Policy Considerations When Using Tax Incentives for Foreign Investment

Many countries are facing two potentially conflicting policy priorities – supporting economic recovery and rebuilding policy space – in the post-pandemic period. Strong investment is essential to boosting the recovery momentum, but generous fiscal incentives to attract FDI could hamper the government’s efforts to rebuild fiscal policy space. Meanwhile, ongoing discussions on global tax reforms will force the authorities to revisit their tax incentive system. In this context, this article reviews the literature on tax incentives and proposes key elements for the efficient and effective use of tax incentives for FDI. The proposed elements are grouped into three pillars: design, management, and governance. Designing the tax incentives should be based on a comprehensive FDI strategy, suitable instruments and clearly defined eligibility criteria for FDI in strategically targeted sectors. Well-designed tax incentives should be implemented transparently under a life-cycle management framework with cost-benefit analysis and pre-specified sunset provisions. Good governance framework can greatly facilitate the effective and efficient design and management of tax incentives, while international cooperation can address the issues related to tax competitions and tax evasion.