Tax incentive

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A tax incentive is an aspect of a government's taxation policy designed to incentivize or encourage a particular economic activity by reducing tax payments.

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Tax incentives can have both positive and negative impacts on an economy. Among the positive benefits, if implemented and designed properly, tax incentives can attract investment to a country. Other benefits of tax incentives include increased employment, higher number of capital transfers, research and technology development, and also improvement to less developed areas. Though it is difficult to estimate the effects of tax incentives, they can, if done properly, raise the overall economic welfare through increasing economic growth and government tax revenue (after the expiration of the tax holiday/incentive period). However, tax incentive can cause negative effects on a government's financial condition, [1] among other negative effects, if they are not properly designed and implemented. [2]

There are four typical costs to tax incentives:

Resource allocation refers to lost government tax revenue resulting from the tax incentive. The second cost refers to the situation when the tax incentives lead to too much investment in a certain area of the economy and too little investment in other areas of the economy. Revenue cost is associated with enforcing the tax incentive and monitoring who is receiving the incentive and ensuring they are properly deserving of the incentive. Therefore, the higher and the more complex the tax incentive, the higher the compliance costs because of the larger number of people and firms attempting to secure the tax incentive. The final cost is similar to the third in that it relates to people abusing the tax incentive. Corruption occurs when there are no clear guidelines or minimal guidelines for qualification. [3]

According to a 2020 study of tax incentives in the United States, "states spent between 5 USD and 216 USD per capita on incentives for firms." [4] There is some evidence that this leads to direct employment gains but there is not strong evidence that the incentives increase economic growth. [4] Tax incentives that target individual companies are generally seen as inefficient, economically costly, and distortionary, as well as having regressive economic effects. [5]

Disambiguation

Many "tax incentives" simply remove part of, or all the burden of the tax from whatever market transaction is taking place. That is because almost all taxes impose what economists call an excess burden or a deadweight loss [ citation needed ]. Deadweight loss is the difference between the amount of economic productivity that would occur without the tax and that which occurs with the tax.

For example, if savings are taxed, people save less than they otherwise would. If non-essential goods are taxed, people buy less. If wages are taxed, people work less.[ citation needed ] Finally, if activities like entertainment and travel are taxed, consumption is reduced.

Sometimes, the goal is to reduce such market activity, as in the case of taxing cigarettes. However, reducing activity is most often not a goal because greater market activity is considered to be desirable.

When a tax incentive is spoken of, it usually means removing all or some tax and thus reduce its burden.

Pseudo-incentives

Regardless of the fact that an incentive spurs economic activity, many use the term to refer to any relative change in taxation that changes economic behavior. Such pseudo-incentives include tax holidays, tax deductions, or tax abatement. Such "tax incentives" are targeted at both individuals and corporations.

Individual incentives

Individual tax incentives are a prominent form of incentive and include deductions, exemptions, and credits. Specific examples include the mortgage interest deduction, individual retirement account, and hybrid tax credit.

Another form of an individual tax incentive is the income tax incentive. Though mostly used in transitioning and developing countries, usually correlating with insufficient domestic capita, the income tax incentive is meant to help the economic welfare of direct investors and corresponds with investing in production activities and finally, many times is meant to attract foreign investors. [6]

These incentives are introduced for various reasons. Firstly, they are seen to counterbalance investment disincentives stemming from the normal tax system. Others use the incentives to equalize disadvantages to investing such as complicated laws and insufficient infrastructure. [6]

Corporate tax incentives

Corporate tax incentives can be raised at federal, state, and local government levels. For example, in the United States, the federal tax code provides a wide range of incentives for corporations, totaling $109 billion in 2011, according to a Tax Foundation Study. [7]

The Tax Foundation categorizes US federal tax incentives into four main categories, listed below: [8]

Corporate tax incentives provided by state and local governments are also included in the US tax code but are very often directed at individual companies involved in a corporate site selection project. [9] Site selection consultants [10] negotiate these incentives, which are typically specific to the corporate project the state is recruiting, rather than applicable to a broader industry. Examples include the following: [11]

In Armenia, corporate income tax incentive is available for Armenian resident entities that meet several criteria under the government’s export promotion-oriented program. Those entities that are part of the government approved program receive reduced corporate income tax rates up to tenfold from the 20% rate. Taxpayers running their operations in free economics zones (FEZ) are free from corporate income tax in respect of income received from activities implemented in free economic zones in Armenia. [12]

List of largest US tax incentive deals

Historical preservation tax incentive

Not all tax incentives are structured for individuals or corporations, as some tax incentives are meant to help the welfare of the society. For example, the historical preservation tax incentive. The US federal government pushes, in many situations, to preserve historical buildings. One way the government does so is through tax incentives for the rehabilitation of historic buildings. The tax incentives to preserve the historic buildings can generate jobs, increase private investment in the city, create housing for low-income individuals in the historic buildings, and enhance property values. Currently, according to the Tax Reform Act of 1986, there are two major incentives in this category. The first incentive is a tax credit of 20% for rehabilitation of historic structures. A historic structure is defined as a building listed in the National Register of Historic Places or a building in a registered historic district, acknowledged by the National Park Service. The second incentive is a tax credit of 10% for rehabilitation of structures built before 1936 but are considered non-residential and non-historical. [17]

Impact

According to a 2020 study, tax competition "primarily reduces taxes for mobile firms and is unlikely to substantially affect the efficiency of business location." [18] A 2020 NBER paper found some evidence that state and local business tax incentives in the United States led to employment gains but no evidence that the incentives increased broader economic growth at the state and local level. [19]

A 2021 study found that multinational firms boosted wages and employment in localities, but that the surplus that the firms generated tended to go back to them in the form of local subsidies. [20]

See also

Related Research Articles

A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer by a governmental organization in order to fund government spending and various public expenditures, and tax compliance refers to policy actions and individual behaviour aimed at ensuring that taxpayers are paying the right amount of tax at the right time and securing the correct tax allowances and tax reliefs. The first known taxation took place in Ancient Egypt around 3000–2800 BC. Taxes consist of direct or indirect taxes and may be paid in money or as its labor equivalent.

A flat tax is a tax with a single rate on the taxable amount, after accounting for any deductions or exemptions from the tax base. It is not necessarily a fully proportional tax. Implementations are often progressive due to exemptions, or regressive in case of a maximum taxable amount. There are various tax systems that are labeled "flat tax" even though they are significantly different. The defining characteristic is the existence of only one tax rate other than zero, as opposed to multiple non-zero rates that vary depending on the amount subject to taxation.

An income tax is a tax imposed on individuals or entities (taxpayers) in respect of the income or profits earned by them. Income tax generally is computed as the product of a tax rate times the taxable income. Taxation rates may vary by type or characteristics of the taxpayer and the type of income.

A subsidy or government incentive is a type of government expenditure targeted towards individuals and households, as well as businesses with the aim of stabilising the economy. It ensures that individuals and households are viable by having access to essential goods and services while giving businesses the opportunity to stay afloat and/or competitive. Subsidies not only promote long term economic stability but also help governments to respond to economic shocks during a recession or in response to unforeseen shocks such as COVID-19.

Tax deduction is a reduction of income that is able to be taxed and is commonly a result of expenses, particularly those incurred to produce additional income. Tax deductions are a form of tax incentives, along with exemptions and tax credits. The difference between deductions, exemptions, and credits is that deductions and exemptions both reduce taxable income, while credits reduce tax.

A tax credit is a tax incentive which allows certain taxpayers to subtract the amount of the credit they have accrued from the total they owe the state. It may also be a credit granted in recognition of taxes already paid or a form of state "discount" applied in certain cases. Another way to think of a tax credit is as a rebate.

A tax cut represents a decrease in the amount of money taken from taxpayers to go towards government revenue. Tax cuts decrease the revenue of the government and increase the disposable income of taxpayers. Tax cuts usually refer to reductions in the percentage of tax paid on income, goods and services. As they leave consumers with more disposable income, tax cuts are an example of an expansionary fiscal policy. Tax cuts also include reduction in tax in other ways, such as tax credit, deductions and loopholes.

Tax competition, a form of regulatory competition, exists when governments use reductions in fiscal burdens to encourage the inflow of productive resources or to discourage the exodus of those resources. Often, this means a governmental strategy of attracting foreign direct investment, foreign indirect investment, and high value human resources by minimizing the overall taxation level and/or special tax preferences, creating a comparative advantage.

A corporate tax, also called corporation tax or company tax, is a type of direct tax levied on the income or capital of corporations and other similar legal entities. The tax is usually imposed at the national level, but it may also be imposed at state or local levels in some countries. Corporate taxes may be referred to as income tax or capital tax, depending on the nature of the tax.

Tax break also known as tax preferences, tax concession, and tax relief, are a method of reduction to the tax liability of taxpayers. Government usually applies them to stimulate the economy and increase the solvency of the population. By this fiscal policy act, government favourable behaving of population sample or general behaving. By announcing a new tax break state budget possibly deprecate some of their revenues from collecting taxes. On the other hand, a new tax break stimulates the economy of subjects in the state, which could possibly strengthen the increase of outcomes that will be taxed. Every tax break must go through the Legislative system to be accepted by authorized institutions to become valid. Most of the countries pledge this position to the Ministry of finance, which approves new tax breaks as tax law. Whether for validation is needed an agreement with other constitutional officials depends on state legislative. However, in the same manner, could the tax break be annulled. In many cases tax break is announced with a limitation factor, which restricts the maximum use of this tax break. For example, a tax credit is given for purchases of electric cars. The tax credit should deprecate 10% from purchases, but the limiting factor is 500$, which can’t be exceeded.

Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments. The methodology can vary depending on local and international tax laws.

<span class="mw-page-title-main">Tax policy</span> Choice by a government as to what taxes to levy, in what amounts, and on whom

Tax policy refers to the guidelines and principles established by a government for the imposition and collection of taxes. It encompasses both microeconomic and macroeconomic aspects, with the former focusing on issues of fairness and efficiency in tax collection, and the latter focusing on the overall quantity of taxes to be collected and its impact on economic activity. The tax framework of a country is considered a crucial instrument for influencing the country's economy.

The Fair Tax Act is a bill in the United States Congress for changing tax laws to replace the Internal Revenue Service (IRS) and all federal income taxes, payroll taxes, corporate taxes, capital gains taxes, gift taxes, and estate taxes with a national retail sales tax, to be levied once at the point of purchase on all new goods and services. The proposal also calls for a monthly payment to households of citizens and legal resident aliens as an advance rebate of tax on purchases up to the poverty level.

Optimal tax theory or the theory of optimal taxation is the study of designing and implementing a tax that maximises a social welfare function subject to economic constraints. The social welfare function used is typically a function of individuals' utilities, most commonly some form of utilitarian function, so the tax system is chosen to maximise the aggregate of individual utilities. Tax revenue is required to fund the provision of public goods and other government services, as well as for redistribution from rich to poor individuals. However, most taxes distort individual behavior, because the activity that is taxed becomes relatively less desirable; for instance, taxes on labour income reduce the incentive to work. The optimization problem involves minimizing the distortions caused by taxation, while achieving desired levels of redistribution and revenue. Some taxes are thought to be less distorting, such as lump-sum taxes and Pigouvian taxes, where the market consumption of a good is inefficient, and a tax brings consumption closer to the efficient level.

<span class="mw-page-title-main">Corporate tax in the United States</span>

Corporate tax is imposed in the United States at the federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Since January 1, 2018, the nominal federal corporate tax rate in the United States of America is a flat 21% following the passage of the Tax Cuts and Jobs Act of 2017. State and local taxes and rules vary by jurisdiction, though many are based on federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable. The corporate Alternative Minimum Tax was also eliminated by the 2017 reform, but some states have alternative taxes. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Groups of corporations controlled by the same owners may file a consolidated return.

The Kepner Income Tax is an approach to taxation, suggested in the United States, that would collect on a progressive income tax and an estate tax. It would repeal the corporate tax and payroll taxes. All income, from whatever source, would be taxed the same. The plan was proposed by Hayden Kepner of the law firm Arnall Golden Gregory. Kepner states that such a tax system would be transparent, easily understandable, could fit on a post-card, and everyone who earns an income would pay taxes. The plan would expand the tax base and he suggests that it would have an incentive to keep federal spending at modest levels. The personal income tax would be made up of three progressive rates: 15%, 25%, and 35%. The estate tax would apply an annual wealth tax of 1-2%, which would be similar to property taxes currently administered at the state level, but would include all property above a threshold amount.

Economic theory evaluates how taxes are able to provide the government with required amount of the financial resources and what are the impacts of this tax system on overall economic efficiency. If tax efficiency needs to be assessed, tax cost must be taken into account, including administrative costs and excessive tax burden also known as the dead weight loss of taxation (DWL). Direct administrative costs include state administration costs for the organisation of the tax system, for the evidence of taxpayers, tax collection and control. Indirect administrative costs can include time spent filling out tax returns or money spent on paying tax advisors.

<span class="mw-page-title-main">Tax Relief and Health Care Act of 2006</span> US law

The Tax Relief and Health Care Act of 2006, includes a package of tax extenders, provisions affecting health savings accounts and other provisions in the United States.

The alternative minimum tax (AMT) is a tax imposed by the United States federal government in addition to the regular income tax for certain individuals, estates, and trusts. As of tax year 2018, the AMT raises about $5.2 billion, or 0.4% of all federal income tax revenue, affecting 0.1% of taxpayers, mostly in the upper income ranges.

<span class="mw-page-title-main">Tax Cuts and Jobs Act</span> U.S. federal tax legislation

The Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018, Pub. L. 115–97 (text)(PDF), is a congressional revenue act of the United States originally introduced in Congress as the Tax Cuts and Jobs Act (TCJA), that amended the Internal Revenue Code of 1986. Major elements of the changes include reducing tax rates for businesses and individuals, increasing the standard deduction and family tax credits, eliminating personal exemptions and making it less beneficial to itemize deductions, limiting deductions for state and local income taxes and property taxes, further limiting the mortgage interest deduction, reducing the alternative minimum tax for individuals and eliminating it for corporations, doubling the estate tax exemption, and set the penalty enforcing individual mandate of the Affordable Care Act (ACA) at $0.

References

  1. ↑ McDonald, B.D.; Decker, J.W.; Johnson, B.A.M. (2020). "You don't always get what you want: The effect of financial incentives on state fiscal health". Public Administration Review. 81 (3): 365–374. doi: 10.1111/puar.13163 .
  2. ↑ Easson, Alex; Zolt, Eric. "Tax Incentives" (PDF). Law Review.
  3. ↑ Easson, Alex; Zolt, Eric. "Tax Incentives" (PDF). Law Review.
  4. 1 2 Slattery, Cailin; Zidar, Owen (2020). "Evaluating State and Local Business Incentives". Journal of Economic Perspectives. 34 (2): 90–118. doi: 10.1257/jep.34.2.90 . ISSN   0895-3309.
  5. ↑ Jensen, Nathan M.; Malesky, Edmund J. (2018). Incentives to Pander: How Politicians Use Corporate Welfare for Political Gain. Cambridge University Press. doi:10.1017/9781108292337. ISBN   978-1-108-41890-4.
  6. 1 2 Holland, David; Vann, Richard (1998). "Income Tax Incentives for Investment". Tax Law Design and Drafting. 2.
  7. ↑ "Who Benefits from Corporate "Loopholes"?". The Tax Foundation. Retrieved 8 September 2011.
  8. ↑ "Composition of Corporate Tax Expenditures". The Tax Foundation. Retrieved 8 September 2011.
  9. ↑ "Site Selection Process". Greyhill Advisors. Retrieved 20 October 2011.
  10. ↑ "Site selection consultants" . Retrieved 4 November 2011.
  11. ↑ "Economic Development Incentives". Greyhill Advisors. Retrieved 8 September 2011.
  12. ↑ June 2022. "Corporate - Tax credits and incentives". PWC. Retrieved 2022-12-03.
  13. ↑ Westneat, Danny (3 May 2016). "Boeing's historic tax break from state even bigger than thought". The Seattle Times . Retrieved 28 December 2017.
  14. ↑ Bumsted, Brad (June 7, 2016). "Pennsylvania tax incentive plan played major role in luring Shell cracker plant". TribLIVE.com. Pittsburgh Tribune-Review . Retrieved 19 September 2017.
  15. ↑ "Location and tax breaks key to Shell's Pennsylvania cracker plant approval". analysis.petchem-update.com. Petrochemical Update. July 8, 2016. Retrieved 19 September 2017.
  16. ↑ Damon, Anjeanette (2014-09-16). "Inside Nevada's $1.25 billion Tesla tax deal". Reno Gazette Journal . Retrieved 2016-11-03.
  17. ↑ "Historic Preservation Tax Incentives" (PDF). National Park Service: U.S. Department of the Interior. Retrieved 2018-03-16.
  18. ↑ Mast, Evan (2020). "Race to the Bottom? Local Tax Break Competition and Business Location". American Economic Journal: Applied Economics. 12 (1): 288–317. doi:10.1257/app.20170511. ISSN   1945-7782.
  19. ↑ Slattery, Cailin R; Zidar, Owen M (2020). "Evaluating State and Local Business Tax Incentives". doi: 10.3386/w26603 . S2CID   219145228.{{cite journal}}: Cite journal requires |journal= (help)
  20. ↑ Setzler, Bradley; Tintelnot, Felix (2021). "The Effects of Foreign Multinationals on Workers and Firms in the United States". The Quarterly Journal of Economics. 136 (3): 1943–1991. doi:10.1093/qje/qjab015. ISSN   0033-5533.
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