International Tax Competition and Tax Incentives in Developing Countries

Tax policy advisers often counsel the governments of developing countries against using investment incentives under their income taxes. A wide variety of arguments have been offered in support of this position. Investment tax incentives can be costly in revenue terms, generating relatively little new investment per dollar of revenue cost and requiring increases in other distortionary taxes; this is especially problematic if the incentives are general (untargeted), so that they benefit a great deal of inframarginal investments, including those that generate significant economic rents. Non-uniform investment incentives that apply only to certain types of capital assets or firms and thus only to certain business sectors may inefficiently distort the allocation of productive resources.Working Paper Number 04-40