form, to defer tax liabilities or to shift income around the globe in a tax-efficient manner. The ever-closer integration of financial markets and the development of more complex and faster electronic banking systems will exacerbate the challenges facing tax authorities and policymakers.
The relentless process of Globalisation forces small open economies into various degrees of economic integration such as customs unions, free trade unions or even common markets. Also Africa is not immune to these pressures for greater economic integration in order to benefit from resulting economies of scale and being able to compete more effectively in the world markets. As the process for economic integration has in certain regions in Africa advanced, the question of harmonising or co-ordinating tax systems of these evolving economic regions needs to be addressed.
The process of tax harmonisation is very complex and politically sensitive as it touches on the key issue of fiscal sovereignty of an independent state. However, as countries move towards an economic union, it needs to be recognized that an internal market requires at least in terms of the indirect taxes (broadly-based consumption taxes such as VAT, general sales tax, excises and customs duties) a harmonisation approach because if different taxes are levied on different basis or at different rates across markets of member states of a trade block, serious obstacles would be created for the free movement of goods and services.
Based on the tax harmonisation experiences of the European Union, the main provision for tax co-ordination are Articles 95 to 99 of the 1992 EC Treaty, which almost exclusively deal with indirect taxation James (2000: 263). Other international experience in this regard suggests that the process of tax harmonisation or co-ordination is primarily advanced in the area of indirect taxation. For example, the European Court’s rulings seemingly advance the development of an integrated system of indirect taxation, but is gradually also taking direct tax issues into account. As the Court is required, inter alia, to abolish obstacles to free movement of goods, persons, services and capital and entrench a system whereby competition in the internal market is not distorted, the process of tax harmonisation / co-ordination needs to cover not only indirect – but definitely also matters of direct tax.
Clearly, policies in terms of corporate and personal income taxation need to be harmonised / co-ordinated to avoid tax incentives for labour and capital to migrate (also known as fiscal competition) within the borders of the common market primarily for tax reasons. Needless to say, SADC will not be immune to similar trends and their implications for tax policy making. The various degrees or approaches towards tax harmonisation / co-ordination will be discussed in more detail when tax policy issues relevant for SADC will be reviewed.
At this stage it suffices to state that the strongest case for tax harmonisation is its support for economic efficiency, lower transaction costs and lower unit costs, thereby advancing the cause of an integrated or common market. As political support for integration grows, so will the need for co-ordinated tax policies.
Arguments against tax harmonisation really centre on the issue of complete harmonisation as differences in certain tax areas would have beneficial competitive results. These matters have been adequately been argued in the field of fiscal federalism. This is the principle of subsidiarity and if the fiscal competition argument would be applied pragmatically, striving towards complete harmonisation would be unnecessary. Hence, the debate should rather focus on what taxes should be co-ordinated to advance the economic integration process, for example in the case of SADC and which taxes might be left to the members states (at a lower jurisdictional level) to support fiscal sovereignty or, alternatively put, to support the principle of subsidiarity at the level of individual member states James (2000: 269).
Developing countries face formidable economic development challenges, which are particularly acute in Africa and the SADC region. Raising living standards, eradicating poverty and reducing inequality in the distribution of income and wealth require periods of rapid, sustained economic growth, accompanied by enhanced employment opportunities and rising real wages. The central questions facing policymakers are: What role should governments assume in meeting these development challenges? What are the policy tools available to government to enhance the growth potential of their economies or indeed the rate of economic growth? Thirdly, should the tax regime be part of this range of policy instruments and, if so, how?
In general, the economic study of taxation focuses on designing a tax regime capable of raising the revenue required to finance government spending in the most efficient and equitable way possible. Despite this, tax incentives often assume a central place in government programmes for increasing the investment rate and, thereby, the rate of economic growth. In fact, most tax systems around the world contain special provisions intended to achieve objectives other than raising revenue, such as encouraging investment, advancing research and development, increasing saving for retirement, promoting charitable giving and a host of other activities. While recognising that tax incentives are often used to encourage a variety of activities, the central focus in this discussion paper is on tax incentives to promote investment, particularly foreign direct investment, though many of the discussion points raised are generic to all tax incentives.
In recent times, the efficacy of tax incentives to achieve their stated objective has come under scrutiny. It has been forcefully argued that tax incentives are often inefficient and ineffective, possibly even having deleterious effects on the economic system. This has become a particularly important question in the SADC region.
Section 4 proceeds by considering the ‘appropriate’ role for government in fostering economic growth, followed by an assessment of the general impact of taxation on investment activities and a discussion of the various types of tax incentives most often encountered. The issues related to harmful tax competition are considered in detail, as well as international efforts at tax co-operation to minimise the deleterious effects of such activities in the global arena.
Economic growth is a function of the accumulation of capital (etc buildings, machinery) in an economy, increases in the labour force participation rate and the rate of technological progress (the methods used to produce goods and services is enhanced by the acquisition of skills and new production techniques to produce outputs more efficiently). A central question in economics is the relative contribution of the "factors of production" (labour and capital) and technological progress to economic growth. The traditional view emphasises that permanent economic growth is the result of improvements in technology. Thus, while improvements in physical and human capital can give impetus to the rate of economic growth, such growth is only sustainable if accompanied by improvements in technological expertise.
Other analysts, however, suggest that accumulation of capital and labour is the most important factor determining a country’s growth performance. The debate on the relative importance of these factors is inconclusive. In the context of a developing country, however, achieving higher rates of economic growth is likely to be found in a balance of increasing the rate of capital accumulation, mobilising the labour force and adopting advanced technology and production methods to produce goods and services more efficiently. In other words, increasing the rate of accumulation of physical and human capital will likely lead to higher rates of economic growth, which will be further enhanced by technological progress.
A key question facing policymakers is what can governments do to increase the rate of economic growth, thereby ensuring a sustained increase in the living standards in the country. In seeking answers to this question, policymakers have often analysed the growth performance in East Asia, where governments seemed to take an active role in encouraging economic growth. Sarel (1996:12) identifies three schools of thought on Government’s role in the "miraculous" economic growth rates witnessed in East Asia since 1960. These include:
Sarel (1996) outlines the main arguments advanced to explain the rapid growth in the East Asian economies. The two primary explanations have focussed on rapid investment growth and export promotion as the "engines of growth". In the context of investment, it is suggested that increasing investment permanently increases the growth rate through economies of scale and other beneficial side effects. The impact of export promotion on economic growth is often thought to arise from exposing domestic industries to foreign technology and foreign competition, thereby improving the rate of technological progress.
The initial levels of investment and export orientation prior to the period of rapid economic growth in East Asia do not seem to support the hypothesis that increased investment and export orientation are the catalysts for growth. Rather, these were complementary to the growth in the region. Sarel concludes the analysis that "from a normative point of view, it is far from clear what specific policies government should pursue, beyond the standard set of policies aimed at getting the basics right".
Stiglitz (1996) reviews the performance of the "East Asian Miracle" in an attempt to distil the broad policy measures adopted to encourage economic growth and to distil policy lessons for other developing economies. On analysis of the multi-faceted approach adopted by the "East Asian Tigers", Stiglitz (1996: 174) concludes as follows:
"No single policy ensured success, nor did the absence of any single ingredient ensure failure. There was a nexus of policies, varying from country to country, sharing the common themes that we have emphasised: governments intervened actively in the market, but used, complemented, regulated, and indeed, created markets, rather than supplanted them. Governments created an environment in which markets could thrive. Governments promoted exports, education, and technology; encouraged co-operation between government and industry and between firms and their workers; and at the same time encouraged competition."
Theoretically, economic growth is a function of the growth in physical and human capital, as well as technological progress. Recognising this, however, does not give rise to a set of government policies that will engender rapid, sustained economic growth of the magnitude necessary to ensure rising living standards in developing countries. This is particularly true in economies where governments recognise the primacy of markets (and the institutional arrangements required to make markets work) to allocate resources to their most productive uses. It is clear, however, that government can, and should intervene in instances where markets are non-existent or are plagued by market failure, which is certainly more prevalent in developing countries than developed ones.
A prime example of "missing markets" in developing countries is the absence of well-regulated financial markets to ensure savings are channelled efficiently into productive uses. For instance, many developing countries do not have well-developed stock exchanges, banking systems, foreign exchange markets or insurance markets allowing investors to effectively share the risk burden of investment projects.
"Market failure" arises where the private and social costs and/or benefits arising from a particular activity are not the same, often referred to as "externalities". In the context of facilitating economic growth, a clear area for legitimate government attention is the encouragement of particular sectors, e.g. high-technology sectors, or particular activities, e.g. research and development. In these sectors and activities, the positive benefits accruing to society as a whole exceed the private benefits accruing to the individual or firm undertaking the activity. In the absence of government intervention, this would lead to under-investment in these activities.
Another area of traditional government intervention is the promotion of regional economic development, e.g. advancing the economic development of historically underdeveloped regions of the country.
The governments of East Asia played an important role in ensuring domestic industries had access to foreign markets for exports, recognising that promoting international trade can have numerous spin-offs for the domestic economy. It is well known that international trade allows countries to focus on the activities in which they have a "comparative advantage" over other countries, with the resulting trade raising social welfare. In addition, international trade:
While the benefits of free international trade are clear, what role should Government (especially developing country governments) play in facilitating such trade? Given the positive benefits to society from international trade (in excess of the private benefits accruing to the trader) Government can, and should play an active role, including facilitating (and even leading) trade negotiations on behalf of business, promoting a country’s products in international markets, and other fiscal stimuli to encourage investment in export-oriented sectors.
The ability of markets to allocate resources efficiently is based on an assumption of "perfect information". Very often, the parties to a transaction do not have full information and cannot acquire the necessary information without incurring considerable transactions costs. Problems of "asymmetric information" arise in the context of lending arrangements, where financial institutions appear unwilling to lend to particular segments of the economy, as they cannot accurately assess the credit risk, e.g. small business sector. Another example arises in the context of marketing particular products, sectors, or even countries and regions.
This discussion obviously points to the catalytic role for government to facilitate the allocation of scarce economic resources to their most productive use. Having identified the need for an active role by government, one must consider the policy tools available to government and the most appropriate intervention. Government intervention can take many forms, including:
The central focus of this section is the efficacy of tax incentives as a policy tool for government intervention to encourage investment and growth.
The tax system can exert strong influences on the decisions of investors, including the types of investment undertaken, the manner in which such investment is financed and the activities of multinational corporations. Before considering this impact in more detail and the effectiveness of tax incentives to achieve particular development objectives, it is imperative to reflect on the fundamental objective of tax policy and tax design. This exercise is particularly important for a developing economy, faced with the imperatives of globalisation and the realities of the modern, technology-based international economy. In this context, the tax system should be designed to:
These challenges are often exacerbated in developing countries, including those in the SADC region, due to:
It is in this context that one must consider the role for tax policy to contribute to extraneous objectives of government and, in particular the potential for tax policy to be used as part of an industrial development strategy.
The central role of physical capital accumulation – investment – in economic growth has been outlined in section 2. Many facets of the tax system can influence the level of investment, the nature of investment (i.e. the type assets accumulated); and the financing of investment. These factors include the tax rates, the tax treatment of asset depreciation and the tax treatment of different forms of capital income, i.e. interest, dividends and capital gains.
Because of the theoretical potential for the tax system to influence investment decisions, many developing countries attempt to stimulate investment, particularly foreign investment (both direct and indirect) through the tax system. It is not uncommon for developing countries (and developed ones, for that matter) to utilise particular tax incentives to encourage investment and to divert investment to particular activities, e.g. export promotion.
Before evaluating the effectiveness of these incentives in turn, one must outline other, perhaps even more critical factors influencing the investment decision, particularly domestic and foreign fixed investment.
It is often argued that in the absence of tax incentives, developing countries will not be able to attract foreign direct investment, particularly of the levels required to sustain economic growth sufficient to address the development challenges in those countries.
In this context, it is important to set out some of the general theoretical and practical factors affecting foreign direct investment. This serves two purposes. First, it outlines that the tax system is only one of many factors that can influence investment decisions. Second, it will lead to a policy recommendation that the tax system cannot compensate for other deficiencies in the investment environment, as outlined below.
Hines (1996) reviews the impact of taxation on the activities of multinational corporations, including decisions regarding the volume and location of investment. Reviewing recent empirical evidence (most of which relates to US direct investment abroad) regarding the relationship between investment and the after-tax rate of return, the study suggests the following:
"The answer that emerges in a variety of contexts and from a variety of approaches is that, in spite of all the other political and economic considerations that are clearly very important, taxation exerts a significant effect on the magnitude and location of FDI".
At face value, conclusions such as this would seem to support the introduction of tax incentives to attract investment. However, this conclusion must not be interpreted narrowly and additional factors must also be borne in mind, including:
"In the absence of a complete general equilibrium model, it is impossible to predict with certainty the impact of tax changes on capital demanded through a multinational firm. The available FDI evidence is suggestive, and further evidence is provided by studies of the ways in which multinational firms are financed."
"The complexity of international investment planning, given the uncertainty firms face in forecasting future economic and political conditions, convinces some observers (such as Vernon, 1997) that tax differences are too small to have anything other than trivial effects on investment location".
Chunlai (1997) reviews the major determinants of foreign direct investment into developing countries. After reviewing the theoretical literature on the subject, Chunlai (1997: 20), suggests that a discussion of the factors affecting the attractiveness of a particular developing country for foreign direct investment can usefully be viewed from the perspective of two types of investment, as well as more general factors:
Given the array of significant factors affecting international investment into a country, it is important to maintain perspective on the potential for tax incentives to affect such a decision, particular in respect of irreversible investment in plant, machinery and equipment. Having outlined this general context, attention is now focussed on discussing the efficacy of the various tax incentives found in international practice.
Section 4.2 discusses in very broad terms the factors contributing to economic growth and section 4.3 considers the general role of tax policy, placing it in the context of a developing country seeking to attract foreign direct investment. Many countries offer various forms of tax incentives as part of economic development strategies, often on the justification that they are a pre-condition to attracting investment into a particular country or region. This section seeks to assess the efficacy of tax incentives in obtaining their stated objectives.
The Commission of Inquiry into Certain Aspects of the Tax Structure of South Africa ("the Katz Commission") characterised a tax incentive as "a form of special pleading, a preferential treatment to a particular target group, enterprise or objective" (RSA, 1994: 196)" and provided the following definition of an incentive:
"Revenue losses attributable to provisions of the Federal tax laws which allow special exclusion, exemption or deduction from gross income or which provide special credit, preferential rates of tax or a deferral of tax liability" (Congressional Budget Act of 1974 – cited in Katz, 1994: 196).
This definition focuses on the direct cost of providing a tax incentive, and is associated with the desire to compile a tax expenditure budget to ensure the costs of tax incentives are reported in a transparent manner. An alternative definition provided by Willis and Hardwick (quoted in Dilnot and Johnson, 1993: 45) is perhaps more appropriate, but complicates efforts to quantify the impact of a tax incentive. According to Willis and Hardwick,
"a tax expenditure is an exemption or relief which is not part of the essential structure of the tax in question but has been introduced into the tax code for some extraneous reason…" (Dilnot and Johnson, 1993: 45).
It has been noted that tax incentives can influence the investment decisions of both domestic and international investors. Incentives are most often targeted to real investment in productive activities by international investors, on the grounds that this will augment the domestic capital stock, introduce into the domestic economy technological advances, thereby meaningfully contributing to economic growth and job creation. Despite advice to the contrary, many developing, developed and transition economies make use of tax incentives to promote these activities, which leads to a consideration of the perceived advantages of such incentives, including:
While tax incentives are undoubtedly more flexible and decentralised than government expenditure programmes, one must view the potential advantages in the context of the arguments against the use of selective tax incentives to promote investment or encourage particular economic activity. Global fiscal experts are growing increasingly sceptical regarding the efficacy of tax incentives, encouraging jurisdictions to resist their implementation on a number of grounds.
Revenue effect and erosion of the tax base
Special tax preferences aimed at attracting mobile factors of production narrow the tax base. In fact, it is often argued that in the face of globalisation, a jurisdiction must offer at least the same incentives as other jurisdictions to avoid capital flight and a reduction in foreign investment inflows. It is perhaps trite, but nevertheless important, to note that offering tax incentives erodes the tax base and, if the policy is to be revenue-neutral, requires a higher tax rate on the narrower tax base or additional taxes on other bases. Alternatively, tax revenue will fall, requiring reductions in expenditure programmes or additional recourse to debt to finance expenditure.
Tax incentives and the erosion of tax bases is currently an important topic for discussion in the European Union. For example, the Dutch Ministry of Finance has commissioned studies to evaluate the impact of tax incentives on effective corporate tax rates in countries across the union. These studies have focussed on how tax incentives have created divergences between the statutory corporate tax rate and the effective corporate tax rate actually paid by companies.
Austria, Belgium and Portugal have the greatest difference between their statutory corporate tax rates and the effective rates faced by firms operating within their jurisdictions, while Sweden, France and the Netherlands have the closest correlation between the statutory rates and the effective rates. The results are summarised in Table 3, with countries ranked according to the divergence between the statutory and effective tax rate.
Table 3: Statutory vs. Effective Corporate Tax Rates in EU member countries.
Rank |
Country |
STR |
ETR |
STR – ETR |
1 |
Sweden |
28.54 |
27.47 |
1.07 |
2 |
France |
34.70 |
32.82 |
1.88 |
3 |
Netherlands |
35.00 |
31.80 |
3.20 |
4 |
Finland |
34.02 |
29.82 |
4.20 |
5 |
United Kingdom |
33.35 |
29.00 |
4.35 |
6 |
Luxembourg |
39.40 |
34.09 |
5.31 |
7 |
Denmark |
35.78 |
29.40 |
6.38 |
8 |
Ireland |
21.94 |
13.86 |
8.08 |
- |
EU average |
36.45 |
26.86 |
9.59 |
9 |
Spain |
35.30 |
24.11 |
11.19 |
10 |
Germany |
50.05 |
38.53 |
11.52 |
11 |
Greece |
32.53 |
20.85 |
11.68 |
12 |
Italy |
50.48 |
35.32 |
15.16 |
13 |
Austria |
36.02 |
17.67 |
18.35 |
14 |
Belgium |
40.28 |
20.99 |
19.29 |
15 |
Portugal |
39.29 |
17.19 |
22.10 |
Source
: Buijink, Janssen and Schols, 1999: 34.The average effective tax rate across all EU countries is almost 10 percentage points below the average statutory rate, largely due to the erosion of the tax base that results from tax incentives available to business. It is clear from the table that the effective tax rate in three countries (Austria, Belgium and Portugal) is about half the statutory rate in these countries.
Italy and Germany (prior to the 1999 sweeping tax reforms) have the highest statutory and effective tax rates. However, Belgium has the third-highest statutory rate, yet the effective rate is in the lowest third of all the EU countries. Similarly, Portugal has the fifth-highest statutory rate, but second lowest effective rate.
It is also pertinent to note that the effective tax rates are more "centred" than the statutory tax rates across all European countries, i.e. the standard deviation of the effective rates is smaller than that for the statutory rates (Buijink, Janssen and Schols, 1999: 3). There are two broad approaches to achieve competitive tax systems to attract foreign investment. First, one could use a proliferation of tax incentives to mitigate the effect of high statutory rates as is used in Italy, Germany and Belgium, with the associated negative implications for efficiency and equity. Second, one could maintain a low statutory rate, with few incentives that erode the tax base, as is the case in Sweden, France and the Netherlands. In considering this, one must also consider the capital stock in each of the countries. Some countries, such as Sweden are likely to be close to the "optimal level of capital stock", which would imply that they would not need to utilise specific incentives to encourage capital formation. On the other hand, smaller countries such as Portugal may have greater scope for using tax incentives to encourage capital formation, as their capital stock is likely to be below the optimal level.
Generally, the second option has been preferred by the South African Government to promote both foreign and domestic investment, while at the same time protecting the overall integrity of the tax system. South African empirical evidence also suggests that this improves, inter alia, revenue collections from the corporate sector, as evidenced in recent years’ consistent collection overruns.
Tanzi (1998: 342) notes that many tax experts hold the view that the growing tax competition arising out of tax incentives as nations compete to attract highly mobile international capital is leading to "fiscal degradation", which, it is submitted, is likely to increase as competition for global capital heightens.
While the direct cost of tax incentives are measurable and can be reported the often-understated costs arise from the misallocation of productive investment resources. Because selective tax incentives ‘artificially’ increase the rate of return to investment, investors make economic decisions giving undue weight to tax considerations. In addition, tax incentives for promoting investment tend to focus too narrowly on the effect of accumulating capital as a source of economic growth. Such an approach disregards the impact in terms of capital deepening, which can exacerbate unemployment in an economy where the labour market that is not equipped for the type of capital investment subsidised. These costs are difficult to measure, but represent a real welfare loss to the economy.
The problems of resource misallocation are compounded by the difficulty in targeting tax incentives to the promotion of new investment. If investment that would have taken place in the absence of the tax incentive can avail itself of the incentive, the tax authorities are merely conferring economic rents (at the expense of other taxpayers) on investors, and not achieving the objectives of the programme. Programmes designed to minimise this possibility and improve the targeting and effectiveness of the incentive are inherently difficult to implement and administer.
A fundamental principle of tax design holds that the burden of taxation should be distributed fairly – the equity principle. This connotes both horizontal and vertical equity. In other words, taxpayers with similar abilities to pay taxes should bear a similar tax burden (horizontal equity) and taxpayers with greater ability to pay should incur a greater tax burden than taxpayers with less ability to pay (vertical equity).
Tax incentives can fundamentally impinge upon the fairness of the tax system. Firstly, because not all taxpayers are in a position to take advantage of a particular tax incentive, taxpayers with similar economic power will incur different tax liabilities, damaging the horizontal fairness of the system. Perhaps even more importantly, wealthier (well-advised) taxpayers are most often in a better position to take advantage of tax incentives than less well off ones are, compromising the vertical equity of the system. When a tax system is perceived to be inequitable or unfair, tax morality can be adversely affected, further compounding the negative effects of tax incentives.
Tax planning and tax arbitrage
International experience suggests that tax incentive schemes encourage tax arbitrage activities through tax planning (i.e. legal arrangements or manipulations in the form of intra-company transfer pricing by switching taxable income to tax entities that enjoy tax preferred status). Tax preference schemes lead to extensive tax evasion with a concomitant escalation of tax administration and enforcement costs due to the accompanying complexity of the tax system. The objective of striving for simplicity in tax administration is thereby ignored and monitoring costs are bound to increase, placing considerable burden on revenue authorities. Moreover, in the absence of sustained - and costly - attempts to enhance tax enforcement procedures, the tax compliance gap is bound to widen, which developing countries can ill-afford.
In reviewing the potential impact of taxation in the East Asian crisis, Nellor (1999) suggests that while taxation was not a primary cause of the crisis, it certainly contributed to it. In an effort to attract highly mobile capital, jurisdictions introduced numerous tax incentives, particularly in the financial system. These incentives introduced a "myriad of tax arbitrage possibilities", which were exposed by investors and certainly contributed to the crisis in some way.
Tax incentives lead to political lobbying activity on two fronts. First, the introduction of tax incentives in many developing countries can be traced to implicit and explicit lobbying by powerful investors. The dependence of developing countries on international capital and the high degree of mobility of such capital combine to give global investors very strong bargaining positions vis-à-vis developing country governments. In this context, it is perhaps unsurprising that many developing countries have resorted to providing tax incentives, even though the investments make commercial sense in the absence of incentives.
Second, the existence of tax incentives increases lobbying for their preservation, when they are perceived to be under threat, especially in the context of a broad tax reform programme, or when tax holidays expire. In such instances, the support galvanised around the retention of a tax incentive can be overwhelming, leading Holland and Vann to lament:
"The fact that many industrial countries maintain tax incentives after the tax reforms of the 1980s is less a statement that they are considered to be effective and more a testament to the political difficulty in removing them once they have been introduced."
Tax sparing occurs when a country (home country) adjusts its taxes to allow multinationals resident in that country to take full advantage of tax reductions offered by the host country in which the investment takes place. For instance, if the UK has a tax sparing agreement with South Africa and South Africa were to grant an investment tax allowance, the UK would tax the income accruing to the multinational, as if it had borne full taxation in South Africa (i.e. the UK would still grant credit for taxes that would have been paid in the absence of the tax incentive). In the absence of such agreements, developing countries are merely transferring their tax base to the home country of the multinational investor, as the tax saved in the host country will be recouped in the country in which the investor is resident.
In an interesting analysis of the effect of tax sparing on the volume and location of foreign direct investment, Hines (1998) compares the FDI activities of companies resident in the USA (which does not grant tax sparing provisions under any circumstances) and Japan (which has tax sparing provisions in some of its Double Taxation Agreements). Hines concludes that Japanese FDI in countries with which it has tax sparing agreements is 1.4 – 2.4 times greater than it would have been otherwise and these Japanese firms are subject to 23 per cent lower tax than their American counterparts.
This analysis suggests that tax-sparing agreements are important for determining the effectiveness of tax incentives and the volume and location of foreign direct investment. It furthermore confirms the view that in the absence of tax-sparing agreements, developing countries should focus on other means of attracting foreign direct investment. It is important to note, however, that there is growing scepticism in many developed countries regarding the efficacy of tax sparing agreements, and a heightened reluctance to grant such provisions to developing countries. This position is intensified because of the growing tax competition that threatens the tax bases of even developed countries. In the light of this, it is imperative that regional blocs, such as SADC, develop a common position in respect of the appropriate use of tax incentives and use this as a platform to negotiate tax sparing agreements with developed economies, thereby improving the prospects for inward investment and the efficacy of such tax incentives.
Tax incentives used in developing countries have taken many guises, but falling within the following generic categories:
In this section, each of these general incentive schemes is reviewed, outlining the advantages and disadvantages of each.
Tax holidays are directed at new firms, which are exempt from taxation for a period of time. Tax holidays are the most popular tax incentives used by developing countries. However, there are a number of shortcomings associated with the use of tax holidays and technical design issues, all of which suggest that they should be viewed with a healthy degree of circumspection. These include:
"Investment tax credits" allow for a reduction in the actual tax liability depending on the expenditure incurred on the investment. Investment tax credits, like investment tax allowances, seek to reduce the cost of capital for investment, without conferring windfall gains on investors with existing assets, as would be the case under a general tax rate reduction programme.
A special form of investment tax credit is the "incremental investment tax credit", which grants the credit only for investment expenditure above a certain threshold. The incremental investment tax credit is thought to address the problem of granting windfall gains to investors that would have undertaken the investment even in the absence of the tax incentive. Such incentives have the potential to provide the same stimulus to investment, but at much lower cost in terms of revenue foregone than other incentive schemes.
An econometric study of the Investment Tax Credit in the USA by Professor J. Bradford DeLong indicates that when the ITC has been in place in the USA, the share of GDP committed to equipment investment has been between one-half and one-percentage point higher than at times when it has been repealed. He further suggests that a ten percent non-incremental ITC would generate between $30 billion and $60 billion of additional equipment purchases, generating additional growth of about 0.3 percentage points a year. While one must bear in mind that these studies pertain to the particular circumstances of the US economy and may have little relevance for developing countries, the powerful conclusion is drawn that "an ITC is the most cost-effective way of reducing the cost of capital for equipment". It is also noted that a broad-based, permanent non-incremental ITC is superior to the incremental or temporary version, as it is more equitable and neutral across time.
Investment tax credits have a number of advantages over tax holidays, including:
Notwithstanding the many advantages over a tax holiday, there are inherent weaknesses with investment tax credits, including the following.
Hence, although investment tax credits are far superior to tax holidays as a means of encouraging investment, there are a number of shortcomings with such tax incentives that are difficult to address and many of the general disadvantages associated with tax incentives pertain. In addition, there is substantial uncertainty regarding the responsiveness of investment spending to changes in the tax-cost of capital, especially if these are deemed to be temporary (in which case the changing investment pattern could be only temporary, or short-term). While studies in developed countries may be instructive in this regard, they cannot be used as conclusive evidence of the responsiveness of investment in developing countries, which is likely to vary from country to country due to the heterogeneity of the circumstances.
"Investment allowances" allow for deductions in the calculation of taxable income, depending on the expenditure on a particular investment. These incentives are closely related to investment tax credits - the only difference is that instead of providing a credit against the companies income tax liability, the allowance provides a deduction in the determination of the company’s taxable income.
The only real difference between an allowance system and a credit system arises in the level of incentive provided when a country operates a graduated corporate tax rate system. An investment tax credit provides the same relief to all taxpayers, regardless of their statutory tax rate. Thus, for instance, for a 5% investment tax credit, a company investing R1 000 000 would have its tax liability reduced by R50 000, irrespective of the statutory tax rate. However, if the incentive was provided in the form of an investment allowance, the actual incentive would depend on the statutory tax rate. Thus, if an investment allowance of 10% is provided for investment, a company investing R1 million would be allowed to deduct R100 000 from its taxable income before determining its tax liability. If the statutory corporate tax rate were 50% this incentive would be worth R50 000 to the firm, but if the statutory corporate tax rate were 30%, the incentive is worth R30 000.
Investment tax allowances enjoy all the same advantages as investment tax credits over tax holidays, but also suffers the same shortcomings and challenges outlined in the previous section.
Tanzi (2000: 27) notes:
"Providing tax incentives in the form of accelerated depreciation has the least of the shortcomings associated with tax holidays and all of the virtues associated with investment allowances/tax credits – and overcomes the latter’s weaknesses to boot."
Two additional advantages of accelerated depreciation regimes are identified. Firstly, they are least costly in terms of revenue foregone. Secondly, if a temporary accelerated depreciation regime is introduced it could easily bring about a short surge in investment spending, as it will bring forward future investment plans. However, one must caution that accelerated depreciation regimes may lead to capital deepening, which may exacerbate problems of structural unemployment found in many developing countries. Hence, any accelerated depreciation programme should be reviewed regularly to assess its impact on capital intensity of industry, and its consequential negative impact on employment.
Export processing zones / Industrial Development Zones
Many countries have used export-processing zones (EPZs) to promote export-oriented investment. The central feature of these initiatives is that a "zone" is designated within which enterprises can incorporate and enjoy fiscal benefits, which frequently entail specific tax incentives such as duty-free import of machinery and raw materials, zero-rating of VAT, tax holidays as well as access to streamlined and efficient tax administration processes.
Holland and Vann (1998: 1007) note that much of the investment into export processing zones is "highly-mobile, cost conscious and tax sensitive", usually vacating the country as soon as the tax incentives are withdrawn. It has been submitted that there is very little benefit to the local economies in countries establishing EPZs as:
Finally, while the EPZs are theoretically easier to administer (as they are ‘cordoned off’ from the rest of the economy) there is still scope for tax avoidance activities, as firms seek to transfer profits into the EPZ, thereby taking advantage of all the tax incentives. Furthermore, depending on the nature of the EPZ, there is a risk of it being classified as a harmful tax practice by bodies for international co-operation such as the EU or the OECD.
Many developed and developing countries impose graduated tax rates on corporate income, often differentiated on the asset base, turnover, taxable income or even activity of the entity involved. Such a system, especially in the context of small business promotion, can provide significant cash-flow benefits, stimulating the growth of these businesses and encouraging job creation. The major drawbacks associated with this regime are associated with designing and implementing a regime that can be effectively policed to ensure only legitimate entities can take advantage of the system.
An across the board reduction of the corporate tax rate is regarded as the most efficient and effective investment incentive available in a policy environment characterised by very difficult trade-offs. Such trade-offs include the need to maintain an efficient and neutral tax system, which is also equitable; the need to generate sufficient revenue for government programmes, without imposing onerous burdens on private economic activity. International experience suggests that the most appropriate manner to accommodate the inherent trade-offs associated with tax policy is to maintain a broad tax base and strive for statutory rates that are as low as possible. In general, the main advantages of such a strategy can be summarised as follows:
The main drawback with such an approach to encouraging investment is that when the change is introduced, it confers significant windfall gains to existing owners of capital, i.e. existing corporate shareholders.
The challenges of globalisation for tax policy include "harmful tax competition", which results when countries compete with each other to attract mobile (and footloose) capital, with potentially deleterious effects for the welfare of domestic citizens. It is very difficult for individual countries acting on their own to address the challenges of tax competition. In this context and given that tax competition is a real threat to the ability of individual governments to effectively raise revenue to meet their expenditure programmes, multilateral organisations such as the European Union (EU) and the Organisation for Economic Co-operation and Development (OECD) have been co-ordinating efforts to mitigate the impact of ‘harmful tax competition’.
While their efforts have been directed at their member states, efforts have been made to include non-member countries in the deliberations and extend the efforts to seek a broad-based solution. While the benefits of this to developing countries may not seem immediately obvious, countries such as South Africa with daunting development challenges would certainly not benefit from a race to the bottom or the "tax degradation" that results from unproductive tax competition.
According to the EU, harmful tax measures resulting in significantly lower effective levels of taxation, including zero taxation, can be delineated by the following characteristics:
The above-mentioned measures and moral suasion practices established by the EU have been matched by the OECD’s design of a comprehensive package of guidelines against harmful tax practices. On 9 April 1998 the OECD Council, representing 29 countries adopted 19 recommendations against harmful tax competition. It furthermore sanctioned the decision to get non-member countries involved in the campaign against this global threat of a zero-sum game that culminates in outbidding each other in respect of ‘attractive’ tax incentives.
The OECD has identified the following characteristics of harmful tax competition:
Harmful tax practices identified
On the basis of the above criteria developed in its earlier work, the OECD’s Committee on Fiscal Affairs has submitted a report on harmful tax competition to the Ministerial Council and proposed recommendations for addressing the negative effects of such activities. In essence, the report is seen as a first step toward reducing the impact of tax havens and harmful tax competition on the global tax base and protecting the integrity of the world tax system. As outlined above, the report emphasises the impact of harmful tax practices aimed at geographically mobile financial and other service activities. Within this framework, the OECD has identified the regimes as potentially harmful, which are set out in table 4.
Table 4: Harmful tax practices
Country |
Regimes1 |
Insurance |
|
Australia |
Offshore Banking Units |
Belgium |
Co-ordination Centers |
Finland |
A land Captive Insurance Regime |
Italy |
Trieste Financial Services and Insurance Centre2 |
Ireland |
International Financial Services Center |
Portugal |
Madeira International Business Center |
Luxembourg |
Provisions for Fluctuations in Re-Insurance Companies |
Sweden |
Foreign Non-life Insurance Companies |
Financing and Leasing |
|
Belgium |
Co-ordination Centers |
Hungary |
Venture Capital Companies |
Hungary |
Preferential Regime for Companies Operating Abroad |
Iceland |
International Trading Companies |
Ireland |
International Financial Services Center |
Ireland |
Shannon Airport Zone |
Italy |
Trieste Financial Services and Insurance Centre3 |
Luxembourg |
Finance Branch |
Netherlands |
Risk Reserves for International Group Financing |
Netherlands |
Intra-group Finance Activities |
Netherlands |
Finance Branch |
Spain |
Basque Country and Navarra Co-ordination Centers |
Switzerland |
Administrative Companies |
Fund Managers4 |
|
Greece |
Mutual Funds/Portfolio Investment Companies [Taxation of Fund Managers] |
Ireland |
International Financial Services Center [Taxation of Fund Managers] |
Luxembourg |
Management companies [Taxation of management companies that manage only one mutual fund (1929 holdings)] |
Portugal |
Madeira International Business Center [Taxation of Fund Managers] |
Banking |
|
Australia |
Offshore Banking Units |
Canada |
International Banking Centers |
Ireland |
International Financial Services Center |
Italy |
Trieste Financial Services and Insurance Centre3 |
Korea |
Offshore Activities of Foreign Exchange Banks |
Portugal |
External Branches in the Madeira International Business Center |
Turkey |
Istanbul Offshore Banking Regime |
Headquarters Regimes |
|
Belgium |
Co-ordination Centers |
France |
Headquarters Centers |
Germany |
Monitoring and Co-ordinating Offices |
Greece |
Offices of Foreign Companies |
Netherlands |
Cost-plus Ruling |
Portugal |
Madeira International Business Center |
Spain |
Basque Country and Navarra Co-ordination Centers |
Switzerland |
Administrative Companies |
Switzerland |
Service Companies |
Distribution Center Regimes |
|
Belgium |
Distribution Centers |
France |
Logistics Centers |
Netherlands |
Cost-plus/Resale Minus Ruling |
Turkey |
Turkish Free Zones |
Service Center Regimes |
|
Belgium |
Services Centers |
Netherlands |
Cost-plus Ruling |
Shipping5 |
|
Canada |
International Shipping |
Germany |
International Shipping |
Greece |
Shipping Offices |
Greece |
Shipping Regimes (Law 27/75) |
Italy |
International Shipping |
Netherlands |
International Shipping |
Norway |
International Shipping |
Portugal |
International Shipping Register of Madeira |
Miscellaneous Activities |
|
Belgium |
Ruling on Informal Capital |
Belgium |
Ruling of Foreign Sales Corporation Activities |
Canada |
Non-resident Owned Investment Corporations |
Netherlands |
Ruling on Informal Capital |
Netherlands |
Ruling on Foreign Sales Corporation Activities |
United States |
Foreign Sales Corporations6 |
|
In addition, the OECD has recommended that additional work is required in respect of "holding company regimes", which it has noted may constitute harmful tax competition. The OECD report also identified jurisdictions that were found to be "tax havens" according to the criteria set out in its 1998 report. These are set out in table 5.
Table 5: Jurisdictions meeting "Tax Haven" criteria in 1998 OECD report
Andorra Anguilla – Overseas Territory of the United Kingdom Antigua and Barbuda Aruba – Kingdom of the Netherlands Commonwealth of the Bahamas Bahrain Barbados Belize British Virgin Islands – Overseas territory of the United Kingdom Cook Islands – New Zealand The Commonwealth of Dominica Gibraltar – Overseas territory of the United Kingdom Grenada Guernsey/ Sark/ Alderney – Dependency of the British Crown Isle of Man – Dependency of the British Crown Jersey – Dependency of the British CrownLiberia The Principality of Liechtenstein The Republic of the Maldives The Republic of the Marshall Islands The Principality of Monaco Montserrat – Overseas territory of the United Kingdom The Republic of Nauru Netherlands Antilles – Kingdom of the Netherlandsa Niue – New Zealandb Panama Samoa The Republic of the Seychelles St Lucia The Federation of St. Christopher & Nevis St. Vincent and the Grenadines Tonga Turks & Caicos – Overseas Territory of the United Kingdom US Virgin Islands – External Territory of the United States The Republic of Vanuatu |
|
a) The Netherlands, the Netherlands Antilles, and Aruba are the three countries of the Kingdom of the Netherlands. b) Fully self-governing country in free association with New Zealand. |
It is interesting to note that certain offshore jurisdictions that would have been included on the list of tax havens made during June 2000 advance agreements with the OECD to eliminate the elements of their tax regimes that made them tax havens. These countries were Bermuda, the Cayman Islands, Cyprus, Malta, Mauritius and San Marino. Aforesaid jurisdictions are committed to eliminate harmful tax practices in terms of highly mobile financial service income by the end of 2005, to embrace international tax standards for transparency, exchange information and adopt fair tax competition policies.
Vito Tanzi (1998) has argued that globalisation has introduced certain difficulties into the international tax arena, especially in the area of unproductive tax competition and fiscal spillovers. While some commentators may see these competitive developments as good – leading to smaller governments – Tanzi notes correctly that unbridled tax competition is likely to lead to:
Because there is no supranational body to regulate these matters, he has suggested the creation of an "World Tax Organisation", because individual governments cannot address the issues on their own and the current initiatives of the OECD and the EU do not include enough countries to be fully effective. While the ultimate objectives and functions of such a body would be the subject of negotiation by member states, some of the functions suggested by Tanzi (1998: 342-3) include:
While this is an interesting idea that could be explored in the medium term, some commentators are more sceptical – preferring regional, voluntary approaches to tax co-operation. SADC seems to offer such opportunity for regional co-operation.
Globalisation has limited the scope for governments to design and implement tax policy independently of international considerations. This is especially true in the case of mobile tax bases, such as financial capital and highly skilled labour, but equally applicable in the area of consumption taxes.
In respect of tax policy as a tool of economic development, the paper has considered the appropriate role of government in this process and the scope for using the tax system to encourage particular economic activities.
In the light of the above discussion, the following general policy conclusions are advanced as a framework to shape the tax reform process.
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