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A tax incentive is an aspect of a government's taxation policy designed to incentive or encourage a particular economic activity by reducing tax payments.
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 incentives can cause negative effects on a government's financial condition, among other negative effects, if they are not properly designed and implemented.
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." There is some evidence that this leads to direct employment gains but there is not strong evidence that the incentives increase economic growth. Tax incentives that target individual companies are generally seen as inefficient, economically costly, and distortionary, as well as having regressive economic effects.
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. 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.
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.
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.
The Tax Foundation categorizes US federal tax incentives into four main categories, listed below:
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. Site selection consultants 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:
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.
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.
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