## 1. Limited fiscal space has long been an important policy challenge for the Caribbean ## Source details **Canonical URL:** [1. Limited fiscal space has long been an important policy challenge for the Caribbean](https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020176-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/wp/2020/english/wpiea2020176-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/wp/2020/english/wpiea2020176-print-pdf.pdf.json) --- ### Overview / context - Caribbean countries face high public debt and low growth, constraining ability to raise revenue to finance investment in human capital and resilience to natural disasters and climate change. - Weak revenue performance driven by sluggish growth, a narrow tax base, and pervasive use of tax incentives. - Literature: benefits of tax incentives on growth and employment are marginal at best (Chai and Goyal 2008, Parys and James 2010, and Klemm and Parys 2012). ### Tax incentives, tourism, and fiscal costs (key statistics) - Tax incentives common in tourism; concessions include lower statutory CIT rates, longer tax holidays (Antigua and Barbuda noted), extended loss carry-forward years (Antigua and Barbuda and Grenada), higher investment tax allowances/tax credits (Antigua and Barbuda and Grenada), and customs concessions (import duties, VAT, excise). - Measured fiscal costs for the ECCU (measurement approach preserved): - Tax expenditure includes CIT foregone revenue and cost of concessions at customs. - CIT foregone revenue estimated using sector-specific value-added with potential CIT base = one-fourth of value-added for sectors benefiting from incentives (assumption from Chai and Goyal 2008). - Foregone customs revenue reflects import duties, excise taxes, and VAT waived on imports. - Key estimates (exact figures preserved): - Total foregone revenue averaged 5.8 percent of GDP in 2010–18 in the ECCU. - Total foregone revenue equaled 21 percent of total tax revenue in the ECCU. - Cost of tax incentives measured against employment: as high as $2,500 per job in the formal sector. - Tourism-sector specifics: - Cost of tax incentives per job shows substantial variation across countries (figures presented in source). ### Citizenship-by-Investment (CBI) programs in the ECCU (numbers and features) - Five ECCU independent countries offer CBI programs: Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, and St. Lucia. - CBI revenues contributed to 3.5 percent of GDP of the ECCU combined GDP in 2016. - ECCU citizenship programs are priced in the $100,000-200,000 range. - Observed intensified price competition within ECCU, raising concerns on integrity, credibility, and fiscal sustainability for countries reliant on CBI revenues. ### Governance, international scrutiny, and risks - Lack of rules-based, transparent systems for revenue incentive policies creates governance challenges (discretionary, case-by-case grants foster unequal treatment/favoritism). - As of March 2019, EU list of non-cooperative tax jurisdictions included 15 jurisdictions, of which 7 are from the Caribbean: Aruba, Barbados, Belize, Bermuda, Dominica, Trinidad and Tobago and the U.S. Virgin Islands. - Lack of progress toward transparent tax systems increases risk of potential sanctions that could further constrain development resources. ### Cross-country empirical findings (sample, methods, and main outcomes) - Sample: ten tourism-based Caribbean countries (six independent ECCU countries plus The Bahamas, Barbados, the Dominican Republic, and Jamaica); sample period 1996–2018. - Main tax variables: statutory CIT rate, length of tax holidays, investment allowance rate; tax competition index measures number of tax incentive changes per year. - Control variables: public consumption (compensation to employees + purchases of goods and services, percent of GDP), Real Effective Exchange Rate (REER), real U.S. PPP GDP, number of airlifts, stock of infrastructure, natural disaster dummy. - Econometric approach: dynamic panel with country fixed effects; F_{i,t} = δ F_{i,t-1} + T_{i,t} γ + X_{i,t} β + μ_i + ε_{i,t}; FE and System IV-GMM estimated; FE preferred. - Main empirical findings (selected exact results and patterns preserved): - Changes in CIT rates and granting tax incentives are not statistically or economically significant in attracting overall FDI (FE and IV-GMM results). - Public consumption is statistically significant and negatively associated with FDI across specifications. - REER is not a significant driver of FDI in most specifications. - Number of flights and U.S. PPP GDP coefficients are positive and statistically significant for FDI. - Stock of infrastructure significant only when interacted with the natural disaster dummy, implying public infrastructure provision enhances resilience and attractiveness post-disaster. - Using number of hotel rooms as proxy for tourism FDI yields mixed results: - CIT rate negatively associated with number of hotel rooms and statistically significant in some specifications. - Pooled OLS: increase in forgone revenue by 1 million EC dollars associated with increase in number of hotel rooms by 0.2 percent for the ECCU. - Overall: tax incentive measures do not appear to have an impact on overall FDI, GDP growth, or employment for tourism-dependent Caribbean economies. ### Selected estimated coefficients from empirical tables (exact entries preserved) - Table 1 (Effect on FDI, GMM) — sample excerpts: - CIT rate: 0.006 0.001 -0.001 0.006 0.028 0.016* - Tax holiday: -0.042* -0.091*** - Investment allowance rate: -0.002 -0.006** - Public consumption: -0.055 -0.088** -0.063 -0.055 -0.087** -0.200*** - US PPPGDP: 0.591** 0.547** 0.725** 0.590** 0.884*** 0.976*** - Observations: 140 140 102 140 96 81; Number of countries: 10 10 10 10 10 10; R-squared: 0.565 0.576 0.504 0.565 0.445 - Table 2 (Effect on Number of Hotel Rooms, GMM) — sample excerpts: - CIT rate (lag): -0.006 -0.006 -0.013** -0.006 -0.009 0.006 - Tax holiday (lag): -0.004 -0.074*** - Investment allowance rate (lag): -0.003* -0.002 - Infra. stock (lag 2): 0.113*** 0.116*** 0.110** 0.110*** 0.073 -0.214* - Observations: 135 135 101 135 93 80; Number of countries: 10 10 10 10 10 10; R-squared: 0.540 .317 0.319 0.468 0.327 - Table 3 (Effect on Number of Hotel Rooms, OLS) — sample excerpts: - CIT rate (lag): -0.017*** 0.000 0.027*** 0.001 0.031** - Tax competition index (lag): 0.170** - Foregone revenue (lag): 0.002*** - Public consumption: -0.064*** -0.124*** -0.173*** -0.124*** -0.134*** - Number of flights (lag): 0.033*** 0.041*** 0.050*** 0.041*** 0.085*** - Observations: 135 135 101 135 93; Number of countries: 10 10 10 106; R-squared: 0.882 0.894 0.843 0.899 0.639 - Table 4 (Effect on Growth, Fixed Effect Panel) — sample excerpts: - CIT rate: 0.005*** 0.004*** 0.003** 0.004** - Public consumption: -0.014*** -0.015*** -0.010*** -0.009** - US PPPGDP: 0.067*** 0.067*** 0.116*** 0.108*** - Infra. stock (lag): 0.022* 0.019 0.009 0.026 - Observations: 160 157 115 96; Number of countries: 11 11 11 16; R-squared: 0.935 0.935 0.921 0.911 - Table 5 (Effect on Employment, Fixed Effect Panel) — sample excerpts: - CIT rate: 0.004*** 0.005*** 0.003* 0.005** - Public consumption: -0.007** -0.006* -0.004 -0.005 - US PPPGDP: 0.074*** 0.080*** 0.095*** 0.104** - Infra. stock (lag): 0.026* 0.023 0.040* 0.018 - Observations: 150 147 105 86; Number of countries: 11 11 11 16; R-squared: 0.82 0.83 0.76 0.79 ### Cross-cutting empirical interpretation - Evidence consistent with prior literature: large fiscal costs of tax incentives with limited economic benefits. - Tradeoff identified: granting tax incentives versus attracting FDI through better provision of public infrastructure — financing infrastructure may be more efficient for attracting investment than tax concessions. - Political economy: unilateral reductions in tax incentives are difficult due to negative externalities and competitive pressures. ### Policy implications and recommendations (preserved language and prescriptions) - Streamline tax incentives and use fiscal savings to finance needed infrastructure investment. - Regional policy integration to resolve collective-action problems caused by negative externalities of tax incentives. - Advance institutional integration in the Caribbean, e.g., establish a common regime for protection, promotion and facilitation of investments by adopting common investment/business agreement (see Al-Hassan et al 2020 for detailed discussion). - This would likely require political backing and commitment to cooperating and setting up a regional institution with a clear political mandate to supervise and enforce the agreement. - Structural reforms to improve the business environment to strengthen competitiveness in global tourism market. --- ### 19. The competition among the ECCU countries to attract foreign investment through the CBIs ### Recent CBI policy changes and competitive dynamics (country actions) - Dominica: amended CBI requirements end-2016, lowering fee for real estate investment option to expand hotel construction. - St. Lucia: substantially eased conditions by reducing cost to generate more revenue and enhance competitiveness. - Antigua and Barbuda: reduced overall price nearly by half in late 2017. - St. Kitts and Nevis: rolled out a Hurricane Relief Fund (HRF) in early 2018, lowering price for donations to the development fund and allowing family members to come for free. ### Rationale for regional coordination and short-term priorities - Regional approach can sustain programs’ long-term viability and contributions to public finance. - Short-term collective-action rationale: - Protect programs’ financial integrity. - Dispel concerns relating to tax rate on offshore income, residency period, and transparency standards to lower perceptions of abuse. - March 2019: ECCU launched initiative to harmonize CBI due diligence processes (implementation could help region-wide sustainability of revenue flows and support financial stability). - Medium-term: explore CBI program coordination on pricing and use of quotas to support revenues over time. ### Theoretical framework: price (Bertrand) competition and asymmetry (preserved model notation) - CBI competition modeled as Bertrand price competition where required CBI investment is strategic variable. - Two groups: low-demand countries (L) and high-demand countries (H); countries identical within type; v_H > v_L. - Demand functions (notation preserved): q_i^j(p) = v_i - p_i^j - δ(p_i^j - p̄) where δ>0 is a substitutability parameter and p̄ is average price level. - Non-Cooperative Equilibrium characterization: - H-type countries charge higher price and grant greater number of new citizenships than L-type countries. - Imposing a minimum price is more binding to Ls; a maximum quota on new citizenships is more restrictive to Hs. ### Pareto improvements via combined price and quantity coordination (key theoretical insights) - Cooperative move can yield Pareto improvements. - Important mechanism-level insights (preserved): - Minimum price always binding for type-L countries (not always for type-H); marginal revenue from increasing minimum price is always higher for H-type countries. - When minimum price high enough, marginal benefit turns negative for L-type countries but remains positive for H-type countries. - Pareto efficiency achieved when revenue gain in H-type countries from increasing minimum price equals revenue loss in L-type countries; single instrument (minimum price or maximum quota) may not dominate non-cooperative outcome. - Only a combination of both the minimum price and the maximum quota can ensure a “fair” distribution of additional revenue from cooperation and, if chosen appropriately, always guarantees an efficient outcome more profitable to both types compared to NCNE. - Empirical policy analogue: Parties to the Nauru Agreement (PNA) Vessel Day Scheme combines limits on number of fishing days and a minimum benchmark fee; outcomes include increased revenue, decreased catch, and stronger bargaining position—though full compliance is difficult. ### Policy recommendation (from section) - Consider coordinated price-quantity mechanism (minimum price + maximum quota) regionally to raise and sustain CBI revenues and prevent race-to-the-bottom dynamics. - Short-term priorities: harmonize due diligence, adopt common standards and application protocols, and share information (efforts already initiated by ECCU). --- ### 28. While feasible, a rule-based mechanism can be introduced to ensure regional policy coordination ### Coordination mechanism summary and operational prerequisites - Coordination using a uniform minimum price (p_min) and uniform maximum quota (q_max) can help reach efficient outcomes and higher CBI revenues. - Removing incentives for race-to-the-bottom protects integrity and long-run sustainability of CBIs as revenue source. - ECCU authorities have harmonized due diligence arrangements, adopted common standards and application protocols, and are sharing information. - With strong regional institutions and harmonized operational arrangements, a regional CBI price and quantity mechanism can be considered over the medium term to maximize economic benefits. ### Appendix: model setup, definitions, and main formal results (exact statements preserved) - Model primitives: - n ≥ 2 independent countries; demand for each country i,j: q_i(j)(p) = v_i - p_i_j - δ(p_i_j - p̄) with δ>0 and v_H > v_L. - Total cost for providing citizenships constant C; marginal cost zero. - Revenue maximization: R_i_j(p) = p_i_j q_i_j(p) − C. - n_L and n_H denote counts with n_L + n_H = n. - Definitions: - Pareto efficient price distribution: no other price distribution improves revenue for all countries with at least one strict improvement (supply-side Pareto efficiency). - NCNE: unique p̃_N with symmetric prices for same-type countries; equilibrium expressions p_L_N and p_H_N (unique NCNE exists and is Pareto inefficient). - CNE: countries commit to uniform p_min and q_max; best responses constrained and summarized by P_i(·), P_i_qmin(·), P_i_0(·), and explicit P_i_qmax in equations preserved. - Main theoretical results (exact statements preserved): - Proposition 1: For every minimum price P_min>0 and maximum quota q_max>0 there exists a unique Cooperative Nash Equilibrium. - Implementability condition (Lemma 1): A Pareto efficient price distribution (p_L^E, p_H^E) with quantities (q_L^E, q_H^E) is achievable by a CNE with appropriate p_min and q_max iff countries with larger quantities charge higher prices; then q_max = max{q_L^E, q_H^E} and p_min = min{p_L^E, p_H^E}. - Feasibility/characterization constraint (preserved equation): - Let Δp ≡ p_H − p_L and Δq ≡ q_H − q_L. Then Δq Δp ⟺ - if Δq ≥ 0 then Δp ≥ 0 - if Δq ≤ 0 then Δp ≤ 0 - Equivalently, since v_H − v_L > 0, 0 ≤ p_H − p_L ≤ (v_H − v_L)/(1 + δ). (13) - Existence of Pareto-improving cooperative allocations: there exists α ∈ (0,1) uniquely such that MRS_L(p̂_L^E,p̂_H^E) = MRS_H(p̂_L^E,p̂_H^E); the efficient distribution (p̂_L^E,p̂_H^E) is a Pareto improvement of the NCNE. - Lemma 2 (comparative statics): - ∂R_L(p,p)/∂p < ∂R_H(p,p)/∂p - and - ∂R_L(p, p_H(p))/∂p > ∂R_H(p, p_H(p))/∂p - where p_H(p) defined by q_L(p,p_H(p)) = q_H(p,p_H(p)). - Proposition 2: A Pareto efficient Cooperative Nash Equilibrium that provides all countries with higher revenues than the Non-Cooperative Nash Equilibrium exists. Key feasibility check: 0 ≤ p̂_H − p̂_L ≤ (v_H − v_L)/(1 + δ). ### Operational recommendations (conditions to implement) - Implement a rule-based regional coordination mechanism using: - A uniform minimum price p_min and - A uniform maximum quota q_max to eliminate unilateral incentives to undercut prices and to cap quantities. - Verify implementability conditions: - Ensure countries with larger quantities charge higher prices. - Verify target satisfies 0 ≤ p_H − p_L ≤ (v_H − v_L)/(1 + δ) to be achievable by a CNE. - Build strong regional institutions and harmonized operational arrangements (due diligence, standards, protocols, information sharing) to support medium-term adoption of a price-quantity coordination mechanism. *Source: IMF working paper chapter "1. Limited fiscal space has long been an important policy challenge for the Caribbean" and related sections (wpiea2020176-print-pdf).* ### 1. Limited fiscal space has long been an important policy challenge for the Caribbean ### 1. Limited fiscal space has long been an important policy challenge for the Caribbean ### Overview / Context - Caribbean countries face high public debt and low growth, constraining their ability to raise revenue to finance investment in human capital and resilience to natural disasters and climate change. - Weak revenue performance is driven by sluggish growth, a narrow tax base, and the pervasive use of tax incentives. - The literature finds that the benefits of tax incentives on growth and employment are marginal at best (Chai and Goyal 2008, Parys and James 2010, and Klemm and Parys 2012). ### Tax incentives and the tourism sector - Tax incentives are common, especially in tourism, where countries compete for hotel and tourism investments and often feel compelled to offer packages to avoid losing investments to neighboring destinations. - Tax competition has intensified through measures such as lower statutory corporate income tax (CIT) rates, longer tax holidays (noted for Antigua and Barbuda), extended loss carry-forward years (Antigua and Barbuda and Grenada), and higher investment tax allowances/tax credits (Antigua and Barbuda and Grenada). - Concessions are also granted at customs for import duties, VAT, and excise taxes. ### Citizenship-by-Investment (CBI) programs in the ECCU - Five Eastern Caribbean Currency Union (ECCU) independent countries offer CBI programs: Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, and St. Lucia (the ECCU comprises six independent countries and two British Overseas Territories). - CBI programs grant foreign high-net-worth individuals citizenship or residency in exchange for financial contributions. - Observations: - CBI revenues contributed to 3.5 percent of GDP of the ECCU combined GDP in 2016. - ECCU citizenship programs are priced in the $100,000-200,000 range, while economic residence programs offered by advanced economies are at much higher prices. - Price competition within the ECCU has intensified, raising concerns on the integrity and credibility of CBIs and on fiscal sustainability for countries reliant on CBI revenues. ### Governance and international scrutiny - Lack of rules-based and transparent systems for revenue incentive policies creates governance challenges: discretionary, case-by-case incentive grants can foster unequal treatment and favoritism. - International scrutiny: as of March 2019, the EU list of non-cooperative tax jurisdictions included 15 jurisdictions, of which 7 are from the Caribbean: Aruba, Barbados, Belize, Bermuda, Dominica, Trinidad and Tobago and the U.S. Virgin Islands. - Lack of progress toward transparent tax systems increases risks of potential sanctions that could further constrain development resources. ### Estimating the fiscal costs for the ECCU - Measurement approach: - Tax expenditure includes CIT foregone revenue and cost of concessions at customs. - CIT foregone revenue estimated using sector-specific value-added from national accounts, with potential CIT base calculated as one-fourth of value-added for sectors benefiting from incentives (assumption from Chai and Goyal 2008). - Foregone customs revenue reflects indirect taxes and fees/charges waived on imports: import duties, excise taxes, and VAT. - Key estimates: - Total foregone revenue averaged 5.8 percent of GDP in 2010–18 in the ECCU. - Total foregone revenue equaled 21 percent of total tax revenue in the ECCU. - Measured against employment, the cost of tax incentives is equivalent to as high as $2,500 per job in the formal sector. - For the tourism sector, cost of tax incentives per job shows substantial variation across countries (figures presented in source). ### Cross-country analysis of tax incentives’ economic impact - Sample and scope: - Expanded analysis to ten tourism-based Caribbean countries: the six independent ECCU countries plus The Bahamas, Barbados, the Dominican Republic, and Jamaica. - Sample period: 1996-2018. - Main tax variables: statutory CIT rate, length of tax holidays, investment allowance rate; constructed a tax competition index measuring number of tax incentive changes per year. - Included estimated foregone revenue for ECCU countries and control variables: public consumption (compensation to employees + purchases of goods and services, expressed as percent of GDP), Real Effective Exchange Rate (REER), real U.S. PPP GDP, number of airlifts, stock of infrastructure, and a natural disaster dummy. - Econometric approach: - Dynamic panel specification with country fixed effects: F_{i,t} = δ F_{i,t-1} + T_{i,t} γ + X_{i,t} β + μ_i + ε_{i,t}. - Transformations: FDI, number of hotel rooms, infrastructure and U.S. PPP GDP logged; public consumption expressed as percent of GDP. - Estimations: country Fixed Effects (FE) and System IV-GMM; FE preferred given small sample size. - Main findings: - Changes in CIT rates and granting tax incentives are not statistically or economically significant in attracting overall FDI (FE and IV-GMM results). - Public consumption is statistically significant and negatively associated with FDI across all specifications. - REER is not a significant driver of FDI in most specifications. - Number of flights and U.S. PPP GDP coefficients are positive and statistically significant for FDI. - Stock of infrastructure is significant only when interacted with the natural disaster dummy, implying that public infrastructure provision enhances resilience and attractiveness post-disaster. - Using number of hotel rooms as proxy for tourism FDI yields mixed results: CIT rate is negatively associated with number of hotel rooms and statistically significant in some specifications; pooled OLS found that an increase in forgone revenue by 1 million EC dollars is associated with an increase in the number of hotel rooms by 0.2 percent for the ECCU. - Overall, tax incentive measures do not appear to have an impact on overall FDI, GDP growth, or employment for tourism-dependent Caribbean economies. ### Policy implications, trade-offs, and coordination - Evidence suggests large fiscal costs of tax incentives but limited economic benefits, consistent with prior literature. - There is a policy tradeoff between granting tax incentives and attracting FDI through better provision of public infrastructure; financing infrastructure may be more efficient for attracting investment than tax concessions. - Unilateral reductions in tax incentives are politically and economically difficult due to negative externalities and competitive pressures. - Recommendations and proposed mechanisms: - Better institutional coordination at the regional level (e.g., rule-based measures and enhanced transparency) could help address collective action problems and reduce wasteful tax competition. - For CBIs specifically, a coordinated price-quantity mechanism (illustrated with a two-country Bertrand competition model in later sections) can potentially raise revenues through combined price and quantity instruments. *Source: IMF working paper chapter "1. Limited fiscal space has long been an important policy challenge for the Caribbean" (wpiea2020176-print-pdf).* ### 19. The competition among the ECCU countries to attract foreign investment through the ### 19. The competition among the ECCU countries to attract foreign investment through the ### Recent CBI policy changes and competitive dynamics - Competition among the ECCU countries to attract foreign investment through the CBIs has intensified in recent years, exemplifying another race to the bottom in the region. - Country-specific amendments and timing: - Dominica amended its CBI requirements in end-2016, lowering the fee for the real estate investment option to expand hotel construction. - St. Lucia substantially eased the conditions for access by reducing the cost to generate more revenue and enhance the program’s competitiveness. - Antigua and Barbuda reduced the overall price nearly by half in late 2017. - St. Kitts and Nevis rolled out a Hurricane Relief Fund (HRF) in early 2018, lowering the price for donations to the development fund and allowing family members to come for free, to make the program more competitive and support real estate developers. ### Rationale for regional coordination and short-term priorities - A regional approach to manage the CBIs would help sustain the programs’ long-term viability and their contributions to public finance. - Short-term collective-action rationale: - Protect the programs’ financial integrity. - Dispel concerns relating to the tax rate on offshore income and residency period and other aspects of transparency standards to lower perceptions of abuse of CBI programs. - March 2019: the ECCU launched an initiative to harmonize CBI programs’ due diligence processes. - Implementation could help region-wide sustainability of the revenue flows and support financial stability. - Medium-term case: explore CBI program coordination on pricing and the use of quotas to support revenues over time. ### Theoretical framework: price (Bertrand) competition and asymmetry - Theoretical characterization: - CBI competition likened to a Bertrand price competition where countries use required CBI investment as a strategic variable (perceived by applicants as the price for citizenship). - Conventional wisdom: price competition can lead to a suboptimal outcome; policy coordination could improve joint outcomes (Deneckere and Davidson 1985). - Symmetric countries: minimum price or cap on number of new citizens can improve revenue. - Asymmetric demand across countries: - Two groups considered: low-demand countries (L) and high-demand countries (H) (e.g., differing freedom of travel associated with their citizenships). - Countries are identical within each category, with L facing less demand than H but with symmetric elasticities and identical constant marginal cost. - Demand functions assumed linear: q_i^j(p) = v_i - p_i^j - δ(p_i^j - p̄) where δ>0 is a substitutability parameter, p̄ is average price level, and v_H > v_L. (Notation preserved from source.) - In the Non-Cooperative Equilibrium: - H-type countries charge a higher price and grant a greater number of new citizenships than L-type countries. - Imposing a minimum price is more binding to Ls; a maximum quota on new citizenships is more restrictive to Hs. ### Pareto improvements via cooperation: price and quantity instruments - Moving from Non-Cooperative to Cooperative Equilibrium can yield Pareto improvements. - Cooperative Equilibrium prices determined by intersection of best response functions of L-types and H-types under cooperation. - Graphical intuition (Figure A1/A3 in Appendix 1 summarized): - Dashed blue line: iso-revenue curve for L-types at Non-Cooperative revenue. - Dashed green line: iso-revenue curve for H-types at Non-Cooperative revenue. - Shaded area: sets of prices that generate revenue improvement for both sets of countries relative to Non-Cooperative Equilibrium. - Equilibrium prices under a minimum price and a maximum quota are higher for Ls and Hs than their respective non-cooperative prices p_L^N and p_H^N. - Key theoretical insights (preserved language and logic): - Because the minimum price is always binding for the type-L countries (but not always the type-H countries), the marginal revenue from increasing the minimum price is always higher for the H-type; an additional increase in the minimum price generates more revenue for H-type countries than for L-type countries. - When the minimum price becomes high enough, its marginal benefit turns negative for L-type countries but remains positive for H-type countries. - Pareto efficiency is achieved when the revenue generated in H-type countries due to an additional unit to the minimum price equals the resulting loss of revenue for L-type countries; this Pareto-efficient outcome may not dominate the non-cooperation equilibrium outcome if only a minimum price or only a maximum quota is used. - Only a combination of both the minimum price and the maximum quota can ensure a “fair” distribution of the additional revenue from cooperation and, if chosen appropriately, the combination always guarantees an efficient outcome that is more profitable to both types compared to the non-cooperative equilibrium. - Any point between the blue line and the green line in Figure A3 can be achieved by setting a combination of a minimum price and a maximum quota; the green line always passes above (p̂_L, p̂_H) and the blue line always lies below (p̂_L, p̂_H). The set of efficient price distributions (black line) always passes through the shaded area; therefore a right combination of minimum price and maximum quota would guarantee an efficient outcome more beneficial to both types than the non-cooperative equilibrium. ### Empirical analogy and precedent for combined instruments - Cross-country policy coordination example: - Party to the Nauru Agreement (PNA) Vessel Day Scheme (VDS) coordinates limits on number of fishing days auctioned per member per year and sets a minimum benchmark fee for a fishing day. - Outcomes of the Scheme: - Increased revenue for parties through licensing fees. - Decreased catch to ensure sustainable fishing. - Leveraged PNA into a stronger international negotiator than parties individually (Bernadett, 2014). - Note: Full compliance with VDS rules has proven difficult, partly due to preexisting multilateral fishing access and trade agreements with major international players such as the EU and the U.S. (Yeeting et al 2018). ### Conclusion and policy recommendations - Tax incentives are costly for the Caribbean countries, yet benefits seem limited. - Cross-country analysis points to a tradeoff: - Offering generous incentive packages to foreign investors versus attracting FDI through better provision of public infrastructure—the latter is particularly important when economies are hit by natural disasters. - Policy recommendations: - Streamline tax incentives and use fiscal savings to finance needed infrastructure investment. - Regional policy integration is the most feasible solution to collective-action problems caused by negative externalities of tax incentives. - Pragmatic institutional approach: - Advance institutional integration in the Caribbean, e.g., establish a common regime for protection, promotion and facilitation of investments by adopting common investment/business agreement (see Al-Hassan et al 2020 for detailed discussion). - This would likely require political backing and commitment to cooperating and setting up a regional institution with a clear political mandate to supervise and enforce the agreement. - Structural reforms to improve the business environment are important to strengthen the region’s competitiveness in the global tourism market. *Source: wpiea2020176-print-pdf - 19. The competition among the ECCU countries to attract foreign investment through the* ### 28. While f easible, a rule-based mechanism can be introduced to ensure regional policy ### 28. While feasible, a rule-based mechanism can be introduced to ensure regional policy coordination ### Regional coordination and CBI policy summary - Coordination mechanism using price and quantity instruments can help countries reach an efficient outcome and higher CBI revenues. - Removing incentives for a race-to-the-bottom protects the integrity and long-run sustainability of CBIs as an important revenue source for the ECCU countries. - ECCU authorities have harmonized due diligence arrangements, adopted common standards and application protocols, and are sharing information. - With strong regional institutions, a regional CBI price and quantity mechanism can be considered over the medium term with the goal to maximize economic benefits of these programs. ### Empirical findings from panel and OLS regressions (Tables 1–5) - Dependent variables studied include: FDI, The Number of Hotel Rooms, Overall GDP, Total Employment. - Key estimated coefficients and significance patterns (selected exact values from tables): - Table 1 (Effect on FDI, GMM): - CIT rate: 0.006 0.001 -0.001 0.006 0.028 0.016* - Tax holiday: -0.042* -0.091*** - Investment allowance rate: -0.002 -0.006** - Public consumption: -0.055 -0.088** -0.063 -0.055 -0.087** -0.200*** - US PPPGDP: 0.591** 0.547** 0.725** 0.590** 0.884*** 0.976*** - Observations: 140 140 102 140 96 81; Number of countries: 10 10 10 10 10 10; R-squared: 0.565 0.576 0.504 0.565 0.445 - Table 2 (Effect on Number of Hotel Rooms, GMM): - CIT rate (lag): -0.006 -0.006 -0.013** -0.006 -0.009 0.006 - Tax holiday (lag): -0.004 -0.074*** - Investment allowance rate (lag): -0.003* -0.002 - Infra. stock (lag 2): 0.113*** 0.116*** 0.110** 0.110*** 0.073 -0.214* - Observations: 135 135 101 135 93 80; Number of countries: 10 10 10 10 10 10; R-squared: 0.540 .317 0.319 0.468 0.327 - Table 3 (Effect on Number of Hotel Rooms, OLS): - CIT rate (lag) entries: -0.017*** 0.000 0.027*** 0.001 0.031** - Tax competition index (lag): 0.170** - Foregone revenue (lag): 0.002*** - Public consumption: -0.064*** -0.124*** -0.173*** -0.124*** -0.134*** - Number of flights (lag): 0.033*** 0.041*** 0.050*** 0.041*** 0.085*** - Observations: 135 135 101 135 93; Number of countries: 10 10 10 106; R-squared: 0.882 0.894 0.843 0.899 0.639 - Table 4 (Effect on Growth, Fixed Effect Panel): - CIT rate: 0.005*** 0.004*** 0.003** 0.004** - Public consumption: -0.014*** -0.015*** -0.010*** -0.009** - US PPPGDP: 0.067*** 0.067*** 0.116*** 0.108*** - Infra. stock (lag): 0.022* 0.019 0.009 0.026 - Observations: 160 157 115 96; Number of countries: 11 11 11 16; R-squared: 0.935 0.935 0.921 0.911 - Table 5 (Effect on Employment, Fixed Effect Panel): - CIT rate: 0.004*** 0.005*** 0.003* 0.005** - Public consumption: -0.007** -0.006* -0.004 -0.005 - US PPPGDP: 0.074*** 0.080*** 0.095*** 0.104** - Infra. stock (lag): 0.026* 0.023 0.040* 0.018 - Observations: 150 147 105 86; Number of countries: 11 11 11 16; R-squared: 0.82 0.83 0.76 0.79 - Note: the tax competition index measures the number of tax incentive changes within a year. - Source for empirical tables: IMF staff calculations. ### Appendix: Price-Quantity Coordination Mechanism for CBIs — model and main theoretical results Model setup and primitives - There exist n≥2 independent countries. Demand for each country i,j: q_i(j)(p) = v_i - p_i_j - δ(p_i_j - p̄) with δ>0, p̄ the average price and v_H > v_L. - Total cost for providing citizenships is constant C and marginal cost is zero. - Each country maximizes revenue R_i_j(p) = p_i_j q_i_j(p) − C. - Countries are classified into types L or H; n_L and n_H denote counts with n_L + n_H = n. Definitions and equilibrium concepts - Pareto efficient price distribution: no other price distribution improves revenue for all countries with at least one strict improvement (supply-side Pareto efficiency). - Non-Cooperative Nash Equilibrium (NCNE): price vector p̃_N where no country can unilaterally increase its revenue. First-order condition yields symmetric prices for same-type countries and explicit equilibrium expressions p_L_N and p_H_N given by equations (2) and (3) (unique NCNE exists and is Pareto inefficient). - Cooperative Nash Equilibrium (CNE): countries commit to a uniform minimum price p_min and uniform maximum quota q_max; each country plays best response subject to p_k ≥ p_min and q_i_j(·) ≤ q_max. Best responses for type i summarized by P_i(·) and constrained forms P_i_qmin(·) and P_i_0(·) (equation (6) and explicit P_i_qmax in (7)). Main theoretical results (exact statements preserved) - Proposition 1: For every minimum price P_min>0 and maximum quota q_max>0 there exists a unique Cooperative Nash Equilibrium. - Proof sketch elements preserved: define F(p) = P_L(P_H(p)) − p; F is continuous and decreasing; F(0) ≥ p_min > 0; lim_{p→+∞} F(p) = −∞; by intermediate value theorem there exists a unique p_L_C>0 with F(p_L_C)=0; p_H_C ≡ P_H(p_L_C). - Implementability condition (Lemma 1): A Pareto efficient price distribution (p_L^E, p_H^E) with corresponding quantities (q_L^E, q_H^E) is achievable by a CNE with appropriate p_min and q_max if and only if countries with larger quantities charge higher prices. Then q_max = max{q_L^E, q_H^E} and p_min = min{p_L^E, p_H^E}. - Feasibility/characterization constraint (equation preserved): - Let Δp ≡ p_H − p_L and Δq ≡ q_H − q_L. Then Δq Δp ⟺ - if Δq ≥ 0 then Δp ≥ 0 - if Δq ≤ 0 then Δp ≤ 0 - Equivalently, since v_H − v_L > 0, Δq Δp ≥ 0 is equivalent to 0 ≤ p_H − p_L ≤ (v_H − v_L)/(1 + δ). (13) - Existence of Pareto-improving cooperative allocations: - Define (p̂_L, p̂_H) that gives the same revenue as the NCNE and (p̂_L^E, p̂_H^E) a convex combination of (p̂_L, p̂_H) and (p_L_N, p_H_N). There exists α ∈ (0,1) uniquely such that MRS_L(p̂_L^E,p̂_H^E) = MRS_H(p̂_L^E,p̂_H^E). The efficient distribution (p̂_L^E,p̂_H^E) is a Pareto improvement of the NCNE. - Lemma 2 (comparative statics, exact inequalities preserved): - H-type countries benefit more (or lose less) from an increase in a common price, while they benefit less (or lose more) from a decrease in a common quantity, i.e., ∂R_L(p,p)/∂p < ∂R_H(p,p)/∂p and ∂R_L(p, p_H(p))/∂p > ∂R_H(p, p_H(p))/∂p - where p_H(p) defined by q_L(p,p_H(p)) = q_H(p,p_H(p)). - Proposition 2 (existence of Pareto efficient cooperative equilibrium improving on NCNE): - A Pareto efficient Cooperative Nash Equilibrium that provides all countries with higher revenues than the Non-Cooperative Nash Equilibrium exists. - Key feasibility condition to check: 0 ≤ p̂_H − p̂_L ≤ (v_H − v_L)/(1 + δ). Illustrative geometry (as described) - The set of Pareto efficient allocations is a continuum; only a subset dominates the NCNE. - Efficient allocation curve never intersects unconstrained best responses: without coordination, each country has incentive to undercut. - Graphical arguments show there always exists an efficient distribution lying between the iso-revenue lines (blue/green) that can be implemented with the right p_min and q_max and that is more beneficial to all types than the NCNE. ### Policy implications and operational recommendations (as derived in the text) - Implement a rule-based regional coordination mechanism using: - A uniform minimum price (p_min) and - A uniform maximum quota (q_max) to eliminate unilateral incentives to undercut prices and to cap quantities. - Conditions for implementability and Pareto improvements must be verified: - Ensure countries with larger quantities charge higher prices (so the implementability condition holds). - Verify the efficient target satisfies 0 ≤ p_H − p_L ≤ (v_H − v_L)/(1 + δ) to be achievable by a CNE. - With strong regional institutions and harmonized operational arrangements (due diligence, standards, protocols, information sharing), consider adopting a price-quantity regional coordination mechanism over the medium term to maximize economic benefits and CBI revenue sustainability. *Source: wpiea2020176-print-pdf (IMF staff calculations, Appendix: A price-quantity coordination mechanism for CBIs).* ### REFERENCES ### REFERENCES ### Core topics and works cited - Regional integration and Caribbean policy: - Al-Hassan A, Burfisher, M., Chow, J., Ding, D., Di Vittorio, F., Kovtun, D., McIntyre, A., Ötker, I., Santoro, M., Shui, L. and K. Youssef, 2020, “Is the Whole Greater than the Sum of its Parts? Strengthening Caribbean Regional Integration,” IMF Working Paper 2020/08 - McIntyre, M., 2017, “Tax Incentives: To use or Not To use?” In Unleashing Growth and Strengthening Resilience in the Caribbean, 101-122. International Monetary Fund, Washington DC - James, S. and S. Van Parys, 2010, “The effectiveness of Tax Incentives in Attracting FDI: Evidence from the Tourism Sector in the Caribbean,” - Tax incentives, tax competition, and fiscal impacts: - Chai, J. and Goyal, R., 2008, “Tax Concessions and Foreign Direct Investment in the Eastern Caribbean Currency Union,” IMF Working Paper 08/257 - Klemm, A. and S. Van Parys, 2009, “Empirical Evidence on the Effects of Tax Incentives,” IMF Working Paper 09/136, (Washington: International Monetary Fund). - Fisher, P. 2007. The Fiscal Consequences of Competition for Capital, W.E. Upjohn Institute for Employment Research, Kalamazoo. - Luger, M. and Bae, S. 2005, ‘The Effectiveness of State Business Tax Incentive Programs: The Case of North Carolina.’ Economic Development Quarterly, Vol. 19 (4) - Institute of Policy Analysis and Research (IPAR), 2011, East African Taxation Project: Rwanda Case Study, www.ipar.org - Theoretical and empirical foundations in industrial organization and competition: - Bénassy-Quéré, A., Gobalraja, N. and A. Trannoy, 2007, “Tax and Public Goods Competition,” Economic Policy, Vol. 22, No. 50 - Friedman, J, 1983. Oligopoly Theory. Press Syndicate of the University of Cambridge - Martin, S., 2009, “Microfoundations for the Linear Deman d Product Differentiation Model, with Applications,” Institute f or Research in the Behavioral, Eco nomic, and Management Sciences, (1221) - Fanti, L. and L. Gori, 2011, “The dynamics of a Bertrand duopoly with differentiated products and bounded rational firms revisited,” Munich Persona RePEc Archive, (33268) - Fisheries, international agreements, and cooperative management: - Bernadett, L., 2014, “The Parties to the Nauru Agreement’s Vessel Day Scheme: Accounting for the Rare Success of an International Agreement.” - Yeeting, A., Weikard, H., Bailey, M., Ram-Bidesi, V. and S, Bush, “Stabilizing Cooperation through Pragmatic Tolerance: the Case of the Parties to the Nauru Agreement (PNA) Tuna Fishery,” Reg Environ Change (2018) 18:885–897. - Migration, investment inflows, and citizenship programs: - Xu, X, El-Ashram A. and J. Gold, 2015, “Too Much of A Good Thing? Prudent Management of Inflows under Economic Citizenship Programs,” IMF Working Paper 15/93 ### Key document identifiers and publication details (as cited) - IMF Working Paper identifiers: 2020/08; 08/257; 09/136; 15/93 - Journal and series details preserved exactly as cited: Economic Policy, Vol. 22, No. 50; Economic Development Quarterly, Vol. 19 (4); Reg Environ Change (2018) 18:885–897 *wpiea2020176-print-pdf - REFERENCES* --- _Source: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020176-print-pdf.pdf_