TAX INCENTIVES FOR INVESTMENT:

AN OECD COST-BENEFIT ANALYSIS

ASSESSMENT FRAMEWORK

Bert Brys Senior Tax Economist

Centre for Tax Policy and AdministrationLAC Fiscal Forum, COSTA RICA

16-17 June 2015

A Cost-Benefit Analysis of Tax Incentives for Investment “Assessment Framework” to: • Improve the empirical analysis & provide

guidance on how to carry out a CB analysis of tax incentives;

• Towards an improved methodological toolbox and better data;

• Simplistic CB indicators which are often used give a false impression of reliability

• Explain policymakers that outcomes of the analysis should be interpreted with caution.

Introduction

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Is policy intervention necessary?

Abandon policy intervention No

Is tax incentive appropriate as a

policy tool?

Yes

NoAre alternative

instruments applicable?

Consider employing alternative

instruments Yes

Are there more effective

alternatives?

Yes

Does benefit of tax incentive exceed costs?

No

Yes

Launch / maintain tax incentive

Abandon tax incentiveNo

YesAre alternative

tools more cost-efficient?

Yes

No

Employ alternative instruments

• “Redundancy ratio”: investment that would have taken place in the absence of the TI

• “Displacement share”: investment that is displaced from outside to within the reach of the TI is not “additional” investment

• “Crowding-out” probability: investment that benefits from the TI may substitute for investment that will no longer take place.

CB analysis for “new” TIs >< the CB analysis of existing TIs!

Why TIs in developing countries who do not have strict international tax rules?

Only true “additionality” matters

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Total benefits = direct + indirect + induced Direct benefits are the sum of:

“Additional” (labour and capital) income earned as a result of the productive use of the “additional” investment undertaken by the agents who benefit from the TIs

• Gross returns are apportioned between individuals/ businesses and the government through the tax system

• In case of FDI, as foreign owners receive the after-tax return on capital, the benefit will be restricted to CIT revenues (plus additional gross labour income)

Measuring the benefits of tax incentives I

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-

(Net of) the income previously earned by the displaced investment

-

(Net of) the income of the “crowded” out investment

+

Income of the “crowded in” investment (if not already taken into account)

+

Unemployment benefits and other labour market (activation) expenses which government no longer needs to pay

Measuring the benefits of tax incentives II

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Indirect benefits are the sum of:“Additional (labour and capital) income generated through inter-industry transactions as a result of the increased “additional” demand for inputs by businesses that benefit directly from the TIs

-

(Net of) income of the “crowded out” investment

+

Foregone unemployment benefits and other labour market (activation) expenses

+

Productivity gains throughout the economy as a result of positive spill-over effects

Measuring the benefits of tax incentives III

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Induced benefits arise when the additional income is spent in the domestic economy (and generates additional income)

Measuring the benefits of tax incentives IV

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The costs of tax incentives are the sum of:

Direct tax revenue costs because of redundant investment+

BEPS and broader tax avoidance and evasion-related revenue costs+

Indirect costs, and in particular compliance costs and administrative and enforcement costs+

Costs as a result of negative external effects

Measuring the costs of tax incentives

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+

The costs of “non-productive” additional government expenses;

+

Loss in efficiency as a result of distortions in investment patterns;

+

Costs (net of benefits) as a result of General Equilibrium effects;

+

Negative multiplier costs.

Measuring the costs of tax incentives

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Using an appropriate discount rate, calculate the Total Benefits and Total Costs

Calculate Benefits-to-Costs Ratio – do not implement TIs with a negative ratio – Rank projects – the higher the ratio the better, although choices may also depend on other factors (e.g. scale of project, distributional impact of investment).

Calculate internal rate of return and compare with pre-determined social rate of return

Calculate the Benefits-to-Costs ratio

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• Do countries carry out cost-benefit analysis of tax incentives for investment? What are country experiences?

• Do participants agree that there is need for more guidance on how to carry out a Cost-Benefit analysis of tax incentives?

Questions and Issues for Discussion

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Bert BRYS, Ph.D.

Senior Tax Economist

Head Country Tax Policy Team

Head Personal and Property Taxes Unit

Tax Policy and Statistics DivisionCentre for Tax Policy and Administration

2, rue André Pascal - 75775 Paris Cedex 16 Tel: +33 1 45 24 15 97 – Fax: +33 1 44 30 63 51

Bert.Brys@oecd.org   || www.oecd.org/tax

For more information, please contact:

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