(e.g. pharmaceuticals and IT) and random businesses, i.e. those that do not have an obvious association with large positive externalities (e.g. boilers and compressors in Bangladesh or beauty and fitness centers in Sri Lanka).

Tax incentives come at a price. They reduce government revenue, add to administrative costs and open the door for political favoritism. Indeed, once tax preferences have been granted to one group of taxpayers, others get organized and put pressure on politicians to receive similar tax treatment. Thus, even if initially tax schemes are designed for a small group of taxpayers, gradually the list of eligible activities, industries and firms almost inevitably grows up. India and Pakistan publish annual revenue foregone statements, which provide an estimate of the cost of tax concessions. This is good practice that would benefit other countries of the region as such reports give greater transparency to the policy making process. In fiscal year 2013‐14, the total cost of all tax concessions (direct and indirect taxes, customs and excise duties) amounted to about INR 5.7 trillion (USD 90 billion) in India and PKR 477.1 billion (USD 4.7 billion) in Pakistan.<sup>60</sup> This is about 4.8% and 2% of these countries’ GDP respectively.

There are no estimates of any potential benefits (e.g. in terms of increase in domestic production, value added or new jobs) that tax expenditures, particularly tax incentives, helped create. Such cost benefit analysis will be very useful in informing public debate on tax incentive policies. Studies in other countries show that where tax incentives have contributed to new job creation, this occurred at significant cost to the economy. A 2008 World Bank study found that the Yemeni government spent about USD 6,000 for each of 8,000 jobs that investment incentives helped create – more than six times the country’s per capita income.<sup>61</sup> A 1999 World Bank study estimated that investment incentives in Thailand cost the government 16 times the average annual wage of an industrial worker.<sup>62</sup> While tax incentives often aim to attract FDI and stimulate business growth, they are not the most effective tool for this purpose. Findings from global studies show that tax incentives on their own do not have a significant impact on foreign direct investment. The World Bank’s Investment Advisory Surveys in developing countries found that factors related to business climate (e.g. ease of import and export, regulatory framework, infrastructure) were more important as a primary motivation for investment than tax incentives.<sup>63</sup> So, improvement of regulatory climate, including by introducing a transparent tax policy and administration that treat all investors equally, will do more to attract investment than special tax schemes.

Similarly, there is no evidence that VAT exemptions in the region helped support select industries or economic activities. Such practices break VAT chain and result in economic distortions. Another problem is that multiple indirect taxes are levied on the same base. This increases the cost of goods and services and reduces competitiveness of South Asian businesses.

> 60 India Ministry of Finance. Revenue foregone under the Central Tax System: Financial Years 2012‐13 and 2013‐14 and Pakistan Ministry of Finance. Pakistan Economic Survey 2013‐14: Tax Expenditure. _In both countries, most of the tax expenditure is on indirect taxes._

> 61 James, Sebastian. 2013. Tax and Non‐tax Incentives and Investments: Evidence and Policy Implications, World Bank, Washington DC

> 62 Ibid

> 63 Ibid

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