Tax holidays fuel poverty, corruption

In the world of investment promotion, tax holidays are one of the incentives governments like to use to attract investors. Tax holidays allow new investors a chance to pay zero tax for a number of years. The arguments in favour often are based on two premises. Firstly, that the new investors create jobs and therefore reduce unemployment. Secondly, foreign investors often put a case that it will take time to generate any profits, and therefore, should be exempt from paying tax over a certain period. Both these arguments in fact are a recipe for corruption and worsening poverty. It is for this reason that I think we should never give tax holidays to any foreign investor. This is how.

Firstly, it is important to understand how taxation works. Two things are taxed in the process of producing goods and services. These are labour and capital. Labour is taxed in the form of the pay as you earn (Paye). A Paye tax in the current situation is progressive meaning that low income earners pay less compared to high earners. Capital is taxed mainly through corporate tax. There are other taxes on capital such as dividend tax and capital gains. So, what are the implications of tax holidays?

When you give a tax holiday, all it means is that all labour engaged by the new investor is taxed.  Capital is not taxed. And there is a long history of low wages as documented by numerous industrial disputes involving some of these foreign investors. These low wages generate little revenue for the government to be able to provide high quality education, build economic infrastructure to fight poverty. This is one channel of poverty perpetuation that tax holidays bring and its positive arguments deliberately ignore.

Any tax regime should be progressive and fair to all players. One dimension is to look at tax exemption from a perspective of capital regressive taxation. By giving tax holidays to foreign investors, we are actually taxing local capital or in other words, local investors. In essence we are stifling their ability to grow their business so that they create more jobs and produce for exports while giving an unfair advantage to another segment of capital, foreign direct investment.

By taxing local capital through tax holidays, we give rise to stagnant wages or propel the rise of the informal economy where decent jobs do not exist, and collecting revenues to fight poverty becomes a costly and an ineffective exercise.

Do we have experience with tax holidays? Surely we do and the reason we should avoid giving them to any foreign investor.  Some foreign investors are crafty and work out these tax breaks with corrupted minds that is often difficult to discern. One key trick that has been played across the African continent is to sell the company at the end of the tax break, citing huge operating costs or lack of profit for whatever item they produce.

They go to sell the company to themselves through offshore companies. This new investor, though it is the same one, comes demanding a new tax holiday for another 10 years. Most African governments then swallow the bait and the cycle continues for another decade. If it is an extractive industry, well a country is mined out of its precious minerals for decades without receiving any tax. This is corruption of some kind that foreign direct investors get away with through tax holidays.

There is no question that all countries need foreign capital. We need it too, but each one should simply pay a fair share of their tax.

Malawi often relies on tobacco exports for foreign exchange earnings and takes various balance of payments loans, including budgetary grants that add to official reserve positions.  While I believe in free capital movement, tax holidays expose some inherent exploitation of Malawi citizens. Most of the tobacco is grown by poor farmers and companies that enjoy these tax holidays are quick to repatriate foreign exchange earned by poor farmers.

At the same time, some of their earnings are made offshore without going through our banking system. This too, is exploitation, corruption and a mechanism that diminishes host countries ability to provide key services such as health, economic functions, business infrastructure, education etc to fight poverty.

So, what is the fuss about tax holidays? In the presence of discretionary measures in how they are granted without the backing of any law, it is prone to breed corruption.

Are tax holidays a solution to bringing foreign direct investment? There are surely not and we need not get so much obsessed with them as they create unfair advantages across businesses and deny government needed revenue. Can we give Boeing and Airbus 50-year tax holidays so they set aircraft plants at Kanengo  in Lilongwe or Mpherembe in Mzimba? Would the tax holiday motivate them?

The point often neglected is that tax holidays have never been the first best tool to attract foreign investment. Giving a tax holiday when a heavy manufacturing business can only have three hours of electricity in 24 hours cannot attract serious investors. n