The effectiveness of tax incentives in attracting investment: evidence from developing countries

Abstract

This article summarizes the first part of my dissertation which empirically investigates the relationship between corporate taxation and investment in developing countries, with particular attention to tax incentives. It attempts to answers three questions: (i) is lowering the corporate tax burden as effective to encourage investment in countries with a relatively unattractive investment climate as it is in countries with a relatively attractive investment climate?, (ii) are specific tax incentives effective in attracting investment?, and (iii) do governments take each others’ tax policy into account when making tax policy decisions? In a first study, we find that foreign direct investment is less sensitive to the marginal effective corporate tax rate in countries with a relatively unattractive investment climate. A second study reveals that lower CIT rates and longer tax holidays are effective in attracting FDI in Latin America and the Caribbean but not in Africa. This result is broadly confirmed in a third study that focuses on the effectiveness of tax incentives in two monetary unions: the Eastern Caribbean Currency Union and the African CFA Franc zone. Moreover the third study indicates that reduced complexity of the tax system and more legal guarantees help to attract investment in the CFA Franc zone. Finally, the second study also shows that those tax instruments to which firms are most sensitive - the CIT rate and tax holidays -, are the ones on which governments compete the strongest.JEL Classification Codes: H21, H25, H26, H32, F21, H87