Capital Ethiopia Newspaper

Tax incentives to attract FDI, harming developing economies

Corporations  evade tax worth $160 bln annually
Developing economies are suffering greatly from tax incentives they offer to international companies to attract investment in their respective countries. 
According to the Trade and Development Report, 2014: Global Governance and Policy Space for Development; the current structure of the global economy is making it difficult for developing countries to expand government revenues and to choose their tax structure.
“Lowering trade tariffs has significantly reduced revenues from border taxes, while the increased mobility of capital and the intensive use of fiscal havens have greatly altered the conditions for taxing income and wealth,” the report reads.
The report also suggests that tax competition among countries has the potential to trigger a fiscal “race to the bottom” in an effort to attract or retain foreign investors. Corporate and income tax rates have declined in developed and developing countries alike, while the incidence of value added tax and other indirect taxes has increased. A more fragile tax structure has become a more regressive one too.
“Foreign companies take their investment decisions in an international context, comparing the profitability of similar investments in different locations. Thus, a neighbouring country or a country in another region that is endowed with the same or similar natural resources may feel the pressure to offer similar or even better incentives to compete as a destination for FDI,” reads the report.
“This not only undermines the effectiveness of fiscal incentives, but also runs the risk of leading to a race to the bottom, where all countries reduce their taxes to harmfully low levels, with no winners but the foreign private firms” the report underlines.
The report further reads that, a study in four countries in East Africa (Kenya, Rwanda, Uganda and the United Republic of Tanzania) by Tax Justice Network-Africa and Action Aid International (2012) shows that tax incentives are resulting in large losses of government revenue of up to USD 2.8 billion annually, depriving those countries of critical resources for development and poverty reduction.
A large proportion of illicit financial flows – which make use of all kinds of mechanisms for circumventing judicial and regulatory oversight – goes through offshore financial centres, based in “secrecy jurisdictions”. Approximately 8 to 15 percent of the net financial wealth of households is held in tax havens, mostly unrecorded. The resulting loss of public revenue amounts to USD 190 to USD 290 billion per year, of which USD 66 to USD 84 billion is lost from developing countries, equivalent to two thirds of annual official development assistance. As for corporations, their main vehicle for tax avoidance or evasion and capital flight from developing countries is the misuse of “transfer pricing” (i.e. when international firms price the goods and services provided to different parts of their business to create profit–loss profiles that minimize tax payments). By this means, developing countries may be losing over USD 160 billion annually, well in excess of the combined aid budgets of developed countries.
The Trade and Development Report, 2014 further argues that offshore financial centres and the secrecy jurisdictions that host them are fully integrated into the global financial system, and large shares of trade and capital movements (including foreign direct investment) are channeled through them. Using those jurisdictions is now part of “normal” business practice in most large firms and banks. Moreover, the most important providers of financial secrecy are some of the world’s biggest and wealthiest countries or specific areas within those countries. Thus, changing this system requires not only knowledge of the technicalities involved, but also firm political leadership.
In many developing countries fiscal space is still heavily influenced by the operations of their extractive sectors. The report notes that tax incentives provided to these industries have been excessively costly in terms of foregone public revenues. UNCTAD’s calculations for a sample of resource-rich developing countries show that between 2004 and 2012 Governments captured only about 17–34 per cent of the rents generated in extractive industries dominated by private firms.
The report also observes that many Governments – both from developed and developing countries – are trying to improve tax collection. With regard to policies in extractive industries, this has meant renegotiating or cancelling existing contracts, increasing tax or royalty rates, introducing new taxes and changing the degree of State ownership of extractive projects. Regarding illicit financial flows, some Governments are also adopting a general anti-avoidance rule in legislation to increase the probability that “aggressive” tax schemes end up being declared illegal once challenged in courts. They can also more effectively address transfer pricing abuses in their international trade by using reference prices for a number of traded goods, particularly for commodities.