## 1. Regional Comparisons: GDP Growth and Tourism Receipts

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### Introduction and scope
- Tax concessions defined as preferential tax treatment for certain types of firms or entities.
- Purposes: promote investment ("tax incentives" or "investment incentives") or achieve social objectives.
- Examples: corporate income tax (CIT) holidays for five to ten years; exemptions from import-related duties and taxes on capital imports or a wide range of imported goods for statutory or civic bodies or nonprofit organizations.
- Cross-country evidence: overall economic characteristics often more important for attracting successful investments than tax incentives; tax incentives are not generally cost effective (Zee, Stotsky, and Ley, 2002). A survey of 159 multinational firms in the Caribbean found tax concessions were not among the top 15 of 40 critical investment areas (Foreign Investment Advisory Service, 2004; World Bank, 2005).
- Content unit scope: documents concessions in six ECCU countries (Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines); assesses revenue forgone; evaluates effect of tax incentive regimes on FDI using indices from Wei (2000) expanded to many developing and emerging market economies.

### Main finding (summary)
- ECCU countries rely heavily on tax concessions; reliance increased significantly in Antigua and Barbuda and in St. Kitts and Nevis.
- Estimated tax revenues forgone:
  - Range between 9½ and 16 percent of GDP annually.
  - As a percent of current revenues, losses range between 30 and 70 percent.
- Effect of tax incentive regimes on FDI appears modest.

### Concession practices and governance
- Legal instruments used: Fiscal Incentives Act, Aid to Pioneer Industries Act, Hotels Aid Act, sector-specific acts (Offshore Banking Act, International Business Companies Act), Common External Tariff Act, and other legislation or arrangements.
- Typical concession forms:
  - Import-related tax exemptions (most common; exemptions on capital goods, raw materials, equipment; may be 100 percent or lesser amounts and of varying lengths).
  - Corporate Income Tax (CIT) holidays (vary in amount and length; some tourism tax holidays extended from a maximum of 5 to 25 years).
- Granting process characteristics:
  - Authority typically vested with Cabinet and/or minister of finance; broad discretion.
  - Little public disclosure, limited monitoring, weak enforcement of conditions.
- Consequences: scope for rent-seeking, unequal treatment, market distortion, favoritism, potential abuse.

### Firm-level sample and stylized facts
- Sample: 145 firms receiving concessions (1996–2000); sectors: services, trade, light manufacturing; tourism excluded due to lack of data.
- Concession incidence in sample:
  - All firms received exemptions from import-related taxes; about half also received CIT exemptions.
  - Average tax holiday: 2.6 years.
  - Average reduction in effective CIT rate: 32 percent.
  - Average reduction in effective import duty and consumption tax rate: 91 percent.
- Other sample facts:
  - 1 of 10 firms received an export allowance.
  - 1 of 4 received either a tax holiday extension or expanded import/consumption tax exemptions.
  - Concessions granted to new and existing firms; in 1996–97 about half of firms receiving incentives had been previously established; 1 of 4 existing firms had concessions extended during 1996–97.
- Size correlations (rank correlation analysis; significance at 5 percent denoted by *):
  - Employment vs. Years of Tax Concession Holidays: 0.337* (No. obs (161))
  - Employment vs. Reduction in Effective CIT: 0.320* (No. obs (161))
  - Employment vs. Reduction in Effective Tariff: 0.015 (No. obs (163))
  - Capital vs. Years of Tax Concession Holidays: 0.208* (No. obs (138))
  - Capital vs. Reduction in Effective CIT: 0.177* (No. obs (138))
  - Capital vs. Reduction in Effective Tariff: -0.082 (No. obs (140))

### Purposes of concessions (Dominica and St. Vincent and the Grenadines, early 2000s)
- Customs revenue forgone by purpose (Table 2, In percent of total; classification based on SRO 18 codes of 2001):
  - Fiscal incentives 2/: Dominica 30.2; St. Vincent and the Grenadines 9.5
  - Special cabinet decisions: Dominica 21.0; St. Vincent and the Grenadines 23.3
  - Government agreements 3/: Dominica 15.8; St. Vincent and the Grenadines 33.1
  - Government and statutory bodies: Dominica 9.2; St. Vincent and the Grenadines 13.7
  - Personal effects and vehicles: Dominica 7.0; St. Vincent and the Grenadines 1.5
  - Tourism: Dominica 3.9; St. Vincent and the Grenadines 0.3
  - Civil servants and Parliamentarians 4/: Dominica 3.5; St. Vincent and the Grenadines 0.3
  - Primary industry: Dominica 2.5; St. Vincent and the Grenadines 0.7
  - Military and diplomat: Dominica 2.5; St. Vincent and the Grenadines 0.8
  - Other approved purposes: Dominica 2.0; St. Vincent and the Grenadines 1.2
  - Charities and Churches: Dominica 1.4; St. Vincent and the Grenadines 0.3
  - Education, culture, and health: Dominica 0.9; St. Vincent and the Grenadines 0.8
  - Transportation: Dominica 0.0; St. Vincent and the Grenadines 0.6
  - Unclassified: Dominica 0.0; St. Vincent and the Grenadines ...
- Interpretation: Fiscal Incentives and Hotels Aid Acts plus government agreements account for less than 50 percent of customs duty concessions; special cabinet decisions about 20 percent; government and statutory bodies about 9 to 14 percent. Less than half of concessions were for investment purposes; the rest for social and welfare purposes.

### Revenue costs of concessions (aggregate findings)
- Revenue loss components: forgone revenue, efficiency losses, administrative costs, social costs from corruption/rent-seeking.
- Main quantitative findings:
  - Overall revenue losses from concessions on import-related taxes and the CIT range between 9½ and 16 percent of GDP a year.
  - As a percent of current revenues, losses range between 30 and 70 percent.
  - By comparison, a study on the Philippines estimated revenue forgone at 1 to 2 percent of GDP annually (Easson, 2004).
- Exemptions from import duties and taxes:
  - Revenue forgone from concessions on import duties or taxes have exceeded 8 percent of GDP annually and have increased over the past decade.

### Customs revenue forgone (1991–2003, In percent of GDP)
- Difference between statutory and effective import-related tax rates:
  - Ranges from more than 8 percent in Dominica to more than 22 percent in Antigua and Barbuda.
- Estimated average customs revenue losses for ECCU:
  - Average losses nearly 8 percent of GDP for the region.
  - Country ranges about 4 percent of GDP in Dominica to over 12 percent in St. Kitts and Nevis.
- Table 3 customs revenue forgone (1991–93; 2001–03, In percent of GDP):
  - Antigua and Barbuda: 5.1 (1991–93), 9.2 (2001–03)
  - Dominica: 4.2, 4.3
  - Grenada: 11.4, 11.3
  - St. Kitts and Nevis: 5.8, 12.2
  - St. Lucia: 5.9, 5.9
  - St. Vincent and the Grenadines: 6.7, 6.1
  - ECCU average: 6.5, 8.2
- Observations:
  - Concessions increased since early 1990s, especially in Antigua and Barbuda and St. Kitts and Nevis.
  - Customs revenue forgone in Antigua and Barbuda and St. Kitts and Nevis was about 5 percent of GDP a year higher in 2001–03 compared with early 1990s.
  - Given stable dollar exchange rate and CPI inflation around 2 percent over the past decade, increases likely reflect higher incidence or more generous terms of concessions rather than import-price inflation.

### Corporate income tax (CIT) holidays and forgone revenue
- Method: Forgone revenue from CIT holidays estimated from difference between statutory and effective CIT rates.
- Assumption for effective CIT base: corporate income tax base assumed to be 25 percent of GDP (in line with Jamaica) due to lack of national accounts income-side data for ECCU members.
- Statutory and effective CIT rates:
  - Statutory rates have ranged between 30 and 40 percent in the region.
  - Effective rates are between 6 and 20 percent.
- Estimated forgone revenue from CIT concessions (2003, In percent of GDP):
  - Range from 3 percent of GDP in Grenada to about 6 percent of GDP in Antigua and Barbuda (Figure 3 referenced).
- CIT yield trends (Table 4, In percent of GDP):
  - ECCU average yield fell from 3.5 percent of GDP (1990–94) to 3 percent (1999–2003).
  - Country examples: Antigua and Barbuda 2.1 (1990–94) to 2.5 (1999–2003); Dominica 3.4 to 0.9; Grenada 3.2 to 3.6; St. Lucia 4.2 to 4.0; St. Vincent and the Grenadines 4.5 to 4.4.
- Caveats on estimates:
  - Differences between statutory and effective rates may reflect treatment of investment, depreciation, interest, debt-equity ratios, and administrative leakages.
  - Weak tax administration implies part of estimated revenue loss may be due to leakages rather than concessions, biasing estimates upward.
  - Profit distribution skewed toward large profitable firms (often recipients of tax holidays) could mean actual CIT base is larger and effective rates overestimated, biasing forgone-concession estimates downward.

### Revenue gains from removing concessions: elasticity-based illustration
- Framework: revenue change from removing concessions depends on price elasticities of import demand and corporate incomes.
- Empirical import price elasticities for developing countries cited: range between –1.0 and –0.4.
- Assumption used for illustrative calculation: price elasticity = -0.7 for both import volumes and corporate incomes.
- Estimated revenue gain from removing concessions (elasticity = -0.7, In percent of GDP):
  - Revenue gain = 9 percent of GDP on average for the ECCU.
  - Country values (Table 5):
    - Antigua and Barbuda: Import-related Taxes 6.2; Corporate Income Taxes 4.2; Total 10.4
    - Dominica: 3.1; 4.1; 7.2
    - Grenada: 7.8; 2.4; 10.2
    - St. Kitts and Nevis: 9.0; 3.0; 12.0
    - St. Lucia: 4.6; 2.9; 7.6
    - St. Vincent and the Grenadines: 4.1; 3.2; 7.3
    - ECCU average: 5.8; 3.3; 9.1

### FDI performance and benefits of incentives
- Key observation: Despite increased concessions, ECCU’s world ranking of FDI as a share of GDP has fallen.
- FDI performance index trends (Table 6; index = country FDI inflow share in world's FDI inflow divided by share of country's GDP in world's GDP):
  - ECCU fell from fifth to twentieth by 2002 in average ranking among more than 150 countries.
  - ECCU Caribbean FDI inflows declined from 12.3 to 3.7 percent over the period noted (World Bank, 2005).
  - ECCU index by period: 1979–83 16.0; 1984–88 11.7; 1989–93 11.7; 1994–98 8.1; 1999–2003 4.3.
  - Country examples: Antigua and Barbuda 24.1 (1979–83) to 2.6 (1999–2003); St. Lucia 37.4 to 2.3.
- Data limitations: no routine data on employment generated by incremental investments or other taxes derived from them; prevents full cost-benefit analysis for job creation or net revenue gain.
- Sample evidence: concession terms positively correlated with firm size (capital and employment).

### Cross-country indices and regression evidence
- Indices constructed using Wei (2000) methodology expanded to 80 countries: FDI restrictions index and FDI incentives index.
- Additional regressors: statutory CIT rate, average import tariff rate, institutional quality (governance index sum of six dimensions), quality of infrastructure (roads index).
- ECCU summary statistics (Table 7 highlights):
  - ECCU statutory corporate income tax rate mean: 35.0
  - ECCU average import tariff: 24.2
  - ECCU quality of institutions mean: 3.1
  - ECCU quality of infrastructure mean: 24.2
- Bivariate correlations:
  - FDI restrictiveness negatively and significantly correlated with FDI (Rank correlation: –0.46***).
  - Little evidence that FDI incentives are associated with higher FDI (Rank correlation: –0.15).
  - Statutory CIT rates and import-related tax rates negatively related to FDI (rank correlations –0.15* and –0.23*** respectively).
- Cross-country OLS regression results (selected findings):
  - Incentives index is insignificant across specifications (no robust positive association between incentives index and FDI).
  - FDI restrictions index negatively associated with FDI (coefficients often negative and significant).
  - Higher statutory corporate income tax rates negatively associated with Ln(FDI/GDP) and Ln(FDI per capita) in some specifications (example coefficients: corporate income tax –0.047** in Table 8; –0.056** in Table 9).
  - Quality of institutions positively associated with FDI per capita (example coefficient 0.264**).
  - ECCU fixed effect appears and can be significant in specifications.
- Interpretation: evidence supports importance of lower statutory CIT rates, absence of FDI restrictions, and better institutional quality for attracting FDI; little robust support that concessional incentives themselves raise FDI.

### Policy alternatives and recommendations
- Re-evaluate incentive strategy urgently; consider regional harmonization to limit revenue losses and prevent tax competition.
- Priority strategy: improve investment climate rather than increase concessions. Key measures:
  - Improve regulatory environment.
  - Develop infrastructure.
  - Lower statutory tax rates (subject to macroeconomic constraints).
  - Raise labor productivity through skills acquisition and labor market reform.
- Fiscal transparency and monitoring:
  - Strengthen data gathering on costs and benefits of tax concessions through routine monitoring and review.
  - Publish cost of all concessions regularly in a tax expenditure annex to the budget.
- Principles for granting concessions:
  - Concessions should be nondiscretionary, transparent, and limited in size, duration and scope.
  - Make concession-related investment legislation rule-based with clear eligibility criteria.
  - Eliminate ad hoc concessions for social and welfare purposes; incorporate social spending in budget process (Dominica policy since mid-December 2003: do not grant ad hoc import concessions).
  - Respect fiscal constraints; avoid borrowing to provide concessions.
- Choice of instruments:
  - CIT holidays: easy to administer but tend to benefit high-profit investors who may have invested without the holiday; increase potential for tax avoidance (transfer pricing); hinder record-keeping and oversight.
  - Indirect tax incentives (import-related exemptions): prone to abuse (diversion of qualified purchases); should be avoided.
  - Tax credits for investment: target investment directly, require tax returns; disadvantages include reducing tax liability to zero in some periods, distortion toward short-lived assets, potential for multiple-claim abuse; monitoring and minimum holding periods recommended.
  - Accelerated depreciation and loss-carry-forward provisions: target investment, enhance transparency, do not distort toward short-lived assets, reduce abuse potential; may provide smaller benefits than tax credits but preferable to holidays for projects with initial losses (e.g., hotel and tourism projects).
- Illustrative comparisons (assumptions: tax rate 30 percent, discount rate 10 percent):
  - Tax holidays example (Table 10, $30 investment over 3 periods): present value of profits under 1-period holiday = -2.7; 2-period holiday = 1.3; 3-period holiday = 0.0.
  - Accelerated depreciation and loss carry forward example (Table 11): present value of profits = 1.9; more profitable than tax holidays in the example due to accelerated initial depreciation and loss carry forward.

### Conclusions (summary)
- Tax concessions have been a central component of ECCU investment strategy, primarily through import-related tax concessions and CIT holidays, applied with substantial discretion.
- Larger firms received more incentives for longer durations.
- Evidence indicates limited benefits in terms of FDI but substantial costs in forgone revenue.
- Estimated forgone revenue from tax concessions range from 9½ to 16 percent of GDP annually for ECCU countries.
- Recommended policy actions:
  - Re-evaluate and possibly regionalize incentive strategies.
  - Focus on enhancing investment climate (regulatory reform, infrastructure, lower statutory tax rates, labor productivity).
  - Reduce or phase out concessions and broaden tax base.
  - Monitor and publicize costs and benefits of concessions routinely.
  - When granted, make incentives nondiscretionary, transparent, limited; prefer accelerated depreciation and loss-carry-forward over tax holidays; avoid indirect tax incentives.

*Source: _wp08257 (excerpt provided).*

### 1. Regional Comparisons: GDP Growth and Tourism Receipts........................................7

### 1. Regional Comparisons: GDP Growth and Tourism Receipts

### Introduction
- Tax concessions are defined as preferential tax treatment for certain types of firms or entities.
- Concessions are used to promote investment ("tax incentives" or "investment incentives") or to achieve social objectives.
- Examples: corporate income tax (CIT) holidays for five to ten years; exemptions from import-related duties and taxes on capital imports or a wide range of imported goods for statutory or civic bodies or nonprofit organizations.
- Cross-country evidence: emerging consensus that overall economic characteristics may be more important for attracting successful investments than tax incentives; tax incentives are not generally cost effective (Zee, Stotsky, and Ley, 2002).
- A survey of 159 multinational firms operating in the Caribbean found tax concessions were not among the top 15 of the 40 areas critical for investments (Foreign Investment Advisory Service, 2004; World Bank, 2005).
- Increasingly generous concessions documented in some cases, including extensions of tax holidays.

### Scope of this content unit
- Documents the use of concessions in six Eastern Caribbean Currency Union (ECCU) member countries.
- Assesses costs in terms of revenue forgone.
- Evaluates effect of tax incentive regimes on FDI in a wide sample of countries using measures of tax incentive regimes as constructed in Wei (2000), expanded to cover many developing and emerging market economies.
- The six ECCU countries studied: Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

### Main finding (summary)
- ECCU countries rely heavily on the use of tax concessions.
- Reliance on these concessions has increased significantly in Antigua and Barbuda and in St. Kitts and Nevis.
- Tax revenues forgone are large, ranging from 9½ to 16 percent of GDP annually.
- As a percent of current revenues, losses range between 30 and 70 percent.
- The effect of tax incentive regimes on FDI appears to be modest.

---

### Tax concessions in the ECCU: practices and features
- Concessions are provided through Fiscal Incentives Act, Aid to Pioneer Industries Act, Hotels Aid Act, sector-specific acts (Offshore Banking Act, International Business Companies Act), Common External Tariff Act, and other specific legislation or arrangements.
- Typical concession forms: import-related tax exemptions and Corporate Income Tax (CIT) holidays.
- Exemptions on importation of capital goods (raw materials and equipment) are most common; may be 100 percent or lesser amounts and of varying lengths.
- CIT holidays vary in amount and length; some tourism tax holidays extended from a maximum of 5 to 25 years.
- Granting process characterized by discretion, lack of transparency, and limited monitoring:
  - Cabinet and/or minister of finance typically vested with authority and broad discretion.
  - Little public disclosure on decision-making and awards.
  - Little enforcement of conditions on awarded incentives.
- Consequences noted: scope for rent-seeking, unequal treatment, market distortion, favoritism, potential abuse.

---

### Firm-level analysis (sample and stylized facts)
- Sample: 145 firms in the region receiving concessions from 1996 through 2000; sectors covered include services, trade, and light manufacturing; tourism facilities excluded due to lack of data.
- All sampled firms received exemptions from import-related taxes; about half also received CIT exemptions.
- Firm size range: employment from 2 to 450; capital investment from about US$3,500 to US$5 million.
- Average concessions in sample:
  - Average tax holiday: 2.6 years.
  - 32 percent reduction in the effective CIT rate.
  - 91 percent reduction in the effective import duty and consumption tax rate.
- Other sample facts:
  - One of 10 firms received an export allowance.
  - One out of four received either a tax holiday extension or expanded coverage in import duties and consumption tax exemptions.
  - Concessions granted to both newly-established and existing firms; in 1996–97, about half of firms receiving incentives had already been established, some several decades earlier; one of four existing firms had their concessions extended during 1996–97.
- Firm size correlations (Table 1: Rank Correlation Analysis):
  - Employment: Years of Tax Concession Holidays coefficient 0.337* (No. obs (161)); Reduction in Effective CIT 0.320* (No. obs (161)); Reduction in Effective Tariff 0.015 (No. obs (163)); Export Allowance 0.171* (No. obs (163)); Extension 0.123 (No. obs (165)).
  - Capital: Years of Tax Concession Holidays coefficient 0.208* (No. obs (138)); Reduction in Effective CIT 0.177* (No. obs (138)); Reduction in Effective Tariff -0.082 (No. obs (140)); Export Allowance 0.110 (No. obs (141)); Extension 0.197* (No. obs (141)).
  - Note: * denotes significance at 5 percent.

---

### Purposes of concessions (evidence from Dominica and St. Vincent and the Grenadines)
- Detailed breakdown available only for Dominica and St. Vincent and the Grenadines for the early 2000s; customs revenue forgone by purpose reported (Table 2).
- Table 2 (Concessions by Purpose, 2001-2003 1/ — In percent of total; classification based on SRO 18 codes of 2001):
  - St. Vincent and
  - Dominicathe Grenadines
  - Fiscal incentives 2/30.29.5
  - Special cabinet decisions21.023.3
  - Government agreements 3/15.833.1
  - Government and statutory bodies9.213.7
  - Personal effects and vehicles7.01.5
  - Tourism3.90.3
  - Civil servants and Parliamentarians 4/3.50.3
  - Primary industry2.50.7
  - Military and diplomat2.50.8
  - Other approved purposes2.01.2
  - Charities and Churches1.40.3
  - Education, culture, and health0.90.8
  - Transportation0.00.6
  - Unclassified0.0...
- Interpretation from the data: concessions under Fiscal Incentives and Hotels Aid Acts plus government agreements accounted for less than 50 percent of total customs duty concessions; special cabinet decisions accounted for about 20 percent; government and statutory bodies accounted for about 9 to 14 percent. Less than half of concessions were for investment purposes; the rest were for social and welfare purposes.

---

### Revenue costs of concessions
- Granting tax concessions entails:
  - Efficiency losses from preferential treatment.
  - Revenue costs from forgone revenue.
  - Administrative costs.
  - Social costs from corruption or rent-seeking associated with abuse of concession provisions.
- Customs and excise departments compile data on revenue costs of import-related concessions; data for 2001–03 permit estimation of revenue forgone from import duties and consumption taxes for each of the six ECCU countries.
- Main quantitative findings:
  - Overall revenue losses from concessions on import-related taxes and the CIT range between 9½ and 16 percent of GDP a year.
  - As a percent of current revenues, losses range between 30 and 70 percent.
  - By comparison, a study on the Philippines estimated revenue forgone at 1 to 2 percent of GDP annually (Easson, 2004).
- Exemptions from import duties and taxes:
  - Revenue forgone from concessions on import duties or taxes have exceeded 8 percent of GDP annually and have increased over the past decade.
  - Data collected by customs and excise departments show that, in the early 2000s, exemptions granted ranged from (text truncated in source).

---

### Additional contextual findings and literature links
- Competition in the tourism market has been cited as a justification for widespread use of incentives; hotel room capacity increased sharply in the wider Caribbean while hurricane-related damage to ECCU hotel capacity (e.g., Antigua and Barbuda) was significant.
- Perverse effects noted:
  - Incentive dependence: investment decisions and existing firms become anchored around incentives, leading to quasi-permanent subsidies.
  - Competitive outbidding among countries can render incentives excessively generous and cost-ineffective.
- Related literature and prior ECCU work summarized:
  - Bain (1995) assessed costs in early 1990s.
  - Andrews and Williams (1999) suggested streamlining administration of concessions.
  - Lecraw (2003) advocated coordinated, harmonized approach to granting concessions.
  - Wei (2000) constructed measures of tax incentive regimes; this study expands Wei’s sample.

*Source: _wp08257 - 1. Regional Comparisons: GDP Growth and Tourism Receipts (excerpt).*

### 4.3 percent of GDP in Dominica to 12.2 percent in St. Kitts and Nevis (Table 3). In the early

### _wp08257 - 4.3 percent of GDP in Dominica to 12.2 percent in St. Kitts and Nevis (Table 3). In the early

### Customs revenue losses and concessions
- Customs and excise departments’ estimates and rate-difference estimates produce similar revenue loss figures.
- Difference in statutory and effective import-related tax rates:
  - Ranges from more than 8 percent in Dominica to more than 22 percent in Antigua and Barbuda.
- Estimated average customs revenue losses for the ECCU region:
  - Average losses are nearly 8 percent of GDP for the region.
  - Country ranges: about 4 percent of GDP in Dominica to over 12 percent in St. Kitts and Nevis.
- Table 3 customs revenue forgone from concessions (1991–2003, In percent of GDP):
  - Antigua and Barbuda: 5.1 (1991–93), 9.2 (2001–03)
  - Dominica: 4.2, 4.3
  - Grenada: 11.4, 11.3
  - St. Kitts and Nevis: 5.8, 12.2
  - St. Lucia: 5.9, 5.9
  - St. Vincent and the Grenadines: 6.7, 6.1
  - ECCU average: 6.5, 8.2
- Observations on trends:
  - Concessions increased since the early 1990s, especially in Antigua and Barbuda and St. Kitts and Nevis.
  - Customs revenue forgone in Antigua and Barbuda and St. Kitts and Nevis was about 5 percent of GDP a year higher in 2001–03 compared with the early 1990s.
  - Lack of data on purposes of concessions limits determination of whether increases reflect social/welfare use or investment attraction.
  - Given stable dollar exchange rate and CPI inflation around 2 percent over the past decade, increases likely reflect higher incidence or more generous terms of concessions rather than import-price inflation.

### Corporate income tax (CIT) holidays and forgone revenue
- Method: Forgone revenue from CIT holidays estimated from difference between statutory and effective CIT rates.
- Assumptions for estimating effective CIT rates:
  - Corporate income tax base assumed to be 25 percent of GDP (in line with Jamaica) due to lack of national accounts income-side data for ECCU members.
- Statutory and effective CIT rates:
  - Statutory rates have ranged between 30 and 40 percent in the region.
  - Effective rates are between 6 and 20 percent.
- Estimated forgone revenue from CIT concessions (2003, In percent of GDP):
  - Ranges from 3 percent of GDP in Grenada to about 6 percent of GDP in Antigua and Barbuda (Figure 3).
- CIT yield trends (Table 4, In percent of GDP):
  - ECCU average yield fell from 3.5 percent of GDP (1990–94) to 3 percent (1999–2003).
  - Country examples: Antigua and Barbuda 2.1 (1990–94) to 2.5 (1999–2003); Dominica 3.4 to 0.9; Grenada 3.2 to 3.6; St. Lucia 4.2 to 4.0; St. Vincent and the Grenadines 4.5 to 4.4.
- Caveats:
  - Differences between statutory and effective rates may reflect treatment of investment, depreciation, interest, debt-equity ratios, and administrative leakages.
  - Weak tax administration implies part of estimated revenue loss may be due to leakages rather than concessions, biasing estimates upward.
  - Distribution of profits skewed toward large profitable firms (often recipients of tax holidays) could mean the actual CIT base is larger and effective rates overestimated, biasing forgone-concession estimates downward.

### Revenue collection from removing concessions: Elasticities approach
- Elasticities framework: revenue change from removing concessions depends on price elasticities of import demand and corporate incomes.
- Empirical import price elasticities for developing countries cited: range between –1.0 and –0.4.
- Assumption used for illustrative calculation: price elasticity = -0.7 for both import volumes and corporate incomes.
- Estimated revenue gain from removing concessions under elasticity = -0.7:
  - Revenue gain = 9 percent of GDP on average for the ECCU.
  - Country values: 8 percent of GDP for Dominica to 13 percent for St. Kitts and Nevis (Table 5).
- Table 5 (Assuming price elasticity of –0.7, In percent of GDP):
  - Antigua and Barbuda: Import-related Taxes 6.2, Corporate Income Taxes 4.2, Total 10.4
  - Dominica: 3.1, 4.1, 7.2
  - Grenada: 7.8, 2.4, 10.2
  - St. Kitts and Nevis: 9.0, 3.0, 12.0
  - St. Lucia: 4.6, 2.9, 7.6
  - St. Vincent and the Grenadines: 4.1, 3.2, 7.3
  - ECCU average: 5.8, 3.3, 9.1

### Benefits of incentives: FDI performance in the ECCU
- Key observation: Despite increased concessions, ECCU’s world ranking of FDI as a share of GDP has fallen.
- FDI performance index trends (Table 6, Performance index is country FDI inflow share in world's FDI inflow divided by share of country's GDP in world's GDP):
  - ECCU fell from fifth to twentieth by 2002 in average ranking among more than 150 countries.
  - ECCU Caribbean FDI inflows declined from 12.3 to 3.7 percent over the period noted (World Bank, 2005).
- Table 6 selected data (FDI performance index shown across periods):
  - ECCU: 1979–83 16.0; 1984–88 11.7; 1989–93 11.7; 1994–98 8.1; 1999–2003 4.3
  - Country examples with wide variation: Antigua and Barbuda 24.1 (1979–83) to 2.6 (1999–2003); St. Lucia 37.4 to 2.3.
- Data limitations:
  - No routine data on employment generated by incremental investments or other taxes derived from them; prevents full cost-benefit analysis for job creation or net revenue gain.
  - Sample evidence: concession terms positively correlated with firm size (capital and employment).

### Cross-country analysis and regression evidence
- Indices constructed: FDI restrictions index and FDI incentives index (using Wei (2000) methodology, expanded to 80 countries).
- Other variables included: statutory CIT rate, average import tariff rate, institutional quality (governance index sum of six dimensions), quality of infrastructure (roads index).
- Summary statistics (Table 7 highlights):
  - ECCU statutory corporate income tax rate mean: 35.0
  - ECCU average import tariff: 24.2
  - ECCU quality of institutions mean: 3.1
  - ECCU quality of infrastructure mean: 24.2
- Bivariate findings:
  - FDI restrictiveness is negatively and significantly correlated with FDI (Rank correlation: –0.46***).
  - Little evidence that FDI incentives are associated with higher FDI (Rank correlation: –0.15).
  - Statutory CIT rates and import-related tax rates negatively related to FDI (Figures 7 and 8: rank correlations –0.15* and –0.23*** respectively).
- Cross-country OLS regression results (selected findings from Tables 8 and 9):
  - The incentives index is insignificant across econometric specifications (no robust positive association between incentives index and FDI).
  - FDI restrictions index is negatively associated with FDI (coefficients often negative and significant).
  - Higher statutory corporate income tax rates are negatively associated with Ln(FDI/GDP) and Ln(FDI per capita) in some specifications (e.g., corporate income tax coefficient –0.047** in Table 8; –0.056** in Table 9).
  - Quality of institutions is positively associated with FDI per capita (e.g., 0.264**).
  - ECCU fixed effect appears and can be significant in specifications.
- Interpretation:
  - Results confirm importance of lower statutory CIT rates, absence of FDI restrictions, and better institutional quality for raising FDI.
  - Findings align with broader literature and investor surveys.

### Policy alternatives and recommendations
- Core recommendation: Re-evaluate the use of incentives to promote development; consider regional harmonization of concessions to limit revenue losses and prevent tax competition.
- Emphasized strategy: Enhance investment climate rather than increase concessions. Key components:
  - Improve regulatory environment.
  - Develop infrastructure.
  - Lower statutory tax rates (subject to macroeconomic constraints).
  - Raise labor productivity through skills acquisition and labor market reform.
- Fiscal transparency and monitoring:
  - Strengthen data gathering on costs and benefits of tax concessions through routine monitoring and review.
  - Publish cost of all concessions regularly in a tax expenditure annex to the budget.
- Principles for concessions:
  - Concessions should be nondiscretionary, transparent, and limited in size, duration and scope.
  - Make concession-related investment legislation rule-based with clear eligibility criteria.
  - Eliminate ad hoc concessions for social and welfare purposes; incorporate social spending in budget process (note: Dominica policy since mid-December 2003 is to not grant ad hoc import concessions).
  - Respect fiscal constraints; avoid borrowing to provide concessions.
- Choice of instruments:
  - CIT holidays: relatively easy to administer but:
    - Tend to benefit high-profit investors who may have invested without the holiday.
    - Increase potential for tax avoidance (transfer pricing) and can hinder record-keeping and oversight.
  - Indirect tax incentives (import-related exemptions): prone to abuse (diversion of qualified purchases); should be avoided.
  - Tax credits for investment:
    - Target investment directly and require tax returns, enhancing transparency.
    - Disadvantages: may reduce tax liability to zero in some periods; may distort toward short-lived assets; potential for multiple-claim abuse.
    - Monitoring and minimum holding periods may be needed.
  - Accelerated depreciation and loss-carry-forward provisions:
    - Advantages: target investment, enhance transparency, do not distort toward short-lived assets, reduce abuse potential.
    - May provide smaller benefits than tax credits but can be preferable to holidays for projects with losses in initial set-up period (e.g., hotel and tourism projects).
- Illustrative examples comparing incentives (assumptions: tax rate 30 percent, discount rate 10 percent):
  - Tax holidays (Table 10 example for a $30 investment over 3 periods): present value of profits under 1-period holiday = -2.7; 2-period holiday = 1.3; 3-period holiday = 0.0.
  - Accelerated depreciation and loss carry forward (Table 11 example): present value of profits = 1.9; more profitable than tax holidays in the example due to accelerated initial depreciation and loss carry forward.

### Conclusions
- Tax concessions have been a key component of ECCU investment strategy; substantial discretion applied, mainly import-related tax concessions and CIT holidays.
- Larger firms have tended to receive more incentives for longer durations.
- Evidence indicates limited benefits in terms of FDI but substantial costs in forgone revenue.
- Estimated forgone revenue from tax concessions range from 9½ to 16 percent of GDP annually for ECCU countries.
- Policy prescription:
  - Re-evaluate incentive strategy urgently, possibly regionally.
  - Focus on enhancing investment climate (regulatory reform, infrastructure, lower statutory tax rates, labor productivity).
  - Reduce or phase out concessions and broaden tax base.
  - Monitor and publicize costs and benefits of concessions routinely.
  - When granted, make incentives nondiscretionary, transparent, limited, and consider accelerated depreciation and loss-carry-forward instead of tax holidays; avoid indirect tax incentives.

*Italic: Source: _wp08257 (excerpt provided).*

### Appendix I. Calculating the Change in Revenue from Removing Import-Related

### Appendix I. Calculating the Change in Revenue from Removing Import-Related Tax Concessions

### Framework for current revenue and after-tax import price
- Current revenue intake from imports given existing tax concessions: ecifctPv**
- Definitions:
  - cv is the quantity of imports with the tax concessions
  - cifP is the average c.i.f value of the imports and is normalized to take the value of 1
  - et is the average effective tax rate
- Average effective after-tax import price: eafttP+=1

### Effect of removing tax concessions on after-tax price and quantity
- Increase in average after-tax import price on removal of concessions:
  - )1/((/)eeaftafttttPP+−=Δ  where t is the average statutory tax rate for imports and ett≥
- Import price elasticity relationship:
  - ε= ΔΔ aftaftPP vv // , where 0≤ε generally
- Change in quantity of imports:
  - )1/()(eecctttvvvv+−=−=Δε

### Change in revenue from imports after removal of concessions
- Change in revenue expression:
  - eceecectvttttvtvvtR−+−+=−=Δ)}1/()(1{ε
- Rearranged expression (separating price and volume effects):
  - )}1/()({))}(1/()(1{ eeeceeecttttvtttttvR+−+−+−+=Δεε
- Interpretation:
  - The first term captures the after-tax price effect of removing tax concessions
  - The second term captures the volume effect of a higher after-tax import price

### Sign of ΔR and critical conditions
- From the expression, the sign of ΔR is:
  - 0 > ΔR, if tte/)1(+−>ε
  - 0 < ΔR, if tte/)1(+−<ε
  - 0 = ΔR, if ett=; or tte/)1(+−=ε
  - 0)}1/(){(>+−= Δ ttttv eec δε δR

### Empirical context and implication for ECCU
- Khan (1974) and Khan and Knight (1988) estimated aggregate import price elasticities range from –0.4 to 1 for developing countries, with small open countries more price inelastic with respect to imports.
- Given the average statutory and effective tax rates in the ECCU (about 41 and 26 percent, respectively), revenue will increase after removing tax concessions, and the increase is greater the more price inelastic the ECCU countries are to imports.

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### Appendix II. Constructing Foreign Direct Investment Regime Indices — methodology overview
- Indices based on Wei (2000) methodology.
- Each index is a sum of four variables; each variable takes a value of either 0 or 1.
- Data sources: publicly available sources, including Pricewaterhouse Cooper’s Investment Guides and various investment agency reports.
- Table coverage: data for 80 economies, including the 40 mostly middle- and high-income countries in Wei (2000).

### FDI restrictions index components (each scored 0 or 1)
- (1) Controls on foreign exchange that interfere with ability of foreign firms to import intermediate inputs or repatriate profits
- (2) Ban on foreign investments in strategic sectors (in particular, national defense and the mass media)
- (3) Ban on foreign investments in other sectors where their presence would be considered harmless in most developed countries
- (4) Limits on ownership share

### FDI incentives index components (each scored 0 or 1)
- (1) Special incentives to invest in certain industries or geographical areas
- (2) Exports specially promoted, including through export-processing zones and special economic zones
- (3) Tax concessions specific to foreign firms, excluding those designed specifically for export promotion
- (4) Cash grants, subsidized loans, reduced rent for land use, or other nontax concessions specific to foreign firms

### Data presentation example
- Appendix II. Table 1 lists country-level binary variables and summed indices for FDI Restrictions and FDI Incentives for 80 countries (year 2000). Examples from the table include:
  - Antigua and Barbuda: FDI Restrictions overall 0; FDI Incentives overall 2
  - Barbados: FDI Restrictions overall 1; FDI Incentives overall 3
  - China: FDI Restrictions overall 1; FDI Incentives overall 3
  - Korea, Republic of: FDI Restrictions overall 4; FDI Incentives overall 2
  - Taiwan: FDI Restrictions overall 4; FDI Incentives overall 2
  - United States: FDI Restrictions overall 1; FDI Incentives overall 2
- (Table lists raw 0/1 entries for individual components and summed overall indices for each country.)

*Source: _wp08257 - Appendix I. Calculating the Change in Revenue from Removing Import-Related Tax Concessions (Appendices I–II).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp08257.pdf_