By Okello Joseph Ayo and Anita Peace
“To lay with one hand the power of the government on the property of the citizen and with the other to bestow it upon favored individuals to aid private enterprises and build up private fortunes is none the less a robbery because it is done under the forms of law and is called taxation." (Justice Samuel F Miller.1)
Tax incentives are one of the Uganda government’s most popular tools for attracting foreign investors and startup businesses. From potential investments in agribusiness to hospitality, and from steel to textile industries, tax incentives have been used in a bid to grow the industrial sector.
Though business and tax experts observe that tax incentives result into loss of huge revenues by the government that would have otherwise been collected and used in improving business environment (Patricia, 2019).(Lakuma 2018; Lwanga et al., 2018) estimates a revenue loss of one percent of Gross Domestic Product.
These incentives are directed to foreign investors as per the fact that there is insufficient domestic capital for the desired level of economic development. In assessing whether tax incentives have created more harm than good, it is crucial to consider that the companies that get these incentives have clearly failed to achieve the objectives they were set out to such as creating employment.
With this knowledge, we can draw that the system is not fully working for the Ugandan economy, suffice to say that even the type of labor employed by these investors are below the paye threshold of 235,000 Uganda shillings in terms of salaries earned.
The first point of discontentment with this system begins with the transparency of the process and procedure for managing and granting tax exemptions and the reporting structure on tax revenue foregone.
Tax exemptions are clumsily managed with no clear and consistent legal framework across on how they are managed, monitored and evaluated.
The argument is that the incentives do not necessarily go to the sectors or companies which are most productive or employ most Ugandans or produce the most essential goods and incentives are sometimes granted arbitrarily, perhaps after some officials get paid to front certain companies and not others.
The African Development Bank and the IMF on domestic tax mobilization have established that in many cases, tax incentives and exemptions are awarded in an ad hoc manner with unspecified deadlines or no clear criterion for managing the tax incentives or exemptions regime, including lack of specific criteria for qualification to get the tax relief.
It is, for example, alleged that the Presidency may be involved in the extensive award of tax incentives and exemptions to prospective investors on an ad hoc basis.
"We should set up black and white criterion on who qualifies for whatever exemptions and land bonanza. The current one is prone to mischief and undermines Uganda’s economic development,” Julius.
How then can we then say that tax incentives are good if we know that the whole system is inefficient for beneficial implementation?
The question therefore would be, are tax incentives necessary to draw in Foreign Direct Investments?
A study conducted on tax incentives and exemptions by the Tax Justice Alliance of Uganda (2018) shows that, when tax exemptions are gauged against Foreign Direct Investment (FDI), government would have grounds to continue granting tax exemption.
But on the other hand, the return of investment in terms of revenues, employment created and community development appear to be meager.
The youth continue to search for jobs, URA continues to fail to raise the required taxes and the communities in which beneficiaries of tax holidays operate only receive a bare minimum in the corporate social responsibility investment made.
Further, that developing countries do not need to grant tax incentives to draw in FDI because the choice to invest by genuine multinational corporations is not anchored on tax incentives only, it is largely basically supported by other parameters such as market potential, energy and adequate infrastructure.
This therefore means government ought to step away from tax incentives as a means of attracting FDI and instead move to improving the parameters that really matter such as infrastructure. (Zee, 2001) in their IMF paper note that tax exemptions disrupt the proper functioning of market forces as the sectorial allocation of resources is distorted by differences in tax rates.
Current evidence reveals that the societal costs of tax exemptions are high when measured against benefits, in terms of additional investments are low (SEATINI, 2019).
The report further points out that, “the disadvantages of tax incentives vastly outweigh the advantages and such incentives are not needed to attract FDI.”
Although tax incentives eventually attract investment, we cannot ignore the fact that the costs of the incentives such as corruption and lack of transparency, resource allocation costs, and revenue costs may subsequently override the benefits realised from the investment.
This report also sights that that incentives per se do not attract Foreign Direct Investment (FDI).
There are other factors that play a more significant role in attracting FDI such as the market size, efficiency and strength of political institutions, the education, skills and productivity of the local labor force, level of technology, and other factors of production should be put in place to create a conducive environment for productivity.
Governments also need to acknowledge and consider other factors such as natural endowment of physical resources, and cultural and geographic proximity to major source countries.
These are neither unalterable nor easily amenable to policy but influence FDI.
Assessments by the International Monetary Fund (IMF) and the World Bank indicate that countries, which have been successful at attracting investments, did not necessarily achieve that through offering tax incentives, but rather by investing in factors such as good quality infrastructure, low administrative costs of setting up businesses and political stability.
This argument therefore rules out the presumption that the best way to attract investment is through tax incentive, and provides justification to oppose tax incentives advance. If we have proof that countries that have effectively attracted investment did not do it through tax incentive, then we are under the wrong impression that tax incentives will work the magic for Uganda.
(OECD, 2015) notes that most developing countries use tax holidays and income tax exemptions that are costly to attract investment.
The report also stipulates that sector-specific tax incentives for domestic markets and extractive industries generally have minor impact. However, tax exemptions for export oriented sectors and mobile capital are relatively effective.
The report further notes that good infrastructure, macroeconomic stability, rule of law and the like are much more important in attracting investment. The OECD also notes that tax exemptions to investors “generally rank low in investment climate surveys in low-income countries.”
Tax exemptions have even been reported to be redundant and therefore deemed unnecessary because even without them, investment would have been undertaken as they scarcely weigh in on the choice to invest. Further, they come at a considerable fiscal cost.
They do not only reduce tax revenue collected, they reduce opportunities for necessary public spending on infrastructure, public services or social support, or requiring higher taxes on other activities in compensation for the huge tax revenue lost in offering them.
Why favoring foreign firms over domestic firms is harmful.
SEATINI notes that tax incentives may cause allocation inefficiency of resources that lead to diversion of investment in certain activities (activities with tax incentives) and consequently deprive other non-tax favored areas of investment.
This result from the fact that tax favored activities are obviously less expensive and therefore more profitably hence attracting more investment leading to abandonment of non-taxed favored activities.
Tax incentives are often granted to foreign firms with the aim of attracting FDI, this robs domestic firms of the opportunity to fairly compete with the tax-favored foreign firms and this alone has its negative consequences. As a result, on top of the huge revenue directly lost from these exemptions, there is revenue indirectly lost from the non-beneficiaries because their businesses are affected because of unfair competition.
We have witnessed local firms being driven out of the market or fail to grow because they don’t stand a chance with tax-favored foreign firms .
This is one of the biggest reasons why domestic investment has continued to be low and chances of success for local firms is even lower because the tax exemption system favors foreign firms leaving local firms out to dry.
The case for these local firms can be figuratively compared to going to war without weapons, with an armed opponent.
It simply means you have lost the war before it even begins. In instances where the rules for granting tax exemptions are not fixed, with no designated guidelines and incentives are granted arbitrarily, a crooked system like this gives room for tax resistance in the form of protests, avoidance and evasion from the non-beneficiaries because the question of “who are they to deserve preferential treatment” is raised.
IMF notes that the discrimination leads to resentment by the non-beneficiaries. It sparks off a chain reaction that ultimately ends in doom for the tax system.
Domestic firms will lobby to have the incentives extended to them-the pressure builds up and a few more tax exemptions are granted- the incentives may spread, leading to a deterioration of the domestic tax system.
Domestic firms are then induced to enter into tax avoidance strategies in that for Uganda’s case, the tax authorities do not have sufficient capacity adequately counter.
The tax revenue losses stemming from tax incentives are dynamic and result from diverse sources both direct and indirect some of which include, the opportunity cost resulting from revenue foregone from projects that would have been undertaken even if the investor did not receive any tax incentives and revenue lost from investors and activities that illegitimately claim incentives, the erosion of the revenue base due to taxpayers abusing the tax incentive regimes to avoid paying taxes on non-eligible activities or income.
The cost of Tax incentives in Uganda is estimated at 1.09 Trillion, from a logical perspective this is a lot of money that should not be lost into something that has consistently failed to yield substantial results and it’s an investment that should not be undertaken.
From the discussion presented above, it is clear that tax incentives do not obviously attract investors and to make matters worse, the legal frame work for granting tax incentives and administration in Uganda is overwhelmed with corruption and therefore may not be able to achieve the objectives of increasing employment and Balance of Trade (BOT) through attracting investors.
In Uganda, officials have a large amount of discretion in determining which investors or projects receive favorable treatment which creates a big time opportunity for corruption .Corruption in Uganda’s tax incentive system suppresses its ability to effectively deliver its intended objectives as the incentives never fall in the right hands.
If Uganda is to use tax incentives as an effective tool to skyrocket the number of employment created and improve Balance of Payment (BOP), government must pay keen attention on who is granted a tax incentive by making sure the system is free from corruption.
The first thing that should be made clear is who qualifies for tax incentives, this means drawing a standard criteria for how activities, businesses or investors that are qualify for the incentives will be determined.
The eligibility criteria must satisfy the condition that a particular investment is in a priority sector, if the investor will meet desired employment or export targets and comply with environmental requirements.
Tax incentives can play a useful role in encouraging both domestic and foreign investment.
The extent of their usefulness, and at what cost, depends upon how well the tax incentive programs are designed, implemented and monitored.
The current exemption regime in Uganda is fluid hence undermining the purpose of the tax incentive approach in attracting investment to create jobs and improve balance of payment position. In a bid to attract investors, many scholars have reached a conclusion that the experience for developing and transition countries with tax incentives has been different with that of the industrial countries.
Tax incentives have not by and large been successful in attracting investment, especially FDI. This underlines the conclusion that tax incentives cannot overcome the other more fundamental problems that discourage investment.
They also agree that tax incentives have imposed serious costs on developing and transition countries that need to be considered relative to the benefits that they have yielded.
This indicates that there are more cost-effective ways to do this other than tax incentives whose costs have proved to be more than the benefits, therefore the government should instead shift its focus to non-tax factors to attract investors. i.e create a consistent and stable macroeconomic and fiscal environment, Political stability, and Adequate physical, financial, legal and institutional infrastructure.
The authors of this article originally published it on LinkedIn under the same title