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Types of Tax Concessions for Promoting Investment in Free Economic and Trade Areas

By Chang Woon Nam and Doina Maria Radulescu

Abstract

Apart from the countries in transition, a large number of developing (and also developed) countries have also established free economic and trade areas(FETA) with the aim of attracting foreign capital by providing tax incentives, creating employment opportunities and promoting exports and regional development. Major theoretical justifications for the establishement of such economic zones generally maintain that there are economies of scale in the development of land and in the provision of common services and utilities as well as external economies of agglomeration by having similar industries grouped together. As mentioned above, one of the crucial characteristics of the FETA is the provision of generous tax promotion schemes solely allowed in this enclave. In general such measures include: (a) profit tax exemption, (b) free or accelerated depreciation, (c) investment tax allowance, (d) subsidy for investment costs, etc. The incentive effects of various tax concessions on firms' investment decisions can be compared on the basis of the net present value model. Without taxation, the net present value (NPV) is equal to the present value of future gross return, discounted at an appropriate interest rate less the present value of the investment cost. An investment project is therefore considered to be profitable when the NPV is positive. After the introduction of tax on corporate income, the present value of the asset generatd from an investment amounts to the sum of present value of net return (gross return less taxes) and tax savings led by an incentive depreciation provision, for example. In the study the theoretical approach is accompanied by a model simulation based on the selected parameters.

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