MA KIN G The political economy of tax incentives for investment in the Dominica

MA KIN G The political economy of tax incentives for investment in the Dominican Republic: “Doctoring the ball” OECD DEVELOPMENT CENTRE Christian Daude, Hamlet Gutiérrez and Ángel Melguizo Working Paper No. 322 Research area: Latin American Economic Outlook January 2014 Authorised for publication by Mario Pezzini, Director, OECD Development Centre The Political Economy of Tax Incentives for Investment in the Dominican Republic: “ Doctoring the Ball ” DEV/DOC(2014)1 2 © OECD 2014 DEVELOPMENT CENTRE WORKING PAPERS This series of working papers is intended to disseminate the Development Centre’s research findings rapidly among specialists in the field concerned. These papers are generally available in the original English or French, with a summary in the other language. OECD Working Papers should not be reported as representing the official views of the OECD or of its member countries. The opinions expressed and arguments employed are those of the authors. Working Papers describe preliminary results or research in progress by the author(s) and are published to stimulate discussion on a broad range of issues on which the OECD works. Comments on Working Papers are welcomed, and may be sent to the OECD Development Centre, 2 rue André Pascal, 75775 PARIS CEDEX 16, France; or to dev.contact@oecd.org. Documents may be downloaded from: http://www.oecd.org/dev/wp ©OECD (2014) Applications for permission to reproduce or translate all or part of this document should be sent to rights@oecd.org CENTRE DE DÉVELOPPEMENT DOCUMENTS DE TRAVAIL Cette série de documents de travail a pour but de diffuser rapidement auprès des spécialistes dans les domaines concernés les résultats des travaux de recherche du Centre de développement. Ces documents ne sont disponibles que dans leur langue originale, anglais ou français ; un résumé du document est rédigé dans l’autre langue. Les documents de travail de l’OCDE ne doivent pas être présentés comme exprimant les vues officielles de l’OCDE ou de ses pays membres. Les opinions exprimées et les arguments employés sont ceux des auteurs. Les documents de travail exposent des résultats préliminaires ou des travaux de recherche en cours menés par l’auteur/les auteurs et sont publiés pour stimuler le débat sur un large éventail de questions sur lesquelles l’OCDE travaille. Les commentaires sur les documents de travail sont bienvenus et peuvent être adressés au Centre de développement de l’OCDE, 2 rue André Pascal, 75775 PARIS CEDEX 16, France; ou à dev.contact@oecd.org. Les documents peuvent être téléchargés à partir de: http://www.oecd.org/dev/wp ou obtenus via le mél (dev.contact@oecd.org). ©OCDE (2014) Les demandes d'autorisation de reproduction ou de traduction de tout ou partie de ce document devront être envoyées à rights@oecd.org OECD Development Centre Working Paper No. 322 DEV/DOC(2014)1 © OECD 2014 3 TABLE OF CONTENTS ACKNOWLEDGEMENTS .......................................................................................................................... 4 PREFACE ....................................................................................................................................................... 5 RÉSUME ........................................................................................................................................................ 6 ABSTRACT .................................................................................................................................................... 6 I. INTRODUCTION ..................................................................................................................................... 7 II. A BRIEF LITERATURE REVIEW OF THE POLITICAL ECONOMY OF TAX INCENTIVES FOR INVESTMENT: AROUND AND WITHIN ....................................................................................... 9 III. THE POLITICAL ECONOMY OF TAX INCENTIVES FOR INVESTMENT IN THE DOMINICAN REPUBLIC ......................................................................................................................... 12 IV. WORKING FROM WITHIN: A COMPARATIVE ANALYSIS ...................................................... 22 V. CONCLUSIONS .................................................................................................................................... 26 REFERENCES ............................................................................................................................................. 27 OTHER TITLES IN THE SERIES/ AUTRES TITRES DANS LA SÉRIE .............................................. 30 The Political Economy of Tax Incentives for Investment in the Dominican Republic: “ Doctoring the Ball ” DEV/DOC(2014)1 4 © OECD 2014 ACKNOWLEDGEMENTS We would like to thank Bruce Byiers, Oliver Morrissey, Carlos Scartascini, Christian von Haldenwang, Armin Schiller and participants at the DIE-GDI workshop on “The politics of taxation in developing countries” held on 24-25 September in Bonn for their helpful comments and suggestions. Flora Vever provided assistance in editing the paper. OECD Development Centre Working Paper No. 322 DEV/DOC(2014)1 © OECD 2014 5 PREFACE Fiscal policy can be analysed in different dimensions. There is of course a technical dimension that deals with taxes and expenditures and their effects on economic efficiency. Furthermore, recent advancements in methods and data availability have also allowed the analysis of the distributive incidence of fiscal policy from a normative as well as an empirical viewpoint. However, without considering the political economy dimension, it would be impossible to understand the tax and expenditure levels and structures that we observe in real life. Understanding how different groups influence tax and expenditure policies is essential also to assessing the forces that might oppose fiscal reform or distort fiscal policy such that it becomes a barrier rather than a tool for development. The present paper contributes to the understanding of the use of investment tax incentives, which are widely used in developing countries to foster investment and competitiveness, not always with the desired outcomes. In particular in Central America and the Caribbean, competition to attract foreign direct investment has lead towards a significant erosion of the tax base in many countries. This erosion often leads towards insufficient resources to finance public goods and services that actually enhance the citizens’ livelihood, while tax exemptions are allocated according to political criteria rather than creating dynamic comparative advantages and fostering structural change. The particular case of the Dominican Republic studied in this paper illustrates some of the important ways on how interest groups shape the policy framework in their favour. Exploiting differences in different incentive schemes in terms of their governance, the authors show how interest groups have exerted pressure to preserve their privileged positions when they have control over the administration of tax benefits. However, when they could not control the mechanisms, they actually lobbied to modify the rules of the game. This has important implications in terms of the design of tax incentives, such that more transparency and budgeting tax expenditures explicitly could increase public control over these instruments. This paper was produced as part of the OECD Development Centre work on fiscal policy in Latin America in the framework of the LAC-OECD Initiative fiscal policy pillar, a joint project of the Centre for Tax Policy and Administration and the Development Centre, supported by Spain, Chile and Mexico. We hope it contributes to developing countries’ efforts to increase make fiscal policy a more effective tool of resource mobilisation for development and reform their tax and expenditure policies to narrow the multiple development gaps that still remain. Mario Pezzini Director, OECD Development Centre January 2014 The Political Economy of Tax Incentives for Investment in the Dominican Republic: “ Doctoring the Ball ” DEV/DOC(2014)1 6 © OECD 2014 RÉSUMÉ Les mesures d’incitations fiscales peuvent être un outil utile pour stimuler l’investissement dans les pays en développement. Cependant, dans ces pays, les groupes d’intérêt sont souvent en mesure d’exercer une influence considérable sur sa gestion, voire sur sa conception. En suivant une approche de l’économie politique de la réforme fiscale basée sur le pouvoir nous trouvons comment les groupes d’intérêt fonctionnent dans le cadre institutionnel pour obtenir les résultats qui correspondent le mieux à leurs objectifs. Lorsqu’ils échouent, ils deviennent de puissants partisans du changement. Ces dynamiques de pouvoir ont d’importantes implications pour la conception et la gestion des mesures d’incitations fiscales dans les pays en développement. Classification JEL: D78; H25; O25. Mots-clés: politique fiscale, incitatifs fiscaux; économie politique; République Dominicaine ABSTRACT Tax incentives can be a useful tool to stimulate investment in developing countries. However, in these countries interest groups often are able to exert considerable influence in its management, if not its design. From a power-based approach to the political economy of tax reform we find how interest groups work within the institutional framework to seek outcomes that best fit their objectives. When unsuccessful, they become powerful advocates of change. These power dynamics have important implications for the design and management of tax incentives in developing economies. JEL Classification: D78; H25; O25. Keywords: fiscal policy; tax incentives; political economy; Dominican Republic OECD Development Centre Working Paper No. 322 DEV/DOC(2014)1 © OECD 2014 7 I. INTRODUCTION Loopholes for some mean higher tax rates for everyone else. The Economist. 13 July, 2013. Tax incentives are often used in developing countries to attract foreign direct investment (FDI) and promote additional investment by domestic firms. While their effectiveness is questioned, developing countries nonetheless make use of them as they act as a substitute for a poor overall business climate (OECD, 2008). However, widespread preferential regimes weaken the tax structure by making the tax administration more complicated and preventing countries from raising their levels of taxation, creating the so-called fiscal termites (Tanzi, 2001). Once implemented, these systems generate significant benefits for the recipients who thus become powerful lobbyists, making their modification extremely difficult. Even if these benefits are meant to be temporary, there are strong incentives to maintain them. Tax incentives tend to have non-transparent costs, which make their estimation difficult and increasing their social costs, underrating their impact in terms of forgone revenue. Furthermore, this opacity weakens citizens’ control of the government, by masking key portions of the allocation expenditures and shifting the tax burden within society. In addition, when tax expenditures are not published, budgeted and quantified, it is difficult to evaluate their effectiveness. As formal beneficiaries have legal means to reduce their tax burden, it is in their best interest to avoid changes. In uploads/s1/5jz3wkh45kmw-en.pdf

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