Use and abuse of tax breaks: what do they mean for development?
Taxation is essential to raise sufficient, equitable and accountable financing for development. Only through taxation can governments fund public spending on the essential services at the quality and scale necessary to realise the rights of all citizens. Yet many Southern governments decide not to tax certain corporations and companies in the hope that this will attract cross-border investment.
For example, in 2018, extractive companies with interests in the Amazon benefitted from nearly US$1 billion-worth of tax incentives from the Brazilian government. Foregoing a billion dollars-worth of tax revenue has substantially reduced the capacity of the state to provide basic services to citizens – services that are essential for development and reducing poverty. At the same time, the investments attracted by the tax incentives have brought with them environmental degradation and negative impacts on local livelihoods.
Despite mounting evidence that the practice of offering tax incentives is both largely ineffective and detrimental to development, it is widespread.
Today we launch a new report, Use and Abuse of Tax Breaks, which explains how tax incentives can become harmful, and discusses what can be done to stop their abuse.
Misused and ineffective tax incentives
Those in favour of tax incentives argue that they are necessary to induce investments in areas which would otherwise be unattractive to new investors, and that they generate social and economic benefits, such as new jobs and a broader tax base.
But there is much evidence to suggest that they do not even work to attract investment. For example, in a survey of foreign investors in sub-Saharan Africa which asked to them to rank the factors that influenced where they invest, incentive packages were second last in importance.
Often, the economic benefits of tax incentives do not outweigh the costs. For example, government cost-benefit analysis of tax incentives in the Philippines estimated that foregone revenue due to tax incentives was US$6.6 bn in 2015; in the same year, the annual national health budget was US$2.31 bn. While 123,725 jobs were created as a result of the incentives, each cost US$57,700.
As well as not generating intended economic benefits, tax incentives are prone to misuse. By providing special exemptions to tax rules, they complicate tax administration and create more opportunities for unscrupulous enterprises to avoid paying the right taxes. They are often allocated in ways that evade public scrutiny and can easily result from private lobbying, benefitting only those involved, rather than society. This has consequences not only for the economy, but also for democracy and development.
Curbing harmful tax incentives
Achieving the Sustainable Development Goals will require US$2.5 trillion per year and tax revenue is necessary to meet this financing challenge. Unlike tax evasion, tax incentives are legal. Eliminating abuse and misuse of tax incentives is a relatively straightforward way of unlocking additional funding.
Intense competition for investment drives many governments to hold back their full taxing power. But it is important for them to think first what they want out of investments, and then use tax incentives in exceptional cases, rather than applying them as a broad policy prescription for sustainable development.
Improving governance and financial transparency are key to detecting, deterring and reducing unnecessary and wasteful tax incentives. Christian Aid, together with our partners in the Financial Transparency Coalition, are lobbying and campaigning in many countries for:
- tax incentive regimes underpinned by clear, transparent and credible legal, technical and political processes
- tax incentives justified only by clear links to national development strategies
- comprehensive evaluation of social costs and benefits of new and existing incentives
- laws specifying the scope and limitations of tax incentives
- ongoing review and monitoring of tax incentives by governments
- extension of freedom of information laws so that they apply to firms using tax incentives.
On the international stage, we are calling for better coordination and common policy measures to stop tax competition. It is also important to strengthen transparency in cross-border financial flows and the capacity of Southern governments to exercise taxing powers over transnational corporations.
Only through coordinated action at the national and international levels can we begin to challenge the fundamental ideological assumption that underpins tax incentives. Giving incentives to the private sector is neither the best nor the only way to fund development.