Do tax holidays really leave foreign investors tanned, rested and ready?

Saturday June 16 2012

On June 6, Tax Justice Network-Africa and ActionAid launched a new report on tax incentives in Kenya. The report is part of a broader series on tax incentives in East Africa, “Tax Competition in East Africa: A race to the bottom?” The main conclusion of the series is that East African governments spend a lot of money on tax incentives — as much as $1 billion in Kenya, and $1.28 billion in Tanzania — yet there is very little information about the total quantity of incentives, who receives them, and whether they actually buy the region anything of value.

The report is timely, since the Budget Committee in Kenya’s parliament recently indicated support for expanded tax incentives to spur investment and job creation. The parliamentary report on the Budget Policy Statement 2012-3 calls for a 10-year tax holiday for “large textile industries,” paper milling companies and vehicle manufacturing companies.

This proposal has received no public attention as yet, and it is hard to predict how seriously parliament will take it. But the “Tax Competition” report suggests that MPs and the public should think long and hard about whether such tax incentives actually yield the benefits they are purported to bring.

Tax incentives are part of a broad category of government policy tools known as tax expenditures. They are so-named because they are equivalent to government spending through subsidies, but they occur through the tax system instead. Although there is not much difference between regular expenditure and tax expenditure, tax expenditures are usually less transparent and receive less scrutiny by parliaments and citizens. Subsidies are often treated as regular expenditure, and are therefore part of the normal budget process. They are reported on with all other expenditures. But, according to the 2010 Open Budget Survey, of 26 African countries surveyed, 20 released no information to the public about tax expenditures.

Since tax expenditures involve big money, it is important to ask a few questions about them. These questions are difficult to pose when governments do not provide basic information, which is why “Tax Competition” calls on East African governments to report annually on the cost in revenues lost from all tax expenditures, and to provide a comprehensive list of beneficiaries.

This recommendation is also timely, because reporting on tax expenditures should be addressed by Kenya’s Public Financial Management Bill 2012 that is currently stalled in parliament. Article 82 of the Bill requires an annual report within three months of the end of the financial year that will lay out all “tax waivers,” the beneficiaries and the reasons for the waiver. This would go some way to address the concerns raised in “Tax Competition,” but the language in the Bill could be tightened to ensure that “tax waivers” means all tax expenditures, and that the report contains a full assessment of the revenues lost, as TJN-A/ActionAid recommend.


The larger issue is determining whether these tax expenditures deliver value for money. This question is notoriously difficult to answer. In order to know for sure, we need to ascertain whether companies that benefit from the incentives are actually changing their behaviour in ways that increase investment and create jobs. Does the incentive tilt investors toward investments they might otherwise not make?

The report cites some evidence that casts doubt on the utility of tax incentives. For example, a 2010 survey of foreign investors in Kenya asked them to name the key factors determining where they invested. Only 1 per cent of those investing mentioned financial incentives provided by the government. The report also shows that Uganda provides far less in incentives than Kenya, but receives far more foreign investment.

Still, evidence on the role of incentives is inconclusive. The survey cited above found that few firms had benefited from government incentives, so it is not surprising that few cited those incentives as a key factor. And the sample does not include firms that opted not to invest in Kenya. Would they have been swayed by incentives?

We don’t really know if and when incentives work. But then we must ask: Should we spend $1 billion on something whose effectiveness is unknown? And should those incentives be used disproportionately to benefit foreign, as opposed to domestic investors? At a minimum, governments must take seriously concerns about these incentives by producing a comprehensive strategy for their use, and indicators that can be measured over time to see if claims of increased investment and job creation are at least plausible (and how much public money is required to generate each dollar of investment, and each job).

We can then ask the right questions when we see, as the Export Processing Zone Authority’s own annual report for 2009 shows, that total employment in Kenya’s EPZs decreased every year between 2005 and 2008, even while total sales increased each year over the same period.
Dr Jason Lakin is a programme officer and research fellow at the International Budget Partnership. [email protected]