Post-graduate student Yaremchuk A. S.
Investment
Incentives: Issues of General Relevance
A wide variety of types of
investment incentives are used in
countries with different levels of economic development, and they might be
expected to have different effects. The evaluation of incentives includes some
issues of general relevance.
The first of these issues
concerns whether or not the incentives are "discretionary" or "automatic" policy instruments.
Discretionary investment incentives are
those that are implemented on a case-by-case basis by administrative decision. There may, of course, be general rules that the
administrators follow. The decision as to whether to award an incentive,
however, is contingent on administrative approval. Automatic incentives, in contrast, are those that are available to any firms
meeting certain stated objective
criteria. Examples include type and size of investment, location of
firm, ownership of firm, and profitability of firm.
Economists stress the
advantages of using automatic policy instruments
whenever possible. Such instruments reduce the uncertainty attached to
incentives, reduce the planning time for investments, and reduce the
possibility that noneconomic considerations or favoritism will enter the
decision. Presumably they also reduce the costs of administering the
incentives. It could be argued, however, that discretion allows the administrators to be more selective in awarding grants
and thereby increases the cost-effectiveness of the grants by screening out
inframarginal projects.
In practice, the line
between discretionary and automatic incentives may not be clear-cut. The criteria for eligibility may themselves
require administrative decisions, the
more so the more selective the incentives are intended to
be. Furthermore, administrators will rarely be completely informed about whether the firms using incentives
are fully entitled to use them.
Enforcement and compliance will necessarily require some administrative participation. Therefore incentives
will differ only in the degree to which they are nondiscretionary. We take the
general view that less administrative discretion is a good thing.
Another general issue
concerns the treatment of tax loss firms, that is, firms that have negative taxes owing. Many incentives operate through
the tax system and ultimately influence the firm by affecting its tax
liabilities. Furthermore, many of the firms
eligible for incentives are in a nontaxpaying position, if only temporarily. In fact, these may be precisely the
types of firms for which incentives
would be most socially beneficial. For firms that are in a nontaxpaying position, the incentives will increase the
size of "negative tax liabilities" held by the firm. It is important
to know whether these negative tax
liabilities are treated symmetrically to positive ones, that is, whether they
actually give rise to tax refunds or their equivalent.
Fully symmetric treatment of
positive and negative tax liabilities would require refundability of all negative tax liabilities. Failing that,
unlimited carryforward (and backward) with
full interest would be equivalent in present-value
terms, although it would give rise to a different cash flow for the firm. The appropriate interest cost to ensure
present-value equivalence would be
problematic, however, for firms that faced credit constraints on capital markets. Partial loss-offsetting measures might
involve the carrying forward and
backward of losses but probably only for a limited time period and without interest. Compared with full loss offsetting, this would be similar to the firm's giving an
interest-free loan to the government. Loss-offsetting provisions may differ
from one component of the firm's tax base to another. For example, depreciation
allowances may be taken at the discretion of
the firm, which is equivalent to extending the carryforward of losses arising from this type of capital cost.
Also, some types of investment
incentives, such as investment tax credits, might be refundable even though other components of tax liabilities are not.
Loss offsetting is important
for ensuring that the tax system applies uniformly across different types of
firms. The sorts of firms that are in a negative tax liability position would generally include small, growing firms; firms engaged in large, risky projects; and
perhaps declining firms. Furthermore,
the small, growing ones might be in a cash-constrained position, given their
relatively large investments and given the fact that they may not have established a reputation for themselves on the capital
market. The absence of full loss offsetting
would tend to discriminate against risky
investments, precisely those that might have a high expected return. It would discriminate against small, growing
firms that might already have a high cost of
capital because of imperfections in the capital market. Anything short of full refundability would serve to worsen their
already tight cash flow position. The absence of refundability might also postpone the exit from the market of firms that are
declining. They have an incentive to
stay in business to write off as many of their capital costs as they can. Finally, refundability will be important in
cases in which the credibility of the government is questionable. In this situation,
uncertainty about future government actions
will cause firms to discount future funds from the government in relation to those received up front. Thus
refundable investment tax credits will be
more valuable to the firm than the equivalent present value of funds received, say, through future tax
reductions.
A third important issue is
the distinction between temporary and permanent incentives. Some incentives
may be introduced for a limited length of time, or they may be available to the
firm for only a fixed period. In these cases, the incentive may have as its primary effect a change in the
timing of the firm's investment rather
than a change in the level of its capital stock in the long run. In some circumstances, however, a temporary incentive to
invest may have a permanent effect on
the fortunes of the firm. This will be the case if there are capital market imperfections that discriminate against
young firms starting up (for example,
infant industry arguments for protection).
Incentives may differ in
the degree to which they are selective rather than general. Selectivity may be according to various criteria, such as
type of asset, type of sector,
ownership, and location. In the absence of market inefficiencies, selectivity
of incentives will introduce distortions in the allocation of
capital across sectors.
One final consideration that
is important in evaluating investment incentives is the extent to which capital markets are open to the rest of
the world so capital can flow freely into and out of the country. Typically, developing economies are capital importers and rely
heavily on foreign investment. The tax
treatment of foreign investment will influence the incentive for foreign firms
to invest in the host (developing) country. Furthermore, foreign investors
typically are faced with tax liabilities in their home country and have opportunities to invest in alternative locations. This means that the interaction of the host
country tax system with that of the
home country one will be important in determining the effectiveness of investment incentives. For example, under a system of foreign tax crediting (in which the foreign investor
receives a credit in the home country for
taxes paid abroad), investment incentives could simply reduce foreign tax
credits of firms operating in the host country and have little
or no effect on the actual incentive to invest.
References:
1.
Bosworth, Barry. 1984.
Tax Incentives and Economic Growth. The Booking institution, Washington, D.C.
208 p.
2. Stefan, Hedlund. 1987. Incentives and Economic
systems: Proceedings of the Eighth Arne Rude Symposium, Frostavallen, August
26-27, 1985. Croon
3. http://library.if.ua/books/39.html