By Girls November 28th 2007 Tax Incentives & FDI

Tax Incentives & FDI Evidences Types of Tax Incentives Arguments For Tax Incentives Arguments Against Tax incentives Trends and Questions Cases Ireland Mekong Region China

Types of Tax Incentives Principal TypesExamples in China Tax Holidays An exemption rate for a specified length of time “ 两免三减半 ” 中的 “ 两免 ” Reduced Corporation Tax A lower corporate income tax rate 外资： 30%+3% 经济特区、西部大开发 Investment Allowances Deductions from taxable income 加速折旧 加计扣除 Tax Credits Reductions to total tax paid 购置国产设备的抵免 Exemption from Indirect Taxes No tax paid 进口免税 出口退税 Table 1

Types of Tax Incentives From: Tax Incentives and Foreign Direct Investment (UNCTAD,2000) Table 2

Types of Tax Incentives Table 3: Relative Pros and Cons of Different Types of Tax Incentives TypesProsCons Reduce tax burden Reduce tax revenue Tax HolidaysAvoid contact with tax administration Provide benefits Short-run investment Create distortions between old and new firms Revenue costs are not transparent Reduced CTRevenue costs are transparent Attract investments in the long run Race-to-the-bottom Transfer pricing Tax sparing Investment Allowances and Tax Credits Targeted to certain investments to meet government’s plan Revenue costs are transparent Administrative burden Macroeconomic environments Well-developed accounting systems Exemption from Indirect Tax Avoid contact with tax administration VAT (inputs & outputs) Prone to abuse

Arguments For Tax Incentives More and more countries, irrespective of their stages of development, employ a wide variety of incentives to attract FDI. FDI in Tax Haven 5 times Regional Economic Groupings Tax incentives A decisive factor in location decision

Arguments For Tax Incentives Incentive competition If a country’s neighbor offer tax incentives, then it must also offer them to remain competitive. Investment guide Shift investment to industries or areas e.g. incentives for investment in poor areas incentives for high-tech industries

Hines (1999) CIT: reduction 1% FDI: increase 2% 2.Arguments For Tax Incentives A decrease in CIT (Corporate Income Tax) results in a significant increase in FDI in some Eastern Asian countries.

Arguments Against Tax Incentives revenue losses E.g. One state in the US an average sized new foreign firm : 1.2 % in real per capita revenues a domestic firm : 0.1 % in real per capita revenues 1) loss for the host government Revenue losses: developing countries face more severe budgetary constrains Tax sparing: a transfer of revenue between countries

Arguments Against Tax Incentives 2) “race to the bottom” competition Most notable in Asia Tax competition within the region, but ineffective to the region as a whole 3) Reducing the efficiency of investment E.g. which project is better? (two hands) Project A Tax rate:33% Before-tax return: 12% After-tax return: 8% Project B Tax rate:10%(tax incentive) Before-tax return: 10% After-tax return: 9%

Arguments Against Tax Incentives 4) investors of the “wrong kind” Export-oriented companies---but: transfer pricing, tax sparing Tax-sensitive projects---but: how to select If: short-term profitable projects If: the most profitable projects 5) Administrative burden Discretionary regimes: case-by-case evaluations Complicated tax system: need more effective to cover the costs of implementing them and produce a net overall benefit. corruption problems: opportunities for officials to obtain kickbacks or political favors in exchange for granting tax incentives.

Cases 1: Ireland Cons: small population low levels of local capital few natural resources Pros: a low tax rate the English language EU membership a highly educated population

Case 2: Mekong Region tax incentives Cambodia (20%) Vietnam (32%) Lao PDR (35%) SectorsCertain industries: Hi-tech, infrastructures, environmental protection Certain locations: remote areas Tax holidays8 yearsNegotiable Reduced CIT rates9%25% 10% 15% 20%20% 15% 10% Allowances and creditsRefunded CIT Exemptions of indirect taxes Import dutyimport duties, VATimport duty: 1% Export duty: 0% Others additional incentives in export processing zones negotiate on a case-by-case basis. Similar characteristics of tax incentives:

Case 2: Mekong Region A Empirical Analysis(2001): revenue lost in Vietnam 1.US$76 million: 4,139 Foreign-invested Enterprises 2.US$224 million(0.7% GDP):

Case 2: Mekong Region the Asian financial crisis of country-specific factors Tax incentives’ functions in early ages of companies Do tax incentives boost FDI significantly?

Case 2: Mekong Region Which incentives are more effective? FDI/GDP Tax incentives/GDP Regional cross-country evidence also provides little support for the notion that special tax incentives have attracted significant FDI.

Case 2: Mekong Region Which incentives are more effective? FDI/GDP Standard corporate tax rate on FIE regional cross-section evidence does indicate that low standard CIT rates may have a positive effect on FDI.

Case 3 : China 2002 年, 我国已成为全球第一大直接投资吸收国。

Case 3 : China 我国企业平均税负： 学者估计 我国全社会平均企业所得税税负率约为 15% ， 国有企业： 20% ，外资企业： 10% ，民营企业： 15% 社科院财贸所报告： 内资企业： 25% ；外资企业 13% 财政部： 内资企业： 25 ％：外资企业： 15 ％

Case 3: China 1. 世界银行： 我国 1995 年外商投资企业所得税税收优惠损失收入约 660 亿元人民 币，占当年 G D P 的 1.2% 。 我国以损失 50 亿美元的财政收入（按税收优惠占 G D P 的 1% 计算） 来换取了额外 30 亿美元 F D I 的流入 2. 财政部与美国 MacroSys 公司合作开发了一套企业所得税微观模拟模型 : 我国 2000 年、 2001 年、 2002 年涉外税收优惠成本 : 、 、 亿元。 3. 国内各财税专家和研究机构 : 财政部：我国涉外税收激励的成本分别： 2000 年、 2001 年、 2002 年、 2003 年、 2004 年、 2005 年 、 、 、 、 、 （亿元） 税收优惠成本

Trends and Questions Harmony of Tax Regimes Targeted Tax Incentive Simple Tax System The first-best solution

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