Tax policy’s role in attracting investment for global development

The world economy can’t seem to get a reprieve. Even as parts of the world emerged from the worst of the pandemic in 2022, the developments in Europe, food security, inflation, and looming recession in several major economies pose major threats to global growth, with the International Monetary Fund forecasting only 2.9% growth for 2023.

Countries need tools to drive economic growth, and policies that will enable a quick return to growth while laying a stable foundation for sustainable economic development. In this context, tax policy will continue to be an important tool for both developed and developing countries. Better, more predictable, and modernised tax policy will help address major global issues, such as attracting revenue for development during this period of inflation, digitalisation of the economy, and climate change.

At a most basic level, nations need revenue to provide essential government functions. As the IMF’s Fiscal Affairs Department has noted, tax capacity is part of a fundamental process of state capacity building, and real gross domestic product per capita increases sharply and sustainably following a tipping point in the tax-to-GDP ratio.

Reforms in tax administration, such as investing in the human capacity of revenue agencies and digitalising tax and customs administrations, will increase compliance and revenue. The Arab world, including countries such as the United Arab Emirates, Saudi Arabia, and Egypt, has been a global leader in this effort.

Broadening domestic revenue bases will also boost revenue, which can be done without harming economic growth.

Transparent and predictable

More broadly, in important sectors such as extractive industries and many others, both investors and governments recognise the importance of a fair, stable, simple, transparent, and predictable regulatory and tax regime.

Nations in Africa, Latin America, and Asia have embarked on bold reforms in this area. Most taxpayers, including multinational companies, want to pay their full and legal tax obligations honestly. In turn, they want a stable, transparent, and efficient tax administration. This creates an alignment between the interests of taxpayers and governments – and opportunities for collaboration to achieve common goals, including national development.

Working cooperatively, building trust, and fostering mutual understanding with foreign investors as partners helps avoid costly disputes and attracts new and continued investment. It builds partnerships for development and prosperity for the people in countries that have enacted policies to encourage foreign investment.

In this regard, it’s important to remember the sequence of economic activity: Investment leads to employment, which leads to tax revenue, which leads to development. It all starts with attracting and retaining investment, whether foreign or domestic, and therefore with the investment climate in every country.

This principle applies across all economic sectors and to foreign and domestic investment—both are essential to lasting economic growth. If a country’s businesses don’t wish to invest in their home country, it is a negative sign for the economy, and one that will be noted by foreign investors.

Digitalised economy

Nations today should want more, not less, digitalisation of their economies. Thus, the digital economy should be taxed in a way that encourages growth, avoiding discriminatory taxation against certain companies or certain types of online commerce.

It is also true that complex taxes are more difficult to enforce and have high administrative costs that only deter investment and lower revenue. Many digital services taxes were enacted quickly in the hope of large revenues, but the reality has been quite different.

Instead, focus taxation of the digital economy on attracting investment, providing tax certainty and stability, and improving administration rather than adding complexity to the overall system. Right now, the world still has more work to do in finding better ways to foster and to tax the digital economy.

Energy transition

Climate change is another issue high on the global agenda. The energy transition will involve a shift toward renewables, but fossil fuels will remain an important energy source. What path will lead to a just energy transition that safeguards sustainable economic growth?

The central role of tax policy in promoting the renewables sector can’t be overstated. However, it is important to note that massive subsidies, such as those in the US and potentially in Europe, may not be the most effective way to encourage growth in this industry.

Such massive subsidies could lead to inefficiency and a waste of fiscal resources and worsen macro balances and debt sustainability; to retaliation and a subsidy war that would hurt all countries, especially emerging economies; and to undermining of energy security – “the uninterrupted availability of energy sources at an affordable price” – globally, as subsidies would discourage investment in other sources of energy and increase the susceptibility of the global economy to supply shocks.

Fossil fuels represent about 80% of global energy sources and will remain an important energy source. Fair and efficient taxes or subsidies to energy sources, energy efficiency, and the circular carbon economy to mitigate the environmental impact of fossil fuels will ensure a sustainable energy future.

Going forward

In addressing every global economic challenge, the same principles apply: fair, predictable, and modernised tax systems and partnerships for growth and development that will help countries achieve the United Nations’ Sustainable Development Goals. The most important of these goals in 2023, as always, is the first – no poverty. Economic and tax policies that promote investment are the surest way to achieve this goal and the others, while providing governments with the revenue they need to enhance national development and navigate a turbulent global economy.

Reproduced with permission from Bloomberg Tax & Accounting. Published Apr. 26, 2023. Copyright 2023 by Bloomberg Industry Group, Inc. (+1 800-372-1033) https://pro.bloombergtax.com – this article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.