Rise of ineffective incentives: New empirical evidence on tax holidays in developing countries

Developing countries employ tax incentives in the hope of attracting investors, but questions remain on the effects of these policies. Asking whether tax incentives undermine or facilitate development, this paper investigates tax rates and tax holidays in terms of both economic and social impacts in developing countries 1985-2014 in the largest panel data set ever deployed for this purpose. The collection of new data results in three major contributions to the existing literature. First, the analysis shows that the use of tax holidays has increased over the last decade throughout all four regions surveyed: Latin America, Asia, Africa and the Caribbean. Second, the analysis finds that the effect of tax holidays on FDI is negligible and decreasing, and importantly, that it does not translate into neither real capital accumulation nor economic growth. Third, the paper then investigates how the revenue losses from tax incentives can mean real differences for human development by analyzing the effect on tax revenues, spending, health and education outcomes. The paper concludes that tax holidays are negatively correlated with tax revenues, and as revenues decrease, the spending on education decreases. This has real effects, as evidenced by a significant negative correlation with enrollment in primary education. The analysis concludes that tax holidays overall have more negative than positive impacts on sustainable development.