Investments and tax incentives

Published on: https://bankar.me/clanci/poreski-podsticaj-kao-najskuplja-investicija-drzave/

It is rare for a tax document to genuinely leave me speechless.

Tax regulations usually mean new rules, new obligations and yet another technical discussion. But from time to time, a document appears that attracts attention not only because of what it prescribes, but because of the questions it raises.

This summer, I had planned to write about the corporate world I know well: risk management, investment decisions and the mistakes companies most often make. However, the latest version of the OECD Investment Tax Incentives Database made me temporarily put all other topics aside.

Not because this document introduces a new tax rate, a new rule or a revolutionary technical solution, but because it raises one simple question that should matter to every minister of finance, every investor and every taxpayer:

What if the investor would have come even without the incentive?

That question changes the entire economic calculation. If an investment would have been made even without a tax relief, then the incentive did not change the investor’s decision. The state merely gave up part of its public revenue.

In professional literature, this phenomenon is known as the redundancy effect, meaning a situation in which the state subsidizes an investment that would have taken place even without the subsidy.

At first glance, this may seem like a technical issue of tax policy. In reality, it is one of the most important questions of public money management. Every euro the state does not collect through taxes is a euro no longer available for infrastructure, education, healthcare, public transport or public debt reduction.

This is why the OECD insists that tax incentives should not be viewed as a political instrument or an administrative privilege, but as a state investment that must generate a measurable return.

In many countries, the discussion begins with the question:

“How much incentive should be offered?”

The OECD suggests that the right question should be:

“What problem are we trying to solve?”

That distinction is not academic. If investment is lacking because of insufficient infrastructure, slow administrative procedures, an inefficient judiciary, a shortage of qualified labour or regulatory uncertainty, then even the most generous tax incentive will not solve the underlying problem.

On the contrary, there is a serious risk that the state will finance investments that would have happened anyway, while the real causes of weak competitiveness remain untouched.

In other words, a tax incentive should not be a response to a political desire for investment. It should be a response to a precisely defined problem.

Three scenarios in which the state may lose

State expectation	Possible outcome
More investment	The investor would have come even without the incentive
More jobs	Jobs are merely shifted from one sector to another
Higher economic growth	The fiscal cost exceeds the economic benefit

For this reason, the OECD recommends that an assessment of expected benefits and costs be carried out before any incentive is introduced. Even when a country does not have sophisticated econometric models, a simplified analysis is better than no analysis at all.

This is perhaps the most practical message of the entire document. Not every country needs an army of economists, consultants and analysts, but it must have answers to several basic questions:

• How much will the measure cost?
• How much new investment do we expect?
• How many jobs should it create?
• How will we measure success?
• What will we do if the expected results do not materialize?

When the state allocates ten million euros for subsidies, that cost is visible. It appears in the budget and becomes part of public debate. When the state forgives ten million euros in taxes, the cost is much less visible.

But the economic effect may be almost identical. In both cases, the state has given up ten million euros of public funds.

This is an idea that deserves far more attention than it currently receives. Tax expenditures often pass under the radar precisely because they are not seen as expenditures. In reality, they are expenditures, only in a different form.

One of the more interesting observations made by the OECD is that a successful investment incentive policy requires clear institutional responsibility.

In practice, different ministries and agencies often have different priorities. Institutions responsible for attracting investment naturally seek to attract as many investors as possible. On the other hand, institutions responsible for public finances must consider budget sustainability and long-term fiscal effects.

This is precisely why the OECD believes that ministries of finance have a particularly important role in designing, shaping and overseeing tax incentive systems.

Not because they should act as an obstacle to investment. Quite the opposite. But because they are in a position to ask the most important question:

Is public money truly buying new investment, or is it merely financing a decision that would have been made even without the incentive?

For small economies, this is not only a tax question. It is a question of responsible management of public resources.

What does this mean for Montenegro?

For a small economy, the issue of tax incentives carries additional weight. Large countries can sometimes afford expensive mistakes. Small countries much less so.

Every poorly designed incentive has a greater relative impact on public finances. That is why, for Montenegro, perhaps more than for many other countries, every tax relief or incentive should be based on clear analysis, measurable objectives and subsequent evaluation.

This does not mean that tax incentives are unnecessary. In certain circumstances, they can be an effective instrument for attracting investment, developing less developed regions, encouraging innovation or supporting technological transformation.

But precisely because they can be useful, it is necessary to know when they work and when they do not.

This raises a question worth asking before every future measure.

Four questions before every tax incentive

Question	Why it matters
Would the investor have come even without the incentive?	It determines whether the incentive actually changes the investment decision.
How much public revenue is the state giving up?	Every incentive has its price.
How will we measure success?	Without indicators, there can be no serious evaluation.
When will we reassess the results?	Temporary measures often become permanent without any review of their effects.

If these questions cannot be answered before a measure is adopted, it becomes difficult to find the answer after the money has already been lost.

Perhaps the greatest value of the OECD document lies precisely in reminding us that the success of tax policy is not measured by the number of approved reliefs.

It is measured by results:

• How many new jobs were created?
• How much new investment was attracted?
• How much did productivity increase?
• How much was the competitiveness of the economy improved?
• How much did the standard of living rise?

Only when answers to these questions exist can we speak of a successful investment incentive policy.

Otherwise, we risk allowing the most expensive economic policies to be precisely those that, at first glance, looked the cheapest.

Because perhaps the greatest value of a tax incentive is not that it attracted an investor, but that the state can prove the investment would not have happened without it.

If it cannot prove that, then it is not investment policy.

It is an assumption paid for with public money.

And for small economies, assumptions are often the most expensive form of economic policy.