Rethinking Investment Incentives

This research paper by the International Institute for Sustainable Development (IISD) examines the effectiveness of investment incentives in attracting foreign direct investment (FDI). It argues that fiscal incentives cannot compensate for a weak investment climate and recommends a transition from automatic tax holidays toward targeted, performance-based incentives and transparent tax administration.

• Fiscal incentives are less effective in jurisdictions with weak investment climates. World Bank Group research from 2010 indicates that reducing the effective tax rate from 40% to 20% increased FDI by 8% of GDP for countries in the top half of investment climate rankings, compared to only 1% of GDP for those in the bottom half.
• Tax holidays are described as 'blunt instruments' that often fail to encourage capital investment or domestic business partnerships. They can attract 'footloose investors' who leave once the holiday expires and may encourage tax avoidance through firms closing and reopening as 'new' ventures.
• The document identifies several risks associated with tax holidays, including the transfer of tax revenues from host countries to the home states of investors via double taxation agreements and the use of transfer pricing or shell companies to avoid taxes.
• The cost of creating jobs through investment incentives can be high. World Bank data from 2004 shows that the cost per job created relative to the average annual industrial wage was 16 times in Thailand, 18 times in Indonesia, and 33 times in Bangladesh.
• The author recommends that incentives be 'timely, targeted and temporary' (the three Ts). They should be administered by tax authorities rather than sector ministries, integrated into corporate tax codes, and avoid discretionary granting through bilateral negotiations.
• Performance-based incentives are proposed as a superior alternative to tax holidays. These include tax credits, investment allowances, accelerated depreciation, and financial instruments like loans, grants, and green or social impact bonds.
• While anchor investments can signal stability and build business linkages, they risk becoming 'enclaves' with few positive externalities if the domestic economy is weak and the labor force is unskilled, especially when coupled with tax holidays that generate no revenue for the host government.

APA

Perera, O. (2012). Rethinking Investment Incentives. International Institute for Sustainable Development. https://www.iisd.org/system/files/publications/rethinking_investment_incentives.pdf

Chicago

Perera, Oshani. Rethinking Investment Incentives. International Institute for Sustainable Development, 2012. https://www.iisd.org/system/files/publications/rethinking_investment_incentives.pdf.

Wikipedia

{{cite report |last1=Perera |first1=Oshani |title=Rethinking Investment Incentives |publisher=International Institute for Sustainable Development |date=September 2012 |url=https://www.iisd.org/system/files/publications/rethinking_investment_incentives.pdf |access-date=17 August 2026 |via=Climate Insights Directory}}

BibTeX

@techreport{perera2012rethinking, author = {Perera, Oshani}, title = {{Rethinking Investment Incentives}}, institution = {International Institute for Sustainable Development}, year = {2012}, month = sep, url = {https://www.iisd.org/system/files/publications/rethinking_investment_incentives.pdf}, urldate = {2026-08-17}, note = {Indexed by Climate Insights Directory} }