Options for Low
Income Countries'
Effective andEfficient Use of Tax
Incentives for
Investment

A BACKGROUND PAPER TO THE REPORT PREPARED FOR
THE G-20 DEVELOPMENT
WORKING GROUP BY THE IMF,
OECD, UN AND WORLD BANK

Options for Low Income Countries’
Effective and Efficient Use of Tax
Incentives for Investment
A BACKGROUND PAPER TO THE REPORT PREPARED FOR THE
G-20 DEVELOPMENT WORKING GROUP BY THE IMF, OECD, UN
AND WORLD BANKThis is a background paper to a report prepared at the request of the G20 Development Working
Group by the staffs of the International Monetary Fund, the Organisation for Economic Co-operation
and Development, the United Nations and the World Bank. I t h a s benefitted from consultation
with other organisations working in the tax area, officials of developing countries, Civil Society
Organisations, and business representatives. The report is prepared under the responsibility of theSecretariats and Staff of the four organisations. It reflects a broad consensus among these staff, butshould not necessarily be regarded as the officially-endorsed views of those organisations or theirmember states. The report was presented as requested to the G20 DWG in September, 2015, and to the
Executive Board of the IMF for information, in October, 2015.

October 15, 2015

OPTIONS FOR LOW INCOME COUNTRIES' EFFECTIVE AND
EFFICIENT USE OF TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVESThis background document describes five different tools that can be used for theassessment of tax incentives by governments in LICs.
The first tool (an application of cost-benefit analysis) provides an overarchingframework for assessment. Evaluations of the various costs and benefits of tax
incentives are vital for informed decision making, but are rarely undertaken, partly
because it can be a difficult exercise that is demanding in terms of data needs. The
simple template presented here aims to provide a practicable framework to guideevaluations, steer data gathering, and structure public discussions on the effectivenessand efficiency of tax incentives.
The next three tools (tax expenditure assessment, corporate micro simulation models,and effective tax rate models) can be used as part of a comprehensive cost-benefit
analysis, to shed light on particular aspects. For instance, tax expenditure analysis isessential to understanding the costs of tax incentives in terms of revenue foregone.
Corporate micro simulation models are the most accurate and generally preferred
instrument to perform such a tax expenditure review. Yet, their value goes beyond thisand they are commonly used for wider tax policy analysis, including forecasting anddistributional analysis. Effective tax rate models shed light on the implications of tax
parameters—including targeted tax incentives—on investment returns and help
understand the implications of reform for expected investment outcomes.
Finally, the document presents two tools for assessing the transparency andgovernance of tax incentives in LICs. These discuss principles in transparency andgovernance of tax incentives, and allow for benchmarking existing LIC practices against
better alternatives.
Note that the tools discussed in this background document might well becomplemented by other, more sophisticated analyses. For instance, general equilibrium
models, systematic analysis of micro or macro data, and ex-post evaluations may be
critical for a full understanding of all costs and benefits of tax incentives. Such analyses
might indeed be considered, but are typically beyond reach in the short run in most
LICs due to capacity constraints and data limitations. Priority might therefore be given
to developing the tools discussed in this document.
Note also that this document offers only a brief introduction to the various tools,
without providing a complete handbook on each of them. Further references areprovided for additional reading.

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVESCONTENTSCOST BENEFIT ANALYSIS_________________________________________________________________________ 6
A. A Simple Model _________________________________________________________________________________ 6
B. Taxation and Foreign Investment________________________________________________________________ 8
C. Welfare Assessment _____________________________________________________________________________ 8
TAX EXPENDITURE ASSESSMENT ______________________________________________________________ 10
A. Measuring Tax Expenditures __________________________________________________________________ 11
B. Country Examples _____________________________________________________________________________ 14
C. Corporate Income Tax Incentives______________________________________________________________ 17
CORPORATE MICRO SIMULATION MODELS __________________________________________________ 17
A. Developing a Model ___________________________________________________________________________ 18
B. Data Issues ____________________________________________________________________________________ 21
EFFECTIVE TAX RATE MODELS _________________________________________________________________ 23
A. Workhorse Model _____________________________________________________________________________ 24
B. Use in Policy Analysis __________________________________________________________________________ 28
C. Tax Holidays ___________________________________________________________________________________ 30
DIAGNOSTIC ASSESSMENT OF GOVERNANCE ________________________________________________ 32
A. Ten Principles to Promote Better Management and Administration __________________________ 32
B. Benchmarking Investment Incentives__________________________________________________________ 34
BOXES
1. Estimation Error in Adding-up Tax Expenditures ______________________________________________ 13
2. Illustration of ETR Analysi _____________________________________________________________________ 27
FIGURES
1. Estimating Tax Expenditures ___________________________________________________________________ 12
2. Pooling of Unused Tax Depreciation, Business Losses and Tax Credits ________________________ 19
3. Average METRs on Capital Investment in 56 non-OECD Countries, 2013 _____________________ 29
4. AETRs in Asia-Pacific Under Alternative Incentives ____________________________________________ 30
5. METRs and AETRs for 20 year Tax Holiday ____________________________________________________ 31
TABLES
1. Tax Expenditures in Select Countries in Latin America, 2012 __________________________________ 15
2. Tax Expenditure by Type of Activity, Philippines, 2011 ________________________________________ 16
3. Illustration of Creation of Excel-based CIT MSM ______________________________________________ 20
4TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

4. Simplified Example of a Sample File Created from a Population File __________________________ 22
5. Diagnostic of the representativeness of the sample ___________________________________________ 23
6. Statutory and Effective Tax Rates for G20 Countries, 2012 ____________________________________ 29
References _______________________________________________________________________________________ 41

5

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVESCOST BENEFIT ANALYSISThis section develops a template for cost benefit analysis of tax incentives, aimed to structure
discussion about their effectiveness and efficiency and to offer a guide to the collection of necessary
data. The framework emphasizes both direct and indirect effects of tax incentives – the latter areoften overlooked in policy debates. The model captures several relevant components of acomprehensive welfare assessment, but, it is hoped, in a fairly simple way. In particular, the following
simplifications are made (which could be expanded upon in a more complex model).


Static approach— the model here uses a static (long-term) approach that cannot analyze timing
issues. As costs and benefits of tax incentives often materialize in the future, these timing
aspects could be modeled in a dynamic setting, with appropriate discounting.



Limited fiscal framework—the model includes only taxes on FDI, often the main focus of tax
incentive policies. Yet, there might be complex (and country-specific) interactions with othertaxes, with indirect revenue effects, as well as indirect effects on public expenditures.



Reduced form—equations here capture some of the most relevant feedback effects as identified
in the literature. A more elaborate structural framework of microeconomic behavior and market
structure might be adopted to derive a fully-fledged general equilibrium model that links micro
behaviors with macroeconomic outcomes.

A. A Simple Model
Assume that welfare ( ) of citizens in a developing country depends on private consumption ( )and public consumption—simply represented by tax revenues ( ) that finance public goods. For
simplicity, we assume utility is additive:1
where . captures the valuation of public goods relative to private goods, with ′>0. Private
consumption is constrained by income, which comes from two sources: domestic production ( )is theand earnings of domestic residents working in a multinational corporation (MNC), where
employment in the MNC:
wage rate and2
Domestic production is denoted by the function,
which depends on domestic labor () and domestic capital (the domestic production function in (3), reflected by

6

,

,

3
). Moreover, FDI of the MNC enters. The latter is not a direct input into

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

domestic production, but may affect it indirectly in two ways. First, there may be a technology or
knowledge spillover from FDI upon the domestic sector. In case of such positive spillovers, we have
0 so that domestic output expands due to FDI. Second, FDI may displace domestic capital. In
that case, we have

0 and FDI reduces domestic production (and domestic savers can/then generate returns elsewhere, at a rate.

Labor supply ( ) is assumed fixed. In equilibrium, it equals the sum of labor demand by domestic
firms, labor demand by MNCs, and unemployment:
4
due to FDI inflows will reduce either unemployment or employment in the
An increase indomestic sector (and thus domestic production). If the wage in the MNC sector is higher than in thedomestic sector, all workers will have an incentive to move to the MNC sector. Jobs in that sector
can( ), however, are rationed. Even with full displacement of domestic labor, an increase inraise total income due to higher wages earned by employees in the MNC.
Multinationals are assumed to be wholly-owned by residents abroad (in advanced countries). The
after-tax profits earned by the MNC in the developing country (Π ) will thus flow back to theforeign owner, and equal:
Π

1

,

1

5

where and denote taxes by the developing country on, respectively, economic profit and thenormal capital return ( )—capturing two components of an ordinary corporate income tax. . is a
production function of the MNC, combining FDI with domestic labor, and is assumed to havestandard properties. The components of multinational income that accrue to the host country are
wages earned by host-country employees and tax revenue.
If FDI is a continuous variable and MNCs are unconstrained, the optimal amount of FDI is given by1,

6

and is guided by the cost of capital, which depends on , but is independent of —see below forfurther discussion.
Welfare from public goods depends on total government revenue
R

,

1

,

7

which comes from taxes on economic profit and the normal return of the MNC.

7

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

B. Taxation and Foreign Investment
Business tax incentives aim to attract FDI. In the framework above, this effect is captured by:∆Δ

where ∆∆

8

0 represent profit-related tax incentives (such as reduced corporate tax rates, tax

exemptions, or tax holidays) and ∆0 represent cost-related tax incentives (such as investment tax

credits or accelerated depreciation, which are targeted to reductions in the cost of capital). In aneoclassical setting, equation (5) suggests that only ∆ will affect FDI and/

0. However, in amore general setting where e.g. FDI is lumpy and its choice reflects a discrete location decision, thetax on profit ∆ can matter as well (/<0). We will consider both effects.

Empirical insight into the two components of equation (8) may come from different sources:

Studies looking directly at the impact of tax incentives on FDI. Some studies perform regressions
to measure this effect; others use survey evidence to infer this.



Using a two-step approach, first using studies that look at the impact of tax incentives on
effective tax rates (see later Section) and second using studies that explore the impact ofeffective tax rates on FDI. Here, one needs to distinguish between marginal effective tax rates(METRs), which measure effects on incremental investment (cf. the second term in (8)) andaverage effective tax rates (AETRs), which measure effects on discrete investment (cf. the firstterm in (8)).

Estimated structural models can be used for the second step: they quantify the systematic impactsof taxes on investment, based on investment theories that describe how tax incentives influence firm
behavior. Structural models can be estimated using (micro) data to test their validity and to infer the
average magnitude of tax effects on investment. Many empirical studies, however, take a reducedform approach to infer this effect, using ETRs as explanatory variables. In countries where data
restrictions make it impossible to derive appropriate estimates, officials may rely on the bestavailable knowledge from other—preferably similar—countries.

C. Welfare Assessment
Equation (1) suggests that social welfare is the sum of welfare derived from private consumption
and public consumption, respectively, both of which can be affected by tax incentives. We discuss
the changes in private and public welfare in turn, thereby distinguishing direct and indirect effects.

8

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Private component of welfare
Combining (2) and (3), we derive the change in private consumption as a result of the inflow of FDI:
Δ

Δ

9where is the opportunity cost of domestic saving. The private welfare gain depends on four
factors. The first term measures the direct effect; the other three terms measure indirect effects.
Direct effects
Jobs and wages (first term). Some studies take the number of jobs created by an FDI project tomeasure the benefits of a tax incentive. Equation (9) suggests that the wage paid to theseworkers is important as well.

Indirect effects


Displacement of labor (second term). The jobs created due to the FDI inflow may be occupied bypeople who were previously unemployed. However, to the extent that these workers previously/. Equation (9)worked in the domestic sector, domestic production declines byshows that the net benefits to the developing country is still positive if the wage paid by the
MNC is higher than the production loss in the domestic sector.



Displacement of capital (third term). FDI may (partly) displace domestic capital, e.g. when the FDI
involves a takeover or when there is round tripping. Empirical estimates and general equilibrium
analysis can shed light on such displacement effects. If there is full displacement, the net effecton the total capital stock will be zero.

Productivity spillovers (fourth term). FDI can bring new technologies and skills to a developing
country, with positive effects on the productivity of workers and capital in the domestic sector.
Empirical studies (such as those summarized in the main document) can reveal the importanceof such spillovers.

Public component of welfare
Using (1) and (7), the change in public welfare can be written as
Δ

Π
1

∆

Δ

1

ΔΠ

Δ

10

where the change in profits (ΔΠ ) can be inferred from (5). The change in public welfare depends on
direct and indirect effects, and should be corrected for the social value of public funds:

9

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Direct revenue loss (first two terms between brackets). General tax relief is costly forgovernments as it reduces revenue from the existing base. Targeted tax incentives generally aim
to mitigate such losses by only granting relief to new FDI. Some of these new FDI projects,
however, might have been undertaken even without the incentive, which then leads to revenue
foregone.



Indirect revenue effects (last two terms between brackets). To the extent that tax incentives
attract new FDI, they can expand tax bases. As long as the tax rate remains positive, this basebroadening will recover some of the direct revenue loss from the incentive. However, tax
incentives may also create new leakages (for example through domestic profit shifting to the
incentivized firms), so that tax bases are eroded—so the sign of ΔΠ is ambiguous.



Scarcity of public funds (term ). Public funds may be scarcer than private income, as taxes
necessary to generate public revenue are distortionary. Alternatively—and perhaps especiallyrelevant for developing countries—there can be administrative constraints to domestic revenue
mobilization that make public revenue particularly scarce. With a marginal cost of public funds
1 , a dollar of public revenue is more valuable than a dollar of private
larger than one
income, which should be accounted for in assessing the welfare implications of changes ingovernment revenue.

Evaluation studies on tax incentives sometimes compare the jobs created by (incremental)
investment with the revenue foregone from (non-incremental) investment—the so-called dollarcost-per-job calculations. This essentially takes account of only the direct effects listed above.
Indirect effects, however, can be critical, yet are often more difficult to quantify. Indirect effects canbe inferred from general equilibrium models, which capture linkages and feedback effects throughother markets. This could account for displacement effects, spillover benefits and distortions inresource allocation due to discriminatory treatment. Quantifying these aspects generally requires
calibration of critical parameters, based on available econometric analysis—which is not always
readily available in LICs. General equilibrium models would also enable one to infer themacroeconomic and overall welfare implications of tax incentives. If one is unable to quantify theseindirect effects, it might still be helpful to analyze the direct effects as a starting point.

TAX EXPENDITURE ASSESSMENT
This section discusses how to undertake a tax expenditure assessment, discussed and advocated in
the main body of the paper. Tax expenditures (TEs) usually refer to provisions in the tax code (or in
Ministerial decrees with the force of law) in deviation of some benchmark tax system and to thebenefit of the taxpayer. A TE review quantifies the revenue forgone for each provision thus
identified. The core objective of a TE review is to improve transparency and support policy
evaluation, thus contributing to better informed decision making and better governance. Indeed,
TEs and their revenue costs are inherently less visible than direct public expenditures, with theconsequence that they often undergo less scrutiny and evaluation. This makes them prone tolobbying and pressures from special interest groups, leading to inefficient policy design and

10

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

corruption risks. By supporting transparency and evaluation, TE reporting enables greater control
over the use of public funds. TE assessments should be carried out by the Ministry of Finance andreported as part of the budget process, for example being appended to budget documents orreleased as a separate document.
TEs are not necessarily bad policy. Indeed, offering provisions through the tax code may sometimes
have distinct advantages over direct spending measures, for instance because the tax administration
can exploit economies of scale by utilizing information it already collects for tax purposes. The
purpose of a TE assessment is thus not necessarily to reduce TEs, but rather to enable a proper
assessment and allow for a comparison with alternative (spending) measures to achieve certain
policy objectives.

A. Measuring Tax Expenditures
A TE report generally includes the following elements:A list of tax expenditures, with a clear description (e.g., full/partial profit exemption, tax
allowance, tax credit), duration, and identification of the law/decree that provides for its legal
basis. Each TE should come along with a stated policy objective. In some countries, there are
hundreds of TEs, often scattered throughout the chapters/articles of an Act and across different
Acts.



For each tax expenditure in the list, an estimate of total tax revenue foregone. The report
should provide an indication of the model and data used in the quantification (e.g. microsimulation model, data from tax returns).

Supplementary material, such as an analysis of the distributional impact of the tax relief acrosstaxpayers (e.g. corporations, by size, or sector). Moreover, tax expenditures can be presented
alongside direct expenditures classified by type/ category of expenditure to indicate total
expenditures (direct plus tax expenditure).

When quantifying the revenue forgone from tax expenditures (as in step 2 above), analysts need tomake two calculations. The first is a simulation of tax revenues under the scenario that the given TE
is in place, along the lines of the actual tax code (or Decrees) of which it is part. This revenue iscalled the ‘base case’. The second is a simulation of tax revenues under a scenario where the TE isremoved from the code, along the lines of a specified ‘benchmark’ tax system. This revenue is called
the ‘hypothetical case’. The difference measures the revenue foregone from the tax expenditure (seeFigure 1).
The specification of the relevant benchmark tax system to which tax incentives are to be comparedis often a contentious issue. For some taxes (such as personal income taxes), there is nointernationally agreed benchmark. Indeed, diverse benchmark systems are observed in TE analyses,with countries typically adhering closely to their existing tax system. As these often differ from eachother, international comparisons of TEs are usually problematic (see for example OECD, 1996). For

11

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

other taxes (such as VAT and CIT), the benchmark system is usually defined more uniformly acrosscountries. Still, several choices need to be made with respect to details.
Figure 1. Estimating Tax Expenditures

Tax calculation

OutputBase casetax expenditure is partof tax system

Base casetax revenues

Hypothetical caseTax expenditure is removed
from the tax system

Hypothetical casetax revenues

Estimate of foregone tax revenue= Hypothetical case tax revenues
minus Base case tax revenues

When a benchmark tax system is specified, tax expenditures can be estimated by using alternative
methods:1


The revenue foregone method. This is a calculation of the static revenue loss incurred bygovernment due to a TE. It does not take into consideration changes in behavior of taxpayers
due to the removal of the TE. For example, a tax credit that reduces tax liability by $100, given
current behavior, would involve a TE of $100. This is the easiest and most popular method of
calculating TEs as it uses simple accounting principles, usually based on tax returns (ordocuments provided to customs). This method is likely to be the most attractive for LICs to
pursue.



The revenue gain method. This method calculates the revenue gain from removing a TE, taking
into account behavioral changes by taxpayers. For example, if an investment tax credit isremoved, this might result in lower investment and, therefore, a narrowing of the CIT base. The
computation of the TE would take this behavioral effect into account. In the example above, if
removing the tax credit would cause a loss in revenue of $10 due to a reduction in investment,
the TE associated with the tax credit would be $90 instead of $100. This method better accounts
for the purpose of certain incentives, but can be more contentious given the inevitable1
A third method, not discussed here, is the so-called outlay equivalent method, under which a TE is calculated as the
direct spending equivalent that would result in the same benefit for the taxpayer as the TE. It may differ from therevenue forgone method if direct spending is itself taxable. For example, the equivalent to a $100 tax deduction if the
tax rate were 50 percent would be a taxable transfer of $200. The outlay equivalent method is less popular than therevenue foregone method because the outcome is often viewed as less intuitive.

12

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

uncertainty on the extent of behavioral responses. It is also much more complex and therefore
unlikely to be attractive for LICs.
In calculating TEs, a model is needed to simulate tax revenue under the two different policy
scenarios—that is, with and without the tax incentive. Different models based on different data canbe used for this purpose. For personal income tax and corporate income tax, good practice in thisregard is to use micro simulation models (MSMs) for, respectively, households and firms. They areusually based on administrative tax return data, sometimes complemented with survey data on
certain characteristics. The next section elaborates in more detail on corporate MSMs.
A possible estimation error can arise when different tax expenditures are calculated separately andthen added up. For example, when a tax rate for certain businesses is reduced while, at the sametime, tax depreciation for certain assets is made more generous, the total revenue foregone
measured by adding up two tax expenditure estimates (under ceteris paribus assumptions)erroneously ignores the interaction between those two measures. Such cross-effects can lead to anunderestimation of the revenue effect (Box 1).
Box 1. Estimation Error in Adding-up Tax Expenditures
Consider a CIT system with a reduced tax rate and reduced tax base for targeted (qualifying) investment.
Let (T) denote the basic CIT rate, and (t) denote the reduced CIT rate (with t < T). Let (B) denote the CITbase measured without tax incentives, and (b) denote the base with incentives (e.g. accelerated
depreciation).
In principle, the ‘true’ total tax expenditure from the two incentives would be measured as the difference
between CIT revenues where the basic CIT rate and CIT base without incentives apply, and CIT revenues
where the reduced CIT rate and base apply:

TE *  T  B  t  b(1a)This measure may be expressed alternatively as follows:
TE *  ( B  b ) T  ( T  t ) b  ( B  b ) t  ( T  t ) B(1b)

If tax expenditures are calculated separately for each incentive and then added up, the total tax expenditure
estimate is measured as:TE  ( B  b )t  (T  t )b(2)Comparing (1b) and (2), we see that the sum of two tax expenditures understates the true CIT revenue loss:TE  TE *  (T  t )( B  b )

(3)

13

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Also important to note is that TE estimates obtained from the revenue-foregone method using
aggregate data (e.g. National Accounts or input-output tables) may not reflect the expected true
revenue effect of the removal of tax concessions. Indeed, the revenue calculations not only ignore
behavioral effects, but might also ignore tax non-compliance. In reality, however, there can be asignificant tax compliance gap: a gap, that is, between the expected revenue from a tax under fullcompliance and the true revenue. In principle, one could infer the expected true revenue effect fromthe removal of tax concessions by applying an estimated compliance gap to both scenarios (on theassumption that the incentive itself does not affect the extent of non-compliance). When relying on
taxpayer-level data from tax returns or macroeconomic data, effects of less than full compliance arereflected in the base case and hypothetical case estimates.

B. Country Examples
A growing number of countries now prepare TE reports on a regular basis, including several
developing countries. In some cases, TE reporting is supported by regional coordination initiatives.
For example, the Inter American Center of Tax Administrations (CIAT) has been active for a numberof years in organizing workshops and events to encourage Latin American countries to report theirTEs. The countries thus share modeling and data gathering experiences and use similar methods inperforming their TE estimates (CIAT, 2011). Table 1 shows TEs in selected countries in this region,
both by type of tax and by type of tax expenditure.

14

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Table 1. Tax Expenditures in Select Countries in Latin America, 2012

VAT

Tax expenditure, by tax
Tax expenditure, by type
Exemptions,Deferrals,
Total
Deductions reimbursements
reduced rates
CIT andand credits
regimes, other
CIT
PIT
PIT
Others(percentage of GDP)

(percentage of total revenue foregone)

Argentina
1.19
0.08
0.52
0.61
0.8
64.8
0.2
1.12
0.86
0.73
1.59
0.6
81.5
18.5
Brazil 1/
0.88
0.86
2.73
3.58
13.7
18.3
Chile (2008)
1.68
1.24
0.32
1.56
23.2
25.0
Colombia (2010)
Costa Rica
3.54
0.8
1.02
1.82
0.26
98.4
1.3
Ecuador
2.09
2.31
0.46
2.77
77.8
14.4
El Salvador (2010)
1.97
na
na
1.42
87.9
12.1
1.96
na
na
5.90
0.54
40.7
59.3
Guatemala (2008)
Honduras
3.63
1.08
0.27
1.35
1.48
80.7
1.51
0.92
0.83
1.75
0.56
41.0
23.7
Mexico 2/
Panama2.27
100.0
Paraguay (2010)
1.48
0.23
0.2
0.43
99.2
0.8
Peru
1.3
0.21
0.15
0.37
0.24
79.8
3.4
0.42
0.1
0.52
1.37
70.9
2.3
Dominican Republi 3.23
Uruguay
2.95
1.66
0.63
2.29
1.16
83.8
15.6
Source: Tax Expenditures in Latin America 2008-2012, CIAT Working Paper No. 2-2014.
na=not reported; - (dash) = not measured
Footnotes: 1/ = Federal tax expenditures only. 2/ = Excludes tax expenditure for IEPS oil.

35.0
0.0
68.0
51.8
0.3
7.8
0.0
0.0
19.3
35.2
0.0
16.8
26.8
0.6

An example of a country that has recently released its first TE report is the Philippines. The Ministryof Finance provided its analysis in 2011 to help guide policy regarding tax incentives. In the CIT, thePhilippines employ income tax holidays, special (reduced) tax rates on business income, additional
deductions for labor costs, tax credits for certain raw materials used in exported products, and VAT
and duty exemptions for imported capital equipment. Data availability currently limits TE reportingto tax revenues foregone from income tax holidays and reduced tax rates. Table 2 shows detailed TE
reporting by type of business activity. For 2011, the total TEs from the two categories add up to an
estimated foregone tax revenue of 4.5 per cent of 2011 government revenues (ignoring crosseffects).2 This has induced the government in the Philippines to push for the enactment of a Tax
Incentives Management and Transparency Act. Its aim is to provide resources to establish a TE
measurement and analysis unit and a Fiscal Incentives Rationalization reform bill to coordinate theuse of tax incentives.

2

The Department of Finance explains (Tax Expenditure Account of the Philippines, Fiscal Year 2011) that its 2011 tax
expenditure estimates cover 1,318 firms (submitting electronic returns), reflecting roughly 29 per cent of all
registered investors.

15

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Table 2. Tax Expenditure by Type of Activity, Philippines, 2011
Activity

Number Of
Firms

Special Rate

Income Tax
Holiday

Total Tax
Expenditures

Manufacturing

125

4,691,319,535

8,809,582,762

13,500,902,297

Manufacture of Semi-Conductor Devices

39

2,112,493,372

10,774,248,015

12,886,741,386

Business Processing Outsourcing

23

3,105,925,504

3,785,154,373

6,891,079,877

Generation, Collection and Distribution Of Electricity

14

974,437,378

5,882,612,972

6,857,050,350

Metallic Mining

12

131,277,092

2,092,900,292

2,224,177,384

Non-Metallic Mining (Coal Mining)

1-2,020,790,902

2,020,790,902

Hotels6-

1,890,902,880

1,890,902,880

Collection, Purification, Distribution of Water

4

52,563,291

1,590,511,854

1,643,075,145

Database and Other Computer Related Activities

7

147,349,668

954,173,706

1,101,523,374

Air Transport

2-892,071,822

892,071,822

Buying, Selling, Renting, Leasing, Operation of Dwellings

16

44,960,495

746,257,626

791,218,121

Real Estate Buying, Developing, Subdividing, Selling

22

86,779,506

589,403,119

676,182,625

Building Components Installation Contractors

12

319,699,378

339,764,577

659,463,955

Telecommunications

849,535,755

481,200,071

530,735,826

Wholesale and Retail Trade10

124,800,720

137,638,146

262,438,865

Other Business Activities

578,725,442

180,726,700

259,452,142

Radio and Television Activities

1-

153,210,804

153,210,804

Design, Detailing, Fabrication and Pre-Assembly Works of Heavy Steel

19,225,591

136,076,888

145,302,479

Recreational and Sporting Activities

2

117,211,910-

117,211,910

General Public Service Activities

1

115,270,249-

115,270,249

Generation of Industrial Gases

1

32,125,369

25,325,698

57,451,067

Private Medical, Dental and Other Health Activities

1-

19,234,414

19,234,414

Electrical and Mechanical Work At Site1-

14,802,518

14,802,518

Inland Water Transport

1-

6,835,217

6,835,217

1

4,563,403-

4,563,403

Electroplating or Painting of Electronic Parts, Building Decorations,
Fashion Accessories, Jewelries, Interior Decorations and Light
Engineering Fixtures with Zinc, Gold, Nickel, Aluminum, Zinc
Non-Life Insurance

1

1,831,126-

1,831,126

Restaurants, Cafes and Fastfood Center

1

1,162,326-

1,162,326

Cargo Handling

1

-

-

-

Developer

1

-

-

-

Financial Holding Company Activities

2

-

-

-

Life Insurance

1

-

-

-

Ocean Fishing, Commercial

1

-

-

-

Other Real Estate Activities with Owned or Leased Property

1

-

-

-

Other Supporting Land Transport Activities

2

-

-

-

Sea and Coastal Water Transport

2

-

-

-

Total large corporations

329

12,201,257,110

41,523,425,354

53,724,682,463

3,543,299,134

4,062,877,896

7,606,177,031

Total non-large corporations

1. Figures report income tax expenditures.
Source: Tax Expenditure Account of the Philippines, Fiscal Year 2011, Department of Finance, Philippines
http://www.dof.gov.ph/?p=9417

16

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

C. Corporate Income Tax Incentives
The benchmark of the corporate income tax (CIT) may be defined in different ways. One approach isto specify a normative benchmark, reflecting a system that is generally perceived to be desirable.
However, even specialists usually differ as to the optimal design of the CIT. Given the many
contentious issues regarding a normative benchmark, in practice most countries take their existing
system applying to ‘most companies’ as the benchmark CIT system. This means that profit under thebenchmark is taxed at the standard CIT rate. The benchmark corporate tax base thus typically
includes allowances for depreciation and interest, but no deduction for the cost of equity and noother special provisions for particular sectors or firms.
The (annual) corporate TE on providing a tax holiday may be calculated ex post as the aggregate
amount of CIT revenue foregone by not taxing, at the basic CIT rate, the amount of corporate profit
sheltered by the tax holiday. To obtain such information, qualifying firms need to file a corporate tax
return and report exempt amounts of profits. TE estimates of CIT foregone each year over a holiday
period may suffice to bring about transparency and information for evaluation. A morecomprehensive analysis would also analyze the profile of hypothetical CIT payments over time,taking into account transitional rules governing ‘pools’ (balances) of tax depreciation and businesslosses, and ‘stability clauses’.
Accelerated depreciation might be another form of TE, but one that raises both conceptual andmeasurement issues.3 To circumvent them, standard practice in TE estimation is to take the generally
applied existing depreciation rules used in the CIT system as the benchmark. Accelerated
depreciation is then taken to be the application of rates (and possibly methods) that provide forfaster write-offs for certain asset classes targeted at certain sectors or taxpayers. The corporate TEfrom providing accelerated depreciation may then be calculated as the aggregate amount of CIT
revenue foregone in a given year by accelerated as opposed to regular (or normal) depreciation.
Reporting may also include estimates of the difference in the present value of tax depreciation
claims under the two scenarios (requiring more complex analytics).

CORPORATE MICRO SIMULATION MODELSThis section elaborates on the development and use of a micro-simulation model (MSM) ofcorporate income taxes (CIT). The models (essentially corporate tax calculators) can be developed ina straightforward manner and used in common spreadsheets, such as Excel. For many countries, themain hurdle has been allocating scarce resources to building datasets (based on tax returns) as an
input to the models. Where resources are limited, steps can be taken (as analyzed below) to limit theresource requirement (e.g. by focusing on large taxpayers). Experience shows that the payoff can begreat.

3

Conceptual issues relate to the appropriate benchmark regarding depreciation, such as economic depreciation or
current tax rules. Measurement difficulties arise if economic depreciation is chosen as a benchmark in light ofconsiderable uncertainty.

17

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVESA CIT MSM is essentially a firm-level CIT calculator, with flexibility in the adjustment of tax policy
parameters and economic variables. An important feature is that it can analyze the revenue anddistributional impacts of detailed tax policy changes, such as preferential CIT rates, alternative tax
depreciation rates and methods (with separate calculations for different categories of depreciable
assets), tax allowances and credits and other specific tax incentives.
A CIT-MSM may be used by Ministries of Finance for policy simulations, and for revenue forecasting
purposes. CIT-MSMs contribute to transparency and can improve the quality of information that isneeded for policy preparation. Especially relevant for the underlying paper, is that a CIT MSM is thepreferred instrument to estimate the revenue foregone from corporate TEs. Indeed, models relying
on aggregate data, such as from the National Accounts data, yield less reliable revenue estimatesand can usually not be used to explore detailed tax policy changes. Moreover, unlike tools based on
aggregate data, CIT MSMs can yield insight in how CIT reform affects the distribution of tax
liabilities across firms (by, for example, industry, firm size and location). This may be helpful inaddressing political-economy concerns associated with CIT reform, such as with the removal or
scaling back of tax incentives.
When deciding to develop an in-house CIT MSM, one should of course consider the benefits as wellas costs of developing and maintaining such as model, most notably staff costs. Moreover, one has
to identify constraints regarding the availability (and confidentiality) of data or possibly politicalresistance to the use of such data. Problems may arise also when modeling a proposed but currently
non-existing tax instrument, such as a tax credit for regional development, for which one requires
information on existing levels of investment in targeted region(s) which may not be available. In
such cases, other sources of information (such as survey data) would need to be found andincorporated into the dataset to be able to analyze the tax measure. Before developing a CIT MSM,
moreover, it is important to identify the most relevant applications, guided by the demand for tax
policy analysis in the Ministry of Finance and Revenue Administration.

A. Developing a ModelA CIT MSM uses a structured programming language or software (such as Excel) to calculate CIT
payments at the firm level. The models requires (exogenous) input information and produces(endogenous) output.
18

The input data to a MSM calculation include receipts, expenses and balance sheet items fromindividual corporate tax returns. These values are exogenous to the model and are held fixed
when calculating CIT under alternative tax policies. The other important category of exogenous
input variables are tax policy parameters, such as statutory CIT tax rates (basic CIT rate andpossibly other rates), tax depreciation rates (of which there may be many), and investment tax
credits. The base-case values are obtained from the current tax law. These parameters can bevaried when simulating the revenue implications of tax reform or when calculating themagnitude of TEs (hypothetical cases).

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

The output of the CIT MSM is a number of endogenous variables, which are ‘modeled’ andcalculated by the MSM. Examples include claims for depreciation allowances, which change
when the tax depreciation rate changes, investment tax credit claims, which change withinvestment tax credit rates change, taxable income, and final CIT liability. The output variables,
based on sample data, can be weighted and aggregated to give economy-wide estimates of CIT
revenue under current law. They can also be calculated under alternative hypothetical laws, forexample in the estimation of corporate TEs. Estimates can also be presented for various
aggregates (by industry, firm-size, or other dimensions).

Some tax allowances can be endogenous in the model, for instance, if they depend on firm-specificcharacteristics or outcomes. For example, some CIT systems provide a deduction as a non-linear
function of income based on some qualifying indicator (e.g. small firms under a certain turnover,income, or asset level). Rather than treating the deduction in the model as fixed, it needs to bemodeled as a function D=θ(q), where q measures income based on a qualifying indicator asreported in the tax return and θ is a function of q that determines the deductible amount. The policy
function θ can be changed in the MSM, reflecting tax policy. The model yields an estimate of thededuction, D, and CIT revenue.
Some variables have a dynamic character and need to be traced over time. For example, depreciable
capital costs are written off gradually over time. CIT systems typically require that accounts be keptof balances (stocks) of undepreciated capital to determine tax depreciation claims that can be madein the current year and those that are carried forward to future years. This is illustrated in Figure 2—
beginning of year balances (‘pools’) are increased by Additions (current investment) and reduced by
Deductions (current year claims). Similarly, balances (pools) are used to track unused business losses
and investment tax credits.
Figure 2. Pooling of Unused Tax Depreciation, Business Losses and Tax Credits

pool at endof year (t-1)

additionsdeductions

pool at beginningof year (t)pool at endof year t

19

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Table 3. Illustration of Creation of Excel-based CIT MSM

D

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47

20

Tax returndata
Tax Parameters
Corporate income tax rate
Tax depreciation allowance rate
Investment tax credit (ITC) rate
Income Statement (millions $)Total revenues
Cost of sales, interest expense
Book depreciation
Total expenses
Net income before tax
Income tax - book purposes
Net income financial after tax
Income Tax Payable (millions $)Reconciliation Statement
Net income financial after tax+ Book depreciation+ Income tax - book purposes- Tax depreciation allowance claim
Net income for tax purposes- Prior year losses claimed
Taxable income
Income Tax Payable
Income tax
Investment tax credit claimed

Income tax payable

E

F

Base Case

Hypothetical
Case

Code used to create
Base Case (column E)

40.0%
30.0%
5.0%

40.0%
30.0%
0.0%

1,600.0
1,000.0100.0
1,100.0
500.0
93.0
407.0

1,600.0
1,000.0100.0
1,100.0
500.0
93.0
407.0

1,600.0
1,000.0100.0
1,100.0
500.0
93.0
407.0

407.0
100.0
93.0
117.9
482.1
200.0
282.1

407.0
100.0
93.0
117.9
482.1
200.0
282.1

407.0
100.0
93.0
117.9
482.1
200.0
282.1

112.8
27.2

112.8
27.2

112.8
20.0

=MIN(E46,E25)

85.7

85.7

92.8

=E25-E26

250.0
143.0
393.0
117.9
275.1

250.0
143.0
393.0
117.9
275.1

250.0
143.0
393.0
117.9
275.1

=$D30

200.0
200.0
0.0

200.0
200.0
0.0

200.0
200.0
0.0

20.0
143.0
7.2
27.2
0.0
27.2
27.2
0.0

20.0
143.0
7.2
27.2
0.0
27.2
27.2
0.0

20.0
143.0
0.0
20.0
0.0
20.0
20.0
0.0

+$D8
+$D9
+$D10
+$D11
+$D12
+$D13
+$D14

+$D17
+$D18
+$D19
=MIN(E5*E32,E17+E18+E19)+E17+E18+E19-E20=MIN(E36,E21)=E21-E22=E4*E23

Tax depreciation, loss carryforward, ITC
Tax depreciation
Opening balance UCC
Investment - current year
UCC available
tax depreciation claim
Closing balance UCC
Business Loss carryforward
Opening balance (unused losses)
Prior-year loss claim
Closing balance (unused losses)
Investment Tax Credit (ITC)
Opening balance unused ITC
Investment - current year
ITC earned - current year
Unused ITC available for carryback
ITC carryback
Unused ITC available for current year
Investment tax credit claim - current yea
Closing balance unused ITC

=$D31
=$D32
=E20
=E32-E33=$D36=E22=E36-E37
=$D40
=$D41
=E6*E41=E40+E42=$D44=E43-E44=E26=E45-E46

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Table 3 gives an illustrative example of how a CIT MSM works, showing tax parameters in rows 4-6,
exogenous tax return data in column D and a mix of exogenous data (copied from column D) andendogenous ‘base case’ variables calculated by the spreadsheet model in column E. In the example,
columns D and E are equivalent since they both reflect the actual tax system. Column F shows‘hypothetical case’ values, where the investment tax credit rate is set to zero (elimination of thecredit). Current year investment expenditure (143 currency units) no longer generates credits, but
credits (20 units) carried over from prior years reduce CIT. The example reflects the importance oftaking into account opening balances of undepreciated capital costs (UCC), business losses and tax
credits.
An important step in the development of a CIT MSM is the validation of the model. In particular, a
comparison should be made between the estimated base case aggregate CIT revenue as simulatedby the MSM and the actual aggregate CIT revenue reported in the government accounts. At thispoint, a process begins to check for errors and to adjust the sample size until differences between
estimated and actual aggregate CIT revenue are small enough by some metric.

B. Data Issues
A critical step in the development of a CIT MSM is the creation of a dataset, based on corporatelevel tax returns, which serves as input to the model.4 Ideally, one would copy data from tax returns
for the entire population of corporations. This might be feasible in countries with complete
electronic filing of tax returns. If this is impossible or deemed too resource intensive (for example
because it is necessary to manually transcribe data and take information from paper corporate tax
returns into an electronic database), an alternative is to construct a representative sample. The
results based on the sample can then be weighted to replicate economy-wide results for the entire
population of corporations. Where a sample is used, CIT data transcription generally involves thecreation of two files: a ‘population file’ and a ‘sample file’:The population file includes limited data entries for all corporations. It is used as a basis forestablishing the sample file and to cross-check estimated aggregate CIT revenues from theMSM. The population file may be adjusted compared to the raw data, e.g. by the removal ofinactive corporations, corporations with limited activity (e.g. less than two months in the fiscal
year), and very small corporations identified using an asset and income threshold test.



The sample file is drawn from the population file by first identifying firm-level characteristics(‘dimensions’) to create sub-groups (strata) of firms with common characteristics. For example,
the population file may be stratified (grouped) using the following dimensions: 25 industry
sectors; 4 asset sizes; 10 locations; 2 ownership types (resident, non-resident); 2 types of tax
status (taxable, tax-exempt). These dimensions would create 4000 (25x4x10x2x2) sub-groups.
Each sub-group is relatively homogeneous. Independent sampling of each sub-group provides abetter representation of the population than random sampling from non-stratified population

4

Corporate tax return data are also frequently used by tax administrations to calculate various ratios, which are
inputs to their risk-based auditing practices. The same data can thus be used also to build a MSM.

21

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

data. The stratified population file is used to create the sample file, which has the same numberof sub-groups as the stratified population file. Given the significant contribution of large
corporations to total CIT, it is important to include all large corporations in the sample file. For
each remaining sub-group in the population file, a random sample of firms is drawn andassigned to the corresponding sub-group in the sample file.
Table 4 provides a simplified example of the creation of a sample file from a population file. In theexample, firms are stratified into two dimensions: industry (A, B, C) and size (Large, Medium, Small).
This gives a total of 9 sub-groups. The total population consists of 40,100 corporations, 100 of which
are large. All large corporations are automatically assigned to the sample, given their importance indetermining total CIT revenues. From the remaining 40,000 tax returns, a random selection is made,with a target of including 5 per cent of the returns in the sample. In the example, this results in 2000
corporations being included in the sample (in addition to the 100 large corporations automatically
included).
Table 4. Simplified Example of a Sample File Created from a Population File

Industry
A
B
C
Total

L
50
40
10
100

Population
P= 40,100
MS
5,550
10,4001,060
19,900
390
2,700
7,000
33,000

L
50
40
10
100

SampleS= 2,100
M
S
278
520
53
995
20
135
350
1,650

Weights
L
1.00
1.00
1.00

M
20.40
19.63
18.57

S
19.89
19.98
20.45

The last three columns of Table 4 show weights to be applied to MSM firm-level results for firms ineach of the sub-groups in the sample when constructing estimates for the full population. Largefirms all have a weight of one, as they are all included in the sample. For each of the other (6) subgroups, the weight is determined by dividing the total number of firms in that sub-group in the
population by the total number of firms in that sub-group in the sample. Weighting firm-level
results from any exercise with the MSM will yield aggregate (economy-wide) estimates.
The representativeness of the sample needs to be validated through the comparison of simulated
aggregate outcomes with actual aggregate data. For instance, Table 5 compares actual data on total
assets, total taxable income, and total CIT revenue with the simulated MSM calculation for thesevariables, using a weighted sample. The ratio between the two in the last column is between 99 and102 percent, which suggests a reasonable approximation by the MSM of the true aggregated data. If
the differences are large, the sample size must be increased (e.g. revising upward the target
percentage (5 per cent in the example above)), and possibly new dimensions added, to improve theaccuracy of the sample.

22

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Table 5. Diagnostic of the representativeness of the sample

Population
assetstaxable income CIT liability
190,000,000
7,000,000
2,000,000

Weighted Sample
assetstaxable income CIT liability
193,800,000
6,930,000
1,980,000

Weighted Sample/ Population
assetstaxable income CIT liability
102%
99%
99%

Differences in values between the population and weighted sample may be reduced by increasing
the sample size and/or increasing (or revising) the number of dimensions used to group
corporations. In general, a good stratification of taxpayer characteristics (one that results in largely
homogeneous firms in each strata) allows for a smaller sample size. The degree of homogeneity offirms within each stratum may be tested by calculating the coefficient of variation for selectedvariables (e.g. assets, taxable income, CIT liability) for firms within each stratum and ensuring thatthe values are not greater than roughly 5 per cent.

EFFECTIVE TAX RATE MODELSThis section derives effective tax rates (ETRs) and elaborates on their use. These have been routinely
used in technical assistance work by the IMF and World Bank for many years, and have proved
instructive in better understanding the nature and magnitude of the incentives that various
corporate tax provisions and concessions create for business investment decisions.
ETRs are summary tax burden indicators aimed at measuring what firms effectively pay on theirinvestment returns. They account for not only statutory CIT rates, but also key features of the tax
base, which are important for the distortionary impact of taxation on investment.
There exist various types of ETRs.5 This section focuses on so-called ‘forward looking’ ETRs, which
are derived from algebraic formulae that assess the net present value of a representative investment
project.6 The formulae are transparent and flexible, allowing users to separately identify various
factors influencing net investment returns, including statutory tax rates, depreciation allowances,interest deductibility and tax incentives. Two types of forward-looking ETRs are discussed:7


5

Marginal effective tax rates (METRs) measure the extent to which taxation causes the pre-tax
hurdle rate of return on investment to deviate from its normal (minimum) after-corporate tax
rate of return, which shareholders could obtain elsewhere. METRs reflect the “tax wedge” on

See OECD (1991, 2001, 2003), Nicodeme (2001), Sorensen (2004) and Clark and Klemm (2015) for reviews.

6
Alternatively, backward looking effective tax burden measures are calculated at the firm or aggregate level as actual
tax payments in prior years, divided by adjusted book profits. They have appeal in that they measure the true tax
burden, accounting for tax base measures, tax incentives, enforcement, and income shifting. These aspects, however,cannot separately be identified. Moreover, backward looking effective tax rates cannot measure distortions on future
investment.
7
Seminal work on METR analysis includes Jorgenson (1963), King and Fullerton (1984), Boadway and Bruce (1984).
Devereux and Griffith (2003) introduced AETR analysis.

23

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

investments that just break even. They are routinely used to assess how taxes distort the level ofinvestment (scale decisions).


Average effective tax rates (AETRs) are usually calculated as the present-discounted value of
CIT payment on returns on investment, divided by the present discounted value of the (beforetax) income from the investment. They measure the tax burden on profitable investment
projects, i.e. those earning an above-normal rate of return (due, for instance, to patents, market
power, or location rents). AETRs are used to assess tax effects on discrete investment choices,
and in particular MNC decisions of whether and where to locate FDI (location decisions).

A. Workhorse Model
We derive ETRs from a simple workhorse model of investment, which can easily be extended invarious directions to capture other aspects of taxation. Suppose there is an investment project inperiod 0 of size , which is purchased at price . After period 0, the capital stock ( ) depreciates
every year ( ) at a declining balance rate . At the same time, the capital stock is increased by new
investments every year, , which are purchased at price . The physical capital stock thus
1
. The net present value of the cash flow associatedaccumulates according towith the investment is given by:
1
1

1

1
1

11

where . is a production function with properties
0,0, is the price of output, isthe general rate of inflation and is the minimum (normal) real rate of return required byshareholders (which they could obtain on alternative investments, such as government bonds). The
gross returns to the investment are taxed at the statutory CIT rate . For now, we assume that
financing costs are not tax deductible—reflecting equity-financed investment in most countries.
Moreover, we abstract from personal income tax (PIT) on investment returns or withholding taxes.
Tax depreciation allowances (which are assumed not to be indexed for inflation) are deductible at a
declining balance rate , which may differ from economic depreciation, , where the tax
depreciation rate is constant. The NPV of tax depreciation allowances in terms of the cost ofinvestment is denoted by and given by:
1
1

1

1
1

1

12

Parameter generally lies between 0 and 1, since deprecation for tax purposes is not immediate (inwhich case we would have1). Multiplying by the tax rate gives the value of tax depreciation
allowances in terms of tax savings. According to (11),effectively reduces the price of investment.
In the remainder, for simplicity, we assume that replacement investment in each period t is justso that we can drop timeenough to maintain the capital stock at its initial level, i.e.
. Also, we assume that and increase annually at the general rate ofindices for
24

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

inflation, . We normalize prices
1 so that we express investment and output in real value
terms. Using the geometric sequence, we can rewrite (11) as
1

where

/

1

1

1

13

is the average pre-tax rate of return on the investment project, net of

economic depreciation. In the absence of taxation (0), the NPV of the stream of investments is

proportional to the rate of rate of economic profit (i.e. the rate of return in excess of the normal rateof return), measured by.

The profit-maximizing level of investment is at the point where an additional unit of physical capitalyields no further increase in the NPV:
1

1

0

14

Equation (14) can be rewritten in terms of the so-called ‘hurdle’ rate of return, defined as the real
gross (i.e. before-tax) rate of return net of depreciation ( ).81
1

15

In the absence of tax, the hurdle rate equals the normal rate of return, , i.e. where incremental
investment yields no economic profit. Taxation may affect the hurdle rate in (15), but not necessarily
so. For instance, if
1 (i.e. if tax depreciation allowances are 100 percent of investment cost),
taxation is neutral with respect to investment. However, if
1 (the usual case in most countries),
the hurdle rate of return exceeds the normal rate of return, implying that taxation is predicted toreduce the optimal level of investment.
The marginal effective tax rate (METR) is generally derived from the hurdle rate as follows:
16
The METR thus measures the difference (‘tax wedge’) between the hurdle rate and the after-tax
required rate of return r, as a percentage of the hurdle rate. Combining (15) and (16), the METR canbe rewritten as:

8

The so-called ‘cost of capital’ is closely related to this hurdle rate and is generally defined as the before-tax returnon investment for the project to yield an after-tax rate of return that equals the interest rate plus the rate of
economic depreciation.

25

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

1
1

17

1

The METR will be positive as long as
1 and
0. In that case, the CIT causes the hurdle rate of
return to rise. Fewer investment projects will then be profitable and investment will decline.
The average effective tax rate (AETR) does not use the optimality condition for investment above,
but rather divides the net present value of total CIT payments of any (profitable) project by the netpresent value of (pre-tax) profit for that project:
1

18

The numerator of the second expression in (18) contains two terms. The first term measures the CIT
on economic profit per unit of investment. The second term measures CIT, net of tax depreciation
allowances, on the minimum required normal return, per unit of investment. For projects that earn ahigh rate of economic profit, the first term carries a large weight and is important for the AETR. For
projects that generate a low economic profit, the first term is of minor importance and the second
term becomes more important. This second term is similar to the METR in (17).
Expressions (17) and (18) can be used to numerically compute METR and AETR values, by making
assumptions about the rate of inflation, the real interest rate, the rate of economic depreciation, andby substituting from the tax code the statutory CIT rate and the rate of tax depreciation. For the
AETR, the additional parameter needed is the assumed profitability of the investment. Illustrative
applications are shown in Box 2.
Such calculations can be made for investments that differ with respect to their (economic and tax)
depreciation rates. Moreover, the METR and AETR in (17) and (18) can be easily modified to allow for
the tax deductibility of financing costs—relevant if investment is financed by debt—the inclusion of
PIT on investment returns, or withholding tax rates on FDI. One can also extend the effective tax rate
calculations to allow for cross-border income shifting or various types of investment tax incentives,
as we will show below for the analysis of tax holidays.9

9Klemm (2010) extends the AETR framework to include tax incentives, such as tax holidays and time-varying tax
rates. Clark (2010) introduces multinational tax planning strategies, reflecting the fact that standard ETRs may not be
particularly informative about tax incentive effects on investments by MNCs engaging in aggressive tax planning.

26

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Box 2. Illustration of ETR Analysis
The following table shows calculations of marginal and average effective tax rates under alternative tax
regimes. In the basic ETR model, there are two tax parameters – the statutory CIT rate (u), and the tax
depreciation rate (α). In the base case (current tax regime), these rates are 21 and 8 per cent. Base Case A
considers projects with a pre-tax rate of return of 15 per cent. Base Case B considers projects generating ahigher pre tax rate of return (25 per cent). Other non-tax parameters are held constant.
Parameters

SymbolBase Case A

Regime 1

Regime 2

Regime 3

Base Case B

Regime 3

statutory CIT rate
tax depreciation rate

u
α

0.21
0.08

0.20
0.10

0.21
1.00

0.20
0.06

0.21
0.08

0.20
0.06

economic depreciation rate
real discount rate
real pre-tax rate of return

δ
r
p

0.08
0.03
0.15

0.08
0.03
0.15

0.08
0.03
0.15

0.08
0.03
0.15

0.08
0.03
0.25

0.08
0.03
0.25

inflation rate

π

0.02

0.02

0.02

0.02

0.02

0.02

0.644

0.698

1.000

0.570

0.644

0.570

marginal effective tax rate METR = u(1-A)(r+δ)/(r(1-uA)+uδ(1-A))

0.258

0.217

0.000

0.283

0.258

0.283

average effective tax rate

0.223

0.204

0.168

0.223

0.218

0.214

Calculated values
PV of tax depreciation

A = α(1+r)(1+π)/(r(1+π)+π+α)AETR = ((p-r)u+(r+δ)(1-A)u)/p

In Regime 1, the CIT rate is lowered to 20 per cent, and tax depreciation is accelerated to a 10 per centrate. Both reforms encourage investment, as reflected in lower METR and AETR values. The METR
decreases from roughly 26 to 22 per cent; the AETR decreases from 22 to 20 per cent.
In Regime 2, the CIT rate is unchanged at 21 per cent, but expensing of capital costs is introduced. The
METR is zero implying no tax distortion to scale (marginal investment) decisions. The AETR is also reduced,
implying reduced impediments to locating investment in the country.
In Regime 3, the CIT rate is lowered to 20 per cent (as in Regime 1), but tax depreciation is reduced to 6
per cent. The net effect is a higher METR, implying reduced investment. The AETR is unchanged, comparedto Base Case A. The latter result is sensitive to the rate of pre-tax profit.
Base Case B considers projects earning a pre-tax rate of return of 25 per cent (versus 15 per cent in Base
Case A). Introducing Regime 3 lowers the AETR, compared to Base Case B. While less generous tax
depreciation puts upward pressure on the AETR, this is more than offset by the reduced rate CIT on the
more significant economic profit (compared to Base Case A).

27

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

B. Use in Policy Analysis
ETRs are an important tool for policy analysis in many countries, including developing countries. For
instance, by varying tax parameters—including tax incentives—ETRs shed light on how complex tax
reforms are expected to influence investment. This includes also the variable impact of taxation on
investment in different asset types or by alternative sources of finance. ETRs can be used to infer
trends over time or to provide international comparisons of tax systems. ETRs are routinely used intechnical assistance by the IMF and World Bank to explore the impact of policy reforms on
investment incentives.
ETRs are often used as indicators of “international competitiveness” of tax systems. For example,
Table 6 shows, besides statutory CIT rates, average METRs and AETRs in G20 countries in 2012, ascomputed by the Oxford University Centre for Business Taxation (Bilicka and Devereux, 2012).10 The
average METRs and AETRs are computed as weighted averages for different types of assets anddifferent sources of finance. In particular, the calculations assume that one quarter of investment isin the form of plant and machinery, another quarter in buildings, around 10 percent in intangible
assets, and 40 percent is in inventories. Moreover, 35 percent of investment is assumed to befinanced by debt, while the remainder is financed by equity. From Table 6, we observe that statutory
CIT rates range from 20 percent in Russia and Saudi Arabia to almost 41 percent in Japan. The rangeof AETRs is similarly large, between 16.7 and 36 percent. The METRs range from −10 percent in Italy
to 27 percent in Argentina and Japan.11
A recent study by Chen and Mintz (2013) computes METRs for as many as 90 countries across theglobe—again as a weighted average of METRs for different sectors and sources of finance. Theircalculations, shown in Figure 3, indicate large cross-country differences in tax distortions at themargin of new investment. Figure 4 shows how effective tax rates can shed light on the impact oftax incentives for investment. For 15 countries in the Asia-Pacific region, it compares the AETR in theabsence of tax incentives with that under alternative incentive policies, showing that investments inhigh-technology sectors or in specific geographic areas result in the lowest effective tax burdens.
ETR analysis is routinely used by academics, policy think-tanks, IOs and governments (notably
Ministries of Finance) to analyze the impact on investment of tax policy, including reform of tax
incentive policies. A main attraction is the limited informational requirement, as the values of theparameters entering ETR formulae are determined by tax policy. In other words, the input to ETR
models is found in tax laws and tax regulations. For Ministries of Finance in developing countries
wishing to implement ETR models in their tool-kit, some technical assistance may be required toadapt the general ETR formulae to capture country-specific tax policies.

10

The European Commission publishes ETRs every year as part of its annual publication “Taxation Trends in theEuropean Union”.

11

Several countries have changed their rates since 2012. E.g. Japan reduced its statutory rate stepwise to a current
level of 33 percent.

28

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Table 6. Statutory and Effective Tax Rates for G20 Countries, 2012
RussiaSaudi Arabia
TurkeySouth Korea
China
Indonesia
United Kingdom
CanadaAustralia
MexicoItaly
Germany
India
BrazilSouth Africa
FranceArgentina
United StatesJapan

Statutory Rate
20.0
20.0
20.0
22.0
25.0
25.0
26.0
28.0
30.0
30.0
30.3
30.9
32.4
34.0
34.6
35.0
35.0
40.5
40.8

AETR
16.7
18.1
16.9
18.0
22.4
23.0
24.8
24.4
26.6
26.1
23.0
27.0
28.8
30.7
29.8
29.8
32.3
34.9
36.0

METR
7.9
13.4
8.7
7.2
16.2
18.5
22.3
15.8
19.1
17.1
-10.0
18.2
21.1
23.9
19.3
17.9
27.0
23.2
27.0

Source: Bilicka and Devereux (2012)

Figure 3. Average METRs on Capital Investment in 56 non-OECD Countries, 2013

Source: Chen and Mintz (2013)

29

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Figure 4. AETRs in Asia-Pacific Under Alternative Incentives

Source: Wiedemann and Finke (2015)

C. Tax Holidays
As Figure 4 makes clear, ETR analysis can be extended to include tax incentives, such as those
discussed in the main body of the paper. To illustrate this, we extend ETR expressions above toinclude tax holidays for a limited duration. In that case, the NPV of the cash flow associated with theinvestment at
0 is:
1

1

19

1

1

where
0 is the length of the tax holiday period. From this, the METR and AETR can be derived
along the lines above. Yet, they will now depend on , reflecting the remaining number of holiday
years:
1
1

1

30

20

21

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

where d1/ 1 rfor H 1. This time-variant indicator effectively determines the relevant tax
rate applying to investment in each year of the holiday period. Figure 5 shows METRs and AETRs
assuming a 20 year tax holiday, expressed in each of the 20 years of its remaining duration. In thefirst year, with 20 years of holiday remaining, the METR and AETR are small but positive, close to 5
percent, reflecting future tax on the investment returns accruing after the 20-year holiday period.
Over time, the ETRs gradually increase since an increasing fraction of the future returns to theinvestment will become subject to tax as the remaining holiday period gets shorter. After expiry of
the tax holiday, the standard ETRs apply with no incentive. In that year, the METR and AETR are 20
and 26 per cent, respectively. Interestingly, the METR and AETR exceed this level in the years justbefore expiry: this holds for the METR for investments after the first 14 years of the holiday and theAETR after 18 years. Hence, the tax holiday discourages the firm to invest during these years, relative
to the case with the normal tax regime. The reason is that, for investments in these years just before
expiration of the holiday, the firm is unable to claim depreciation allowances. This increases in the
CIT burden, an effect that more than offsets the CIT exemption for profits in these years.12

Figure 5. METRs and AETRs for 20 year Tax Holiday
35%
30%
25%
20%
METR

15%

AETR
10%
5%
0%
20 19 18 17 16 15 14 13 12 11 10 9

8

7

6

5

4

3

2

1

0

Years of tax holiday remaining at time of investment

Source: IMF FAD calculations. The analysis assumes u=30%, α=25%, δ=12.3%, r=10%, π=3.5%.

12This finding was first reported by Mintz (1990). Klemm (2010) shows how the relative attractiveness of tax holidays,
compared to investment allowances and reduced tax rates changes over time and depends on expected profitability.

31

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVESDIAGNOSTIC ASSESSMENT OF GOVERNANCE
This section discusses two templates that can be used to assess transparency and governancepractices in relation to tax incentives in LICs.

A. Ten Principles to Promote Better Management and Administration
The OECD’s Task Force on Tax and Development has pressed for a more effective global
transparency framework for tax incentives for investment—the purpose of which is to promotetransparency in decision-making processes, increase the information available on costs and benefits,
limit discretion and increase accountability. This led to the development of a set of principles topromote the management and administration of tax incentives for investment in a transparent andconsistent manner (OECD, 2013).
1. Make public a statement of all tax incentives for investment and their objectives within a governing
framework.
Tax incentives should only be granted in accordance with a comprehensive policy, which lays down
principles and policy objectives for the introduction or continuation of a tax incentive. Governments
should provide a justification for tax incentives (e.g. regional/territorial development, employment
creation) with the expected costs and intended benefits. This should be communicated publicly
through a regularly updated statement. Such a statement provides the basis for the assessment of
the performance of tax incentives, any overlap and duplication and allows for governments to beheld accountable for the tax incentives they have granted.
2. Provide tax incentives for investment through tax laws only.
Tax incentives for investment are currently provided through tax laws (e.g., income tax law), but inmany cases are also provided by laws governing investment, Special Economic Zones, etc. and inother cases, through decrees, agreements and regulations. As a result their true extent may be
hidden. All tax incentives provided, along with their eligibility criteria, should be consolidated andpublicised in the main body of tax law. Bringing tax incentives into the tax laws (or mirrored in the
tax laws) increases transparency and may empower the tax administration to administer them. Thosetax incentives that are used should be as simple as possible to both apply for and administer.
3. Consolidate all tax incentives for investment under the authority of one government body, where
possible.
All tax incentives should be placed under the authority of one government body, ideally the Ministryof Finance. Currently, the granting and administration of tax incentives may be the responsibility offinance, trade, investment or other ministries, increasing the risk of corruption and rent seeking.
Consolidating them under a single body increases transparency, helps to avoid unintended overlap
and inconsistencies in incentive policies, limits discretionary power and enables policy makers toaddress problems that may arise with the governance of tax incentives. In countries where the32

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

granting and administration of tax incentives is decentralised and/or carried out by both the central
and sub-national governments, to the extent possible, various levels of government should
coordinate to maximize the efficiency and transparency of their efforts.
4. Ensure tax incentives for investment are ratified through the law making body or parliament.
Tax incentives provided through executive decrees or agreements when not scrutinized by the law
making body do not provide sufficient transparency in their granting and operation. Parliamentary
oversight, or its equivalent, is fundamental to transparency and accountability in the governance oftax incentives. This ensures incentives are subject to scrutiny on their intended purpose and theircosts as well as benefits to the country.
5. Administer tax incentives for investment in a transparent manner.
Once provisions have been enacted in the relevant tax laws and regulations, tax incentives may beclaimed by a taxpayer by meeting the necessary conditions as prescribed, without negotiating withany granting authority, except as provided for under the relevant tax laws. A minimum necessary
condition to be met by taxpayers in the case of a tax incentive should be the requirement to file atax return in the case of VAT and Income Tax, and in the case of other taxes a statement detailingthe duty or other exemptions availed in the prescribed period. In addition to enhancing
transparency, such taxpayer information contributes to data for determining the efficiency andequity of tax incentives. Tax authorities should also periodically carry out audits of cases where tax
incentives have been claimed to ensure that they are not misused.
6. Calculate the amount of revenue forgone attributable to tax incentives for investment and publicly
release a statement of tax expenditures.
The amount of revenue loss attributable to tax incentives should be reported regularly, ideally as
part of an annual Tax Expenditures Report (covering all main tax incentives). While cash expenditurebudgets are usually scrutinised on a yearly basis, the revenue cost of tax incentives is hidden whenestimates of revenues forgone are not calculated and reported. Embedding estimates of revenues
forgone by tax incentives in the yearly budget process provides policy makers with the required
inputs on a timely basis to inform policy decisions. It also supports medium term fiscal planning as
what seems like a small amount of foregone revenue in good fiscal times may become quite highduring periods of fiscal strain. The calculation of revenue forgone should recognise that the benefitsof some investments, mineral extraction, for example, may take many years to realise so losses
should be assessed over the life of the business concerned.
7. Carry out periodic review of the continuance of existing tax incentives by assessing the extent towhich they meet the stated objectives.
Once granted tax incentives usually remain in laws unless revoked or introduced with a ‘sunset
clause’. Hence there is a need to assess performance on a regular basis. Performance reviews may
be conducted once every few years and would include the costs as well as the benefits of the tax
33

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

incentive and if it has met its intended goals. The results of such periodic reviews would inform
decision-making around the continuation or removal of individual tax incentives. The review criteria
and results should be reported publicly. To the extent possible, behavioural responses, both good(e.g., additional incremental investment) and bad (e.g., aggressive tax planning) should be tracked
and communicated.
8. Highlight the largest beneficiaries of tax incentives for investment by specific tax provision in a
regular statement of tax expenditures, where possible.
It may be possible that a few investors, or sectors, benefit from most tax expenditures. The tax
expenditure statement should have sufficient detail to enable policy makers to identify which sectors
benefit from specific tax provisions and, where this is compatible with the requirement of laws andregulations governing taxpayer confidentiality, authorities may wish to consider detailing the major
beneficiaries and the amount by which they benefit from tax incentives. Making such information
public can enhance the legitimacy of governments and their revenue authorities in the eyes ofcitizens which in turn can enhance compliance more broadly.
9. Collect data systematically to underpin the statement of tax expenditures for investment and tomonitor the overall effects and effectiveness of individual tax incentives.
Analysis of tax incentives is data intensive – required for public statements, budgeting, periodic
reviews, tracking of behavioural responses by business, etc. There is a need for the periodic
collection of taxpayer data and on-going analysis of these data by revenue authorities. This may
require introducing mechanisms to do so in some countries.
10. Enhance regional cooperation to avoid harmful tax competition.
In many cases tax incentives are provided in response to what neighbouring countries andcompetitors are offering or perceived to be offering. Hence the issue of tax incentives cannot betackled in isolation. Governments can work together on a regional basis to increase cooperation in
the area of tax to avoid a race to the bottom when they provide competing tax incentives. Efforts toenhance regional cooperation should also cover the use of non-tax instruments e.g., cash subsidies
and loan guarantees, which also provide incentives for investment.

B. Benchmarking Investment Incentives
The World Bank Group has developed a template to assess tax incentives for investment in countries
around the world, in four dimensions: i) the rule of law; ii) transparency; iii) efficient administration;iv) incentive reviews. This subsection discusses the most recent version of the template, which is
dynamic in the sense that it is continuously being updated on-line.

34

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

Rule of law
The issues here are that i) fiscal incentives should be provided through tax laws only; and ii)
ratification of fiscal incentives policies should be through a law-making body / parliament.
Questions
Are all available tax incentives givenout through tax laws only, which
consolidate and publicize in their main
body the list of incentives offered
together with eligibility criteria?
1. Is there a legal basis for granting
fiscal incentives?
2. Are tax incentives provided throughindividual MoUs?
3. Are tax incentives provided based on
decisions of an investment board or
another intra-ministerial body?
4. Are tax incentives provided or
mirrored in the Tax Code/Customs
Code and nowhere else?
5. Were all tax/customs
laws/bylaws/statutes/agreements/decrees providing or mirroring fiscal
incentives scrutinized by a lawmaking body, such as parliament?
6. Are tax incentives provided in asingle non-tax
law/bylaw/statute/agreement/decree
without mirroring in tax/customs
laws?
7. Were all non-tax
laws/bylaws/statutes/agreements/decrees providing tax incentives
scrutinized by a law-making body,such as parliament?

Score and Methodology
1. The score will be defined based on the existent
legal framework underlying granting of fiscal
incentives (including customs duties exemptions).
The best score: all tax incentives are provided in
the Tax and/or Customs Code (Tax and Customs
Codes are under a single authority – Ministry of
Finance) and nowhere else.
The worst score: all tax incentives are provided adhoc, based on decisions of certain individuals.
2. The questionnaire is divided into three sections,which determine a score range, where a country
would fall depending on three scenarios:- Fiscal incentives are provided in tax and/or
customs laws only – highest score range;- Fiscal incentives are provided in non-tax/noncustoms laws – middle score range;- There is no legal basis for granting fiscal
incentives – lowest score range.

Data Source
Survey of a few public
sector representatives
in charge of tax
investment incentives(specifically, Revenue
and Customs
Authorities) and local
law firms
complemented bydesk research to
cross-check and verify
information.
Desk research: Review
of national legal
instruments that havebeen mentioned in
the survey.

Further, negative answers to questions in each of
the sections add to higher score within the predetermined range.
3. The score will be adjusted based on the share of
fiscal incentives granted through: (i) tax/customs
laws; (ii) non-tax/non-customs laws; (iii) without
legal basis. Intuitively, the more fiscal incentives
are granted without legal basis, the lower thescore.

Transparency
Issues here include the public availability of laws and regulations related to investment incentives,
publication of a list of incentives, public statement of principles and policy objectives underpinningincentives regime and disclosure of the largest beneficiaries of investment incentives.

35

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVESQuestions
Are the laws and regulations pertaining
to investment incentives published in asource that is available to all?
1. Are legal instruments available online?
2. Are legal instruments available inpublicly available published sources,
such as an official gazette?
3. Are legal instruments available in hard
copy upon request through aGovernment agency?
4. Are legal instruments available at nocost?
5. Are legal instruments available in
English, if this is not the native
language?

Are all available investment incentives
published in an accessible, publicly
available format?
1. Does the Law mandate that theGovernment maintains and publishes
an inventory of investment incentives
that lists the types of incentives thatare available to investors?
2. Is the list of incentives available inpublished sources available to all (e.g.
official gazette)?
3. Is the list of incentives published
online?
4. Does the list include eligibility criteria?
5. Does the list include documentationand procedures required to claim
incentives?
6. Does the list include value of the
incentives?
7. Does the list include awarding body oragency?
8. Does the list include contact
information for any questions orfollow-up relating to the application
and awarding process?
Are principles and policy objectives forchanges in the incentives regime
publicly stated and subject to public
consultations?
1. Is there an investment attraction
strategy or another document, which
outlines policy objectives and strategy
behind incentives in place?

36

Score and Methodology
1. The score will be defined based on thequantity of negative answers to thequestionnaire
2. Each question will be answered for two
categories of legal instruments:
Laws, legislative bills;
Regulations, decrees, bylaws,
administrative instructions, decisions, andother measures of general application.
3. Within each category, a partial credit will beassigned, depending on the degree ofcompliance with the principle. For example, if
only a certain portion of legal instruments ispublicly available, a partial score
proportionate to the share of available
instruments will be given.
1. The score will be defined based on thequantity of negative answers to thequestionnaire (each negative answer adds a
segment to the circle).
2. Within each category, a partial credit will beassigned, depending on the degree ofcompliance with the principle. For example, if
only a certain portion of incentives is publicly
available, a partial score proportionate to theshare of listed incentives will be given.

1. The score will be defined based on thequantity of negative answers to thequestionnaire (each negative answer adds a
segment to the circle).
2. Within each category, a partial credit will beassigned, depending on the regularity of
implementation of best practices (ifapplicable). For example, if the changes in

Data Source
Survey of a few public
sector representatives incharge of investment
incentives
complemented by desk
research to cross-checkand verify information.
Desk research: Review ofpublic legal databases
and publications toperform a factual checkof sources that havebeen mentioned in thesurvey.

Survey of a few public
sector representatives incharge of investment
incentives
complemented by desk
research to cross-checkand verify information.
Desk research: Review ofnational legal
instruments and factual
check of publications
that have been
mentioned in thesurvey.

Survey of a few public
sector representatives incharge of investment
incentives
complemented by desk
research to cross-checkand verify information.

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES
2.

Is the process for reform/change ofthe incentives regime outlined in theLaw?
3. When changes to the incentives
regime are introduced, are theproposed changes formallycommunicated to the public before
such changes are adopted?
4. Are these changes communicated tothe public through media channels
that are available to all (e.g. online,
local broadcasting station, official
gazette)?
5. Are there opportunities for interested
parties to voice their concerns or offer
comments on the proposed changes
before they are formally adopted?
Are largest beneficiaries of incentives
publicly reported?
1. Is the information on the companies –largest beneficiaries of incentives
reported?
2. Is the information on the sums ofreceived incentives by each beneficiary
reported?
3. Is the reported information
disaggregated by individual sector?
4. Is the reported information
disaggregated by specific incentive?
5. Is the information communicatedpublicly through available to allchannels, such as online, local
broadcasting station, official gazette?
6. Is the information reported regularly?
Does the Government possess
information on concessions granted
outside of the general incentive
regime?
7. Is information on concessions granted
outside of the general incentive
regime available to the general public?

incentives regime are communicated to the
public only sometimes, and not all the times,
the score will be adjusted downwards.

Desk research: Review ofnational legal
instruments and factual
check of media
publications that havebeen mentioned in thesurvey.

1. The score will be defined based on thequantity of negative answers to thequestionnaire (each negative answer adds a
segment to the circle).

Survey of a few public
sector representatives incharge of investment
incentives
complemented by desk
research to cross-checkand verify information.

2. Within each category, a partial credit will beassigned, depending on:- Regularity of the implementation of bestpractices (if applicable). For example, if theinformation is reported less often thanannually, the score will be adjusted
downwards.
- Share of incentives covered by the reported
information. For example, if the informationon largest beneficiaries is reported withrespect to only a certain portion of available
incentives, the score will be adjusted
downwards proportionate to the share ofincentives covered.

Desk research: Factual
check of media
publications that havebeen mentioned in thesurvey.

Efficient administration
Issues under this heading include the transparent and non-discretionary administration of
investment incentives, consolidation of all tax incentives under a single government authority,
coordination mechanisms among authorities responsible for investment incentives, and risk-based
audits of incentives beneficiaries.

37

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVESQuestions
Are revenue authorities (tax and customs
authorities) the main Government agencies
in charge of all tax incentives?
1. Are revenue agencies (tax and customs
authorities), which are both under the
Ministry of Finance, the only administratorsof tax incentives?
2. Are tax incentives administered by a single
non-revenue authority (such as an IPA or aline ministry)?
3. If tax incentives are administered throughnon-revenue authorities, do revenue
authorities have control and overview overthe fiscal incentives given out?
4. If tax incentives are administered throughnon-revenue authorities, is there somecoordination/information exchange withthe revenue authority in place?
Is there a coordination mechanism forauthorities to avoid unintended overlap andinconsistencies in the incentives regulations
and to address problems associated with thegovernance of incentives?
1. Is there an inter-agency coordination
mechanism among the authorities incharge of investment incentives?
2. Is there a formal inter-agency coordination
mechanism among the authorities incharge of investment incentives?
3. Do authorities in charge of investment
incentives exchange information on thetype, amount, and beneficiaries of
incentives granted?
4. Are there standard reporting requirements
established on the type, amount, andbeneficiaries of incentives granted?
5. Are authorities in charge of investment
incentives on sub-national and centrallevels well-coordinated? [If applicable]
Are incentives granted automatically basedon clearly articulated eligibility criteriaprescribed in a law without individual
negotiations with authorities?
1. Are all tax incentives granted automaticallythrough self-declaration by the taxpayer
without the need for a signature, decision,certificate from any government officials?
Are applications for incentives reviewed
based on clear pre-defined publishedcriteria?

38

Score and Methodology
1. The score will be defined based on
the quantity of negative answers to
the questionnaire (each negative
answer adds a segment to the circle).
2. Within each category, a partial
credit will be assigned, depending on
the share of incentives administeredby revenue agencies (tax and customs
authorities). For example, if only acertain portion of fiscal incentives isadministered by revenue authorities,
a partial score proportionate to theshare of the incentives under revenue
authorities will be given.

1. The score will be defined based on
the quantity of negative answers to
the questionnaire (each negative
answer adds a segment to the circle).
2. Within each category, a partial
credit will be assigned, depending on
the regularity of implementation ofbest practices (if applicable). For
example, if the authorities in chargeof investment incentives meet lessoften than once a year under thecoordination mechanism, the scorewill be adjusted downwards.

1. The score will be defined based on
the quantity of negative answers to
the questionnaire (each negative
answer adds a segment to the circle).
2. A partial credit will be assigned toquestion 1 proportionally to the shareof tax incentives granted
automatically.

Data Source
Survey of a few public
sector representatives incharge of tax investment
incentives and local law
firms complemented bydesk research to crosscheck and verify
information.
Desk research: Review ofnational legal instrumentsthat have been mentioned
in the survey.

Survey of a few public
sector representatives incharge of non-tax
incentives and local law
firms complemented bydesk research to crosscheck and verify
information.
Desk research: Review ofnational legal instruments,
internal guidelines of theagencies involved in theadministration of non-fiscal
incentives that have been
mentioned in the survey.

Survey of a few public
sector representatives incharge of tax incentives andlocal law firms
complemented by desk
research to cross-check andverify information.
Desk research: Review ofnational legal instruments,
internal guidelines of theagencies involved in theadministration of fiscal

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES
2.

Are there timelines for each step of theapproval identified and service standards
published?
3. Is it required that a negative decisioncommunicated in writing to the investor?
4. Is it required that a negative decision
motivated (meaning that the implementing
body has to provide justification for thenegative decision)?
5. Is a negative decision subject to appeal
before a higher administrative authority or
the courts of the country?
6. Is the fact of granting of an incentive
published and made available to thegeneral public?
Are investors receiving an incentive required
to file a tax return (in case of VAT or income
tax exemptions), or a statement detailing a
duty or other exemptions availed in theprescribed period (in case of otherexemptions)?
1. Are investors receiving a tax incentive
required to file a tax return/statement?
2. Is the information submitted sufficient for
the revenue administration to carry out acost-benefit analysis?

incentives that have been
mentioned in the survey.

1. The score will be defined based on
the quantity of negative answers to
the questionnaire (each negative
answer adds a segment to the circle).
2. The score will be adjusted basedon the share of incentives
beneficiaries that file a tax
return/statement in practice [if suchinformation is available].

Survey of a few public
sector representatives incharge of tax incentives anda few private sector
representatives
complemented by desk
research to cross-check andverify information.
Desk research: Review of
databases/reports that havebeen mentioned in thesurvey.

Incentives reviews
Issues include statements and publication of costs of tax expenditures, reviews of continuance ofexisting investment incentives based on cost-benefit analysis and systematic collection of data tounderpin effectiveness assessment.
Questions
Is the amount of revenue loss attributable totax incentives regularly calculated andpublicly reported?
1. Has there been an exhaustive calculation oftax expenditures associated with tax
incentives (including customs exemptions)?
2. Are calculations carried out regularly?
3. Are the results of calculations made publicly
available?
4. Is there a legal requirement that tax
expenditures are calculated and publishedregularly?

Score and Methodology
1. The score will be defined basedon the quantity of negative answers
to the questionnaire (each negative
answer adds a segment to thecircle).

Is the performance of each type of incentives
assessed on a regular basis, including thecosts, benefits, and the effectiveness of
attaining the intended policy objectives?

The score will be defined based on
the quantity of negative answers to
the questionnaire (each negative

2. The score will be adjusted basedon the regularity of tax expenditurecalculations. If the calculations arecarried out less often than annually,
the score will be adjusted
downwards.

Data Source
Survey of a few public
sector representatives incharge of investment
incentives complemented
by desk research to crosscheck and verify
information.
Desk research: Review ofinternal guidelines andother sources that havebeen mentioned in thesurvey.
Survey of a few public
sector representatives incharge of investment
incentives complemented

39

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES
1.

2.

3.
4.
5.

40

Is cost-benefit analysis performed for eachtype of investment incentives ex post by
analyzing a sample of beneficiaries (after an
incentive has been granted automatically)?
Are behavioral responses to incentives byinvestors taken into consideration (e.g.
through motivation surveys)?
Are the reviews carried out regularly (at thesame frequency)?
Are criteria and results of the reviews madepublicly available?
Are sunset clauses introduced in laws
granting investment incentives?

answer adds a segment to thecircle).

by desk research to crosscheck and verify
information.
Desk research: Review ofnational legal
instruments, internal
guidelines, and othersources that have been
mentioned in the survey.

TAX INCENTIVES FOR INVESTMENT—TOOLS FOR THE ASSESSMENT OF TAX INCENTIVES

References
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