A Practical Guide to Investment Tax Incentives

1. Conception

Abstract

The conception stage is critical to ensure that investment tax incentives are justified, cost-effective, and aligned with national priorities. Policymakers should establish the need for intervention, compare tax incentives with alternative tools, and weigh expected costs and benefits, including indirect effects. Even simple ex-ante assessments provide valuable insights where capacity is limited and are better than no assessment. It is important to establish governance procedures to prevent undue influence and ensure coherence with other policies.

The conception stage is the foundation of an investment tax incentive policy. It involves determining the need for a policy intervention and assessing whether a tax incentive is an appropriate tool to achieve the desired objective and at what costs (see Box 1.1 for key definitions used throughout this guide). This stage also includes establishing the legal and institutional frameworks necessary to support decision-making and to ensure that tax incentives align with national development priorities, maximise social benefits while minimising economic distortions, and uphold transparency and accountability principles.

A systematic approach to the conception of tax incentives is crucial. This can support sound decision-making based on ex-ante assessments of potential costs and benefits, including direct and indirect effects where possible, as well as the exploration of complementary and alternative policy options. Criteria for assessments include effectiveness, efficiency, equity, administrability, and consistency with development objectives.

Even a simplified ex-ante assessment is better than none. When resources are limited, policymakers can enhance decision-making by prioritising the evaluation of certain effects. If quantitative assessments are challenging, guiding evaluation questions can be used to qualitatively reflect on potential costs and benefits.

A well-structured policy process and governance framework reinforces transparency, accountability, and policy coherence. Objective and transparent assessment of tax incentives, supported by ample government consultation, helps safeguard decision-making from undue stakeholder influence, and promotes integrity, transparency, and accountability in the use of public funds. Effective coordination among relevant agencies at all levels of government is key to ensure policy coherence and prevent fragmented decision-making. Given their wide fiscal perspective and technical expertise in tax design, Ministries of Finance are well placed to oversee the conception, design and implementation of tax incentives, in collaboration with relevant Ministries or agencies. Regional and international cooperation can also support limiting harmful tax competition and potential negative effects on neighboring economies.

Table 1.1. Key steps for improving tax incentive conception

Key Steps	Recommended Actions
1. Determine the need for policy intervention	Identify the rationale justifying government intervention and consider available policy options
2. Assess potential costs and benefits, and define clear policy objectives	Set ex-ante evaluation frameworks and requirements Conduct ex-ante policy assessments to compare policy alternatives and maximise value for money Consider direct and indirect effects, including fiscal and financing implications, and broader economic and development outcomes Define clear and measurable policy objectives aligned with national development goals
3. Establish procedures and governance mechanisms	Introduce tax incentives via primary legislation and consolidate them in the tax code Set incentive duration and plan for ex-post evaluation at the outset Anticipate potential reform challenges and risks Set procedures and institutional arrangements for tax incentive governance

Box 1.1. Key definitions

Throughout this guide:

• Tax incentives for investment are defined as targeted tax provisions that constitute a deviation from the standard tax treatment in a country resulting in reduced or postponed tax liability with the objective of promoting investment (Celani, Dressler and Wermelinger, 2022[1]).

• Effectiveness refers to whether tax incentives achieve intended objectives,

• Efficiency refers to whether objectives are reached at lowest social costs, including revenue losses for government (IMF-OECD-UN-World Bank, 2015[2]).

1.1. Determine the need for policy intervention

The first step in the conception phase is to clearly identify the policy objective, determine whether market failures, distortions or other issues justify government intervention, and gather evidence on alternative policy approaches. The most effective policy choice will depend on the economic and political context, the objectives and considerations that are specific to the policy instrument, including required financial and human resources and potential distortions (see Box 1.2, Example 1).1

1.1.1. Identify the rationale justifying government intervention

Investment tax incentives are best justified when they clearly address a market failure or distortion. Governments use tax incentives for a variety of reasons, including to attract investment, promote specific sectors or regions, and support other development objectives. While these may be legitimate policy goals, the strongest case for the use of tax incentives occurs when the incentive directly addresses a market failure (e.g. positive externalities) or specific distortions (e.g. macroeconomic shocks, sector or technological path-dependencies).2 Left unaddressed, market failures can result in investment that is suboptimal for society and limit other desirable outcomes, related to employment, innovation, regional development, equity and the environment. For example, research and development (R&D) incentives can help address underinvestment in R&D caused by firms’ inability to fully capture the benefits of knowledge spillovers. In such cases, tax incentives may improve efficiency by aligning private and social returns.

The case for investment tax incentives is weaker when market failures and distortions are absent, even if they aim to support desirable policy goals. Incentives shift public resources to recipient firms and subsidise investments. Without positive externalities, they may do so without generating sufficient gains from a societal perspective. Tax incentives also come with other risks and costs that must be considered in policymaking: costs to public revenue, limited effectiveness and windfall gains, economic distortions, administrative and compliance costs, risks of tax avoidance.

A clear understanding of the policy objective is essential for effective policy design. This requires investigating why an undesirable outcome – such as low investment or job creation – occurs (see Box 1.2, Example 2).3 Identifying the root causes of suboptimal outcomes can be challenging and misdiagnosing them can lead to ineffective or even be harmful policy responses.4 In practice, and particularly under political pressure, governments may sometimes find it simpler to propose a tax incentive than to tackle deeper structural challenges. In the absence of clear evidence of a market failure, this can shift the burden to ministries of finance to design incentives in haste, even where other policy tools may be more appropriate.5 Careful diagnosis is particularly important in contexts with strong lobbying pressures to ensure that incentives address genuine market needs rather than catering to influential interest groups (OECD, 2020[3]).

The diagnosis of the policy objective may rely on assessments with quantitative evidence where possible (see Box 1.2, Example 3).6 To understand the drivers of low investment levels, policymakers can use analytical tools such as comparative investment and financial metrics,7 foreign direct investment (FDI) performance analysis,8 binding constraints diagnostics,9 business surveys,10 and econometric assessments of investment barriers11. Sectoral assessments, for instance, can help policymakers identify whether investment gaps stem from externalities, financing constraints, or weak investor confidence.

Adopting a whole-of-government approach and engaging with stakeholders can assist in determining the need and scope of a policy intervention.12 Broad consultations within government and with experts and stakeholders can help validate initial assessments, uncover additional justifications or counterarguments, reveal potential policy complementarities or alternatives, as well as the most appropriate form of intervention, as discussed below (Granger, Phillips and Warwick, 2021[4]; World Bank, 2024[5]; HM Treasury, 2022[6]).13

1.1.2. Consider available policy options

Once the rationale for policy intervention has been established, governments must determine the most appropriate policy instrument to address the identified market failure or policy objective. This requires identifying a range of policy tools – both tax and non-tax – and selecting a set of relevant alternatives against which a tax incentive should be compared. Examining how various tax (e.g., pollution or health taxes, R&D tax incentives) and non-tax instruments (e.g., direct subsidies, regulatory reforms, public investment in infrastructure or education) have been applied in comparable contexts can provide valuable insights into which tools may be most appropriate.14 In some cases, well-designed policy mixes – combining tax incentives with complementary measures – may be necessary. For example, tax incentives aimed at promoting linkages between foreign and domestic companies may require additional policies to strengthen the absorptive capacities of local firms (OECD, 2023[7]).

First best options may not be available due to political, economic, technological and informational constraints. When shortlisting tax incentive and alternative policy options for further cost benefit assessments (see next step), governments also need to consider whether the risk of poor policy design and implementation, as well as administrative and compliance costs, may outweigh the expected benefits. It is also important to consider whether the intervention is politically feasible, considering its potential equity and distributional implications (see Box 1.4, Example 1, and Gillingham and Sweeney (2010[8])). Even when the most efficient policy is not politically viable, it can still be considered as a benchmark to highlight potential trade-offs and guide future policy adjustments.

Box 1.2. Determining the need for policy intervention: country examples

1. The United Kingdom’s HM Treasury Green Book (HM Treasury, 2022[6]), provides guidance on undertaking ex-ante policy evaluation.

2. A guide by the New South Wales Department of Industry in Australia (2017[9]) outlines different types of market failures, and potential government responses.

3. The United Kingdom’s Green Book, published by the Treasury, offers an example of structured approach to establish the rationale for a policy intervention and appraise potential policies, programmes and projects.

1.2. Assess potential costs and benefits, and define clear policy objectives

1.2.1. Set ex-ante evaluation frameworks and requirements

Establishing clear procedures and institutional arrangements to guide investment tax incentive policy is essential. This helps ensure that policies are informed by technical assessments and protected from undue influence and pressure. In some cases, tax incentives are introduced without prior evaluation – sometimes following political commitments that pre-empt diagnosis and feasibility analysis – and then remain in place without ex-post assessments to justify their continuation. To enhance decision-making and safeguard fiscal discipline and transparency in the use of tax incentives, ex-ante policy evaluations could be legally mandated as part of budget planning or fiscal legislation (Redonda, von Haldenwang and Berg, 2023[10]; IMF-OECD-UN-World Bank, 2015[2]; CIAT & UN, 2018[11]; World Bank, 2024[5]). Even without a legal obligation, governments can promote ex-ante policy assessments by issuing evaluation templates and guidance for authorities proposing tax incentives (see Box 1.4, Example 2).

Tax expenditures should ideally be subject to the same scrutiny as direct government spending. This can prevent hidden fiscal risks and ensure policy trade-offs are explicitly addressed (IMF-OECD-UN-World Bank, 2015[2]; CIAT & UN, 2018[11]; World Bank, 2024[5]). While tax expenditures often serve as alternatives to direct spending, they typically receive far less oversight, as they are embedded in the tax system and may remain in effect unless explicitly subjected to evaluation, unlike direct expenditures that undergo regular budget reviews (Berg et al., 2024[12]).

Countries can integrate tax expenditures into the budget process, treating them similarly to direct expenditures and imposing fiscal limits. In these cases, tax expenditures are reported alongside the national budget, either as annexes or in separate reports. Some governments require that ministries proposing new tax expenditures offset their costs by reducing other expenditures or identifying funding sources, such as compensatory taxes (IMF, 2018[13]; World Bank, 2024[5]). Establishing fiscal ceilings for tax incentives can also enhance transparency and ensure that their use remains disciplined (CIAT & UN, 2018[11]; IMF-OECD-UN-World Bank, 2024[14]; World Bank, 2024[5]).15

1.2.2. Conduct ex-ante policy assessments

Ex-ante policy assessments can inform decision making. These assessments help contrast the potential benefits and costs of policy interventions and alternatives. They also help manage trade-offs across outcomes while ensuring alignment with broader national priorities. Assessments can extend from high-level qualitative analyses to more sophisticated quantitative approaches.

Where resources for ex-ante assessments are limited, simplified frameworks can support decision-making. Governments in low-capacity settings can use structured qualitative assessments based on guiding questions and screening criteria to weigh relevant factors and identify the pros and cons of proposed policy options. Prioritisation may be necessary, but a minimum assessment can test whether an intervention is likely to meet its objectives and deliver value for money. Where capacity allows, simple quantitative approaches – such as cost-effectiveness metrics (e.g., jobs or investment generated per unit of fiscal cost) – can complement qualitative analysis (IMF-OECD-UN-World Bank, 2015[2]). Countries new to ex-ante evaluations can start with a subset of incentives, gradually building competence for more systematic assessments. Practical templates for both qualitative and quantitative assessments are available from the World Bank (2024[5]) and Redonda, von Haldenwang and Berg (2023[10]) (see also Box 1.4, Example 3).

Where capacity allows, cost-benefit analysis (CBA) can be considered. CBAs provide a structured way to assess the full economic value of a proposed tax incentive by estimating net economic benefits after accounting for direct and indirect effects, such as redundancy, displacement, and opportunity costs. Key elements of a CBA are discussed in Box 1.3. Practical guidance for undertaking CBAs can be found in IMF-OECD-UN-World Bank (2015[2]), the IMF (Beer et al., 2022[15]), CIAT & UN (2018[11]), and the World Bank (2024[5]) (see also Box 1.4, Example 4).16 While such assessments are essential, they remain underutilised in many countries due to data limitations and capacity constraints. To address these challenges, governments may seek to establish partnerships with universities and think tanks to leverage external expertise and build capacity for conducting CBAs in the long term.

Box 1.3. Elements of a cost-benefit assessment of tax incentives

Investment tax incentives ultimately aim to promote development and improve living standards. A cost-benefit assessment helps determine whether they are likely to deliver net social gains. As elaborated in IMF-OECD-UN-World Bank (2015[2]), the following elements are critical for assessing their economic benefits:

• Net investment effect. The rise in investment after correcting for redundancy (investment that would have occurred anyway) and displacement (investment reduced elsewhere).

• Net employment and wage effects. New jobs can yield significant social gains if they reduce unemployment. However, if new jobs displace existing jobs, the social benefits depend on the productivity (and wage) differential between the new and old jobs.

• Productivity and other spillovers. Where new investment boosts productivity elsewhere in the domestic economy, e.g. in upstream or downstream industries (often seen as a particular benefit from inward FDI), social benefits are greater as it raises income levels more widely.

• Impacts on broader policy goals. Impacts can also arise where tax incentives impact inequalities environmental goals, economy security, or other policy objectives. These potential benefits and costs can be identified, quantified and monetised.17

The social costs of tax incentives depend on the following factors:

• Scarcity of public funds. Government resources are limited and face competing demands. Forgone revenue (when not offset by future tax revenue from additional investment and jobs) may need to be replaced through higher taxes or lower spending elsewhere, imposing additional economic and social costs. If raising revenue elsewhere distorts economic activity, each unit of revenue forgone can cost society more than one unit overall—a concept known as the marginal cost of public funds (MCPF) (see discussion below).

• Administrative and compliance costs, which can rise with more complex tax incentives.

• Distorted resource allocation. Discrimination in favour or against different investments implies that taxes can distort determine resource allocation. These distortions reduce average productivity and lowers income per capita.

Source: Reproduced with modifications from IMF-OECD-UN- World Bank (2015[2]).

Ex-ante assessments also help lay the foundation for effective monitoring and ex-post evaluation of incentives. By clarifying policy goals, key performance parameters, and expected mechanisms of impact, they can support the design of evaluation frameworks, help identify data needs, and trigger data collection measures early in the policy process (see step 3 for more information). Despite their importance, ex-ante policy appraisals remain a legal requirement in only a few jurisdictions (Redonda, von Haldenwang and Berg, 2023[10]; World Bank, 2024[5]).

Consider direct and indirect effects, including fiscal and financing implications, and broader economic and development outcomes

Fiscal costs and financing implications

Estimating revenue forgone remains a core component of any assessment. Unlike direct spending or non-tax instruments such as subsidies, which are typically subject to budget limits, tax incentives reduce revenues rather than outlays, making their fiscal costs less transparent and potentially larger than anticipated if forecasts prove inaccurate. In addition, tax incentives may create tax planning opportunities for non-targeted businesses, such as disguising existing projects as new investments to qualify for benefits (Howell, Stotsky and Ley, 2002[16]; Roca, 2010[17]). Such risks can add unexpected fiscal costs, especially in jurisdictions with weaker tax administration. While careful incentive design can help mitigate these risks, it is important to consider them ex-ante. Various methods exist to forecast the fiscal cost of tax incentives.18 In data- and capacity-constrained settings, relatively simple approaches can provide a useful starting point. For instance, governments can leverage administrative tax data, national accounts, and business surveys to assess the potential number and size of beneficiary firms. Establishing a basic inventory of potential eligible firms, alongside their tax revenue information, can offer insights into the scale and distribution of potential revenue at stake (Heady and Mansour, 2019[18]; World Bank, 2024[5]).19 Where capacity allows, forward-looking tools such as microsimulation models can provide insights into how proposed incentives affect effective tax rates across firm types and investment projects.20 When combined with investment elasticities, such models can also help simulate ex-ante the likely magnitude of new investment activity, supporting a more realistic assessment of expected benefits and fiscal risks.

The fiscal costs of tax incentives could also reflect the cost of compensating for revenue losses. Tax expenditures reduce public revenue and may necessitate compensatory tax increases or spending cuts. Any tax increase, however, generally comes with economic costs – e.g. distortions to labour supply, saving, or investment. To account for these costs, economists often adjust the estimated revenue forgone from a tax incentive by the marginal cost of public funds (MCPF).21

The implications for public spending can also be incorporated. Without offsetting policies (e.g. additional taxes, debt issuance), the revenue lost from tax incentives require spending cuts (see Box 1.4,Example 5). While the MCPF adjustment can capture economic costs of higher taxes, it does not assess the trade-offs associated with spending cuts or debt increases. It is important therefore to clearly communicate the choices involved.

Broader economic and development outcomes

As countries develop their capacity to assess tax incentives, they may wish consider more sophisticated approaches. This can include a more detailed analysis of the fiscal costs of introducing incentives, as well as a more detailed consideration of indirect effects. This section discusses some of these effects, though noting that precise measurement is challenging, especially for capacity constrained governments, and qualitative consideration may be more appropriate.

Tax incentives result in costs when they subsidise investments that would have occurred without the incentive. This can divert public resources without producing additional economic activity. Similarly, displacement effects – where investment or employment in incentivised sectors replaces activity elsewhere in the economy – can limit net benefits of incentives (World Bank, 2024[5]). To avoid overstating benefits of incentives, assessments should aim to exclude non-additional or displaced activity when valuing outcomes. While quantifying these effects can be challenging, governments can start with firm-level data – such as profitability, return on investment, and cost of capital – and investor surveys to assess sensitivities of firms to tax incentives.22 Where capacity allows, forward-looking microsimulation models or ETRs, combined with investment elasticities and scenarios about plausible redundancy rates, can help estimate additional investment. Nevertheless, such ex-ante approaches cannot show whether the incentive has truly caused additional investment.

Tax incentives may also distort resource allocation and affect productivity. Steering investments toward tax-favoured sectors rather than those with the highest economic potential can reduce economic efficiency and hinder long-term growth (Roca, 2010[17]; Hines and Park, 2019[19]; Correia, Santos and Siqueira, 2024[20]). Preferential tax treatment for select businesses can also disrupt competition, creating an uneven playing field and undermining market dynamics (Bagnoli, Leinz and Sales dos Santos, 2023[21]; Amendola et al., 2018[22]). Similar imbalances can arise across countries, where jurisdictions with larger fiscal capacity can offer more generous incentives than those with lower fiscal capacity. In some cases, lobbying may lead to incentives disproportionately benefiting large firms, fostering perceptions of unfairness and potentially weakening tax compliance and public trust (Clark and Skrok, 2019[23]; Amendola et al., 2018[22]). Where these costs are hard to measure, governments can consider the impacts of tax incentives on the functioning of markets qualitatively.

A variety of other effects beyond investment distortions could be considered. Environmental effects, such as increased or reduced pollution, for instance, may be important depending on the incentivised activity and context. Distributional effects may also matter. For example, tax incentives that favour skilled over unskilled labour may widen income inequality unless accompanied by redistribution policies. At the same time, innovation spillovers within firms can partially offset this effect, as knowledge and productivity gains among skilled workers may benefit unskilled coworkers as well (Aghion, 2019[24]).

Tax incentives can also result in positive effects such as knowledge spillovers. Well-designed incentives may correct market failures and generate positive spillovers, such as enhanced productivity in local suppliers and competitors, which can in turn result in expansions to the tax base. These gains may arise from technology transfers, labour mobility, and competition-driven efficiency improvements.

To assess these wider economic and development impacts, a mix of modelling tools and qualitative methods can be used. As a first step, descriptive statistics and qualitative strategies – such as surveys, and focus groups – can offer useful insights into potential indirect effects.23 Mapping the expected effects of a tax incentive through a "theory of change" or "logic model" can further clarify how the policy is expected to influence business behaviour and other development outcomes over time.24 Where feasible, governments can employ more sophisticated economic models for more comprehensive assessments.25

1.2.3. Define clear and measurable policy objectives aligned with national development goals

Clearly defined objectives support ex-post evaluation and where necessary, reform (see Box 1.4, Example 6). The absence of well-defined objectives complicates policy design, monitoring, and evaluation (World Bank, 2024[5]; Redonda, von Haldenwang and Berg, 2023[10]; Beer et al., 2022[15]; Pew Charitable Trusts, 2017[25]). By constrast, establishing measurable benchmarks, such as job creation and investment targets, helps ensure the collection of relevant data to assess expected impacts. Incentives that no longer generate a societal benefit can be more easily identified and reconsidered without extensive evaluations (Beer et al., 2022[15]).

Goals will be most effective if they are specific, measurable, and linked to time-bound development priorities. For instance, if job creation is a stated objective, policymakers can define specific target groups (e.g. youth) and employment types (e.g. skilled or unskilled; seasonal, fixed-term or permanent). This level of precision enhances transparency, facilitates meaningful evaluation, and reduces the risk of rent-seeking. Indicators should be practical to measure at a reasonable cost and frequency. Where performance outcomes cannot be quantified, qualitative assessments can be employed to provide valuable insights, but key causal linkages between the proposed incentive scheme and expected outcomes can be articulated up front (see Monitoring and Evaluation stages).

Box 1.4. Assessing potential costs and benefits, and defining clear policy objectives: country examples

1. An example from the United Kingdom HM Treasury (2022[6]) provides guidance on issues to consider when a shortlisting possible policy options for detailed cost-benefit or cost-effectiveness analysis.

2. Standardized ex-ante evaluation frameworks, such as those implemented in Ireland, the Netherlands, and Korea can facilitate and encourage authorities to implement ex-ante policy assessments (see Government of Ireland (2024[26]), Redonda, von Haldenwang and Berg (2023[10]), and the World Bank (2024[5]) for more information).

3. Ireland (2024[26]), for instance, has adopted the following ex-ante evaluation questions: What is the objective of the tax expenditure?; What market failure is being addressed?; Is a tax expenditure the best approach to address the market failure?; What economic impact is the measure likely to have?; How much is it expected to cost?; What impact is the tax expenditure likely to have from an equality perspective?; What impact is the tax expenditure likely to have from an environmental perspective?; and Are the data collected sufficient for the purpose of reviews?

4. Australian Government (2023[27]) and the United Kingdom’s HM Treasury (2022[6]) provide additional guidance on cost-benefit assessments, and United Kingdom’s HM Treasury (HM Treasury, 2020[28]; HM Treasury, 2020[29]) and Government of Ireland (2012[30]) provide practical government-oriented guidance on evaluation methods and techniques.

5. In Brazil, for instance, any new tax expenditure must be offset by a compensatory tax measure or demonstrate that it does not impact federal budget targets. Additionally, any tax measures introduced to compensate for tax expenditures in the previous budget must be specifically identified and reported.

6. The United Kingdom employs the SMART (Specific, Measurable, Achievable, Relevant, and Time-bound) approach when setting policy objectives, facilitating both implementation and assessment (HM Treasury, 2022[6]).

1.3. Establish procedures and governance mechanisms

A well-structured policy process is essential to ensure that investment tax incentives undergo adequate appraisal ex ante and ex post. Key best practices include granting tax incentives through primary legislation, consolidating them within the tax code and defining clear policy objectives, and ensuring that Ministries of Finance oversee technical policy design. Legislation can require cost-benefit analysis ex ante and ex post, introducing time limits (Oxfam, 2022[31]).

1.3.1. Introduce tax incentives via primary legislation and consolidate them in the tax code

Introducing tax incentives through primary legislation can support transparency and certainty. Tax incentives are often introduced through multiple legal instruments, including secondary legislation, executive decrees, and contractual agreements, which can reduce transparency and increase risks of rent-seeking and inconsistencies with government priorities and other tax rules (OECD, 2025[32]; Pecho et al., 2024[33]). Granting or consolidating incentives through the main tax law can improve clarity, ensure parliamentary scrutiny, facilitate investor access to relevant information, and support sound tax administration (Sofrona, 2025[34]; IMF-OECD-UN-World Bank, 2015[2]; OECD, 2023[35]).26

1.3.2. Set incentive duration and plan for ex-post evaluation at the outset

Incorporating time-bound objectives and ex-post review at the conception of tax incentives can facilitate the adjustment or discontinuation of ineffective measures, limiting unnecessary revenue losses. Making incentives temporary or specifying sunset provisions systematically – where incentives automatically lapse unless explicitly reviewed and reauthorised – can help ensure that incentives remain aligned with their intended policy goals, discouraging indefinite extensions without evidence or discussion about policy impacts (see Box 1.5, Example 1). However, durations that change too frequently can create investor uncertainty.

Tax incentive proposals can be accompanied by a preliminary monitoring and evaluation plan. Such plans can outline key policy goals, monitoring indicators, data requirements and collection strategies, reporting obligations for beneficiaries and government agencies, and evaluation frequency (see Monitoring & Evaluation, and Box 1.5, Example 2) (CIAT & UN, 2018[11]). Planning for evaluation at the conception stage can anticipate and resolve practical issues like whether tax forms need to be adjusted, and whether administrative datasets can be shared and merged for analysis. Where feasible and without infringing taxpayer confidentiality rights, authorities can support transparency by requiring the disclosure of tax incentive beneficiaries, or at least the largest recipients, for each specific tax provision (Sofrona, 2025[34]).

1.3.3. Anticipate potential reform challenges and risks

When introducing or modifying tax incentives, policymakers can anticipate potential reform challenges and legal risks. Early attention to political economy and legal constraints can help preserve policy space and ease future transitions. Where reforms may result in significant adjustment costs, a strategic approach or transitional support measures may be warranted (see Evaluation stage; Trebilcock (2014[36])). For example, where tax incentives are granted through contracts – especially those containing stabilisation clauses – or are protected by international investment agreements (IIAs), governments may face litigation under domestic or international law if they are changed in a way that could breach the contract or treaty obligations (UNCTAD, 2022[37]; IISD, 2024[38]). Governments can mitigate these risks by avoiding overly rigid stabilisation provisions (see Implementation stage), incorporating sunset and renegotiation clauses, and ensuring consistency with domestic legislation and treaty obligations. At the conception stage, policymakers can assess these legal and institutional constraints and consider measures to preserve future policy space. This may involve refining treaty and contract practices to clarify that the withdrawal or modification of a tax incentive does not in itself constitute a breach of investor protection standards, and engaging stakeholders early – through investor associations or grievance mechanisms – to identify transition pathways and reduce the risk of dispute. Flexibility, however, needs to be balanced against the benefits of providing certainty to investors.

1.3.4. Set procedures and institutional arrangements for tax incentive governance

Ensure cross-agency co-ordination to align incentives with broader policy priorities

Formal co-ordination and decision-making structures should involve all relevant government bodies. Cross-agency consultations can help mitigate sectoral capture by increasing transparency, incorporating expert perspectives, and balancing investment goals with fiscal sustainability. Establishing formal co-ordination mechanisms – such as inter-agency committees – can ensure that tax incentives are aligned with broader policy objectives and effectively monitored, thereby reducing risks of policy incoherence and duplication, inefficient administrative fragmentation, and legal uncertainty, particularly when incentives are subject to stabilisation clauses.

Entrust the Ministry of Finance with primary decision-making authority over tax incentive policies

A sound governance framework is crucial for ensuring that tax incentives are designed based on technical assessments rather than political discretion. While line ministries and investment promotion agencies (IPAs) play key roles in identifying sector-specific needs and promoting the country to investors, Ministries of Finance are well placed to oversee the conception, design and overall governance of tax incentives, in collaboration with the relevant line ministries and agencies. As the entity responsible for managing tax policy and fiscal sustainability, it is best positioned to assess the budgetary implications, economic trade-offs, and overall policy coherence with national priorities and other existing incentives.

Countries can institutionalise the role of the Ministry of Finance as the primary authority responsible for introducing tax incentives through fiscal legislation or budget laws. Line ministries and other agencies, such as IPAs or Enterprise Development Agencies, can still contribute by proposing incentives, advising on their design, and supporting implementation, which can be useful to improve policymaking given their expertise and direct contact with business and other stakeholders (OECD, 2024[39]; 2025[32]). This advisory role can be formally reinforced through inter-agency committees discussed above, while maintaining centralized oversight over ex-ante policy assessments and incentive design within the Ministry of Finance (IMF-OECD-UN-World Bank, 2024[14]) (see also Box 1.5, Example 3). Where full centralization is not feasible, the Ministry of Finance can oversee key design elements, such as the selection of instruments and eligibility criteria.27 Where subnational governments play a role in tax incentive policies, formal coordination mechanisms can help maintain consistency and cost-effectiveness. These mechanisms can prevent the unintended accumulation of tax reliefs across national and subnational programmes.

Support regional and international co-operation to avoid harmful tax competition

When introducing tax incentives, policymakers can consider cross-border implications. Incentives offered in one country can have externalities in other economies, such as triggering competitive responses from competing economies. This can risk a "race to the bottom" with governments sacrificing valuable tax revenue without achieving significant investment gains (Knoll et al., 2021[40]; Wiedemann and Finke, 2015[41]). International and regional cooperation may help to mitigate these risks.

Countries can cooperate in various ways to improve tax incentive and investment outcomes. Examples include sharing knowledge and good practices, adopting transparency codes of conduct, and limiting harmful tax practices. Regional co-operation frameworks such as those in the European Union, Caribbean, Southern African Development Community (SADC), East African Community (EAC), and West African Economic and Monetary Union (WAEMU) have sought to cooperate on tax incentive policies to improve revenue mobilisation and reduce harmful tax competition (IMF-OECD-UN-World Bank, 2015[2]; CIAT & UN, 2018[11]). For instance, the SADC Protocol on Finance and Investment and the EAC’s proposed "Code of Conduct" promote transparency and co-operation through information exchange and joint decision-making (see Box 1.5, Example 4). While enforcement remains a challenge in some cases, frameworks such as these provide a platform for mutual learning on design effectiveness, implementation challenges, and evaluation strategies.28 Ultimately, these mechanisms can help to promote good governance and the development of tax incentive policies that support investment without undermining fiscal stability (McIntyre, 2017[42]; OECD, 2018[43]; Economic Commission for Latin America and the Caribbean (ECLAC)/Oxfam International, 2020[44]).

Box 1.5. Establishing procedures and governance mechanisms: country examples

1. Ireland requires all tax expenditures to be time-limited, making them subject to review every 3–5 years, depending on their estimated annual cost (Government of Ireland, 2024[26]).

2. Ireland also requires resources to be allocated to tax expenditure reviews on a proportionate basis to the cost of the tax expenditure. The annual cost of the scheme determines the rigour and frequency of the analysis deemed necessary for each review (Government of Ireland, 2024[26]). In Germany, all subsidies and tax expenditures must undergo regular evaluations to assess whether they achieve their intended objectives. Likewise, in the Netherlands, tax expenditures are reviewed every four to seven years to ensure their effectiveness (Beer et al., 2022[15]). (Additional examples can be found in the World Bank (2024[5]).)

3. In South Africa, only the Minister of Finance is constitutionally authorised to introduce a money bill. Line ministries and other stakeholders must submit tax incentive proposals in writing. Where it is decided to proceed, the Ministry of Finance engages with the proposing authority to refine its design. Internal assessments are supported by a guide on designing incentives developed by the Ministry of Finance.

4. For African members of SADC, the Protocol on Finance and Investment, establishes, among other provisions, that SADC Member States must create a comprehensive SADC Tax Database containing details of all tax incentives offered, including their implementation dates and associated conditions. It also calls for Member States to work towards a common approach in the treatment and application of tax incentives, ensuring that these incentives are only granted through tax legislation.

References

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Notes

← 1.  See, for instance, Granger, Phillips and Warwick (2021[4]) for guidance on undertaking ex-ante policy evaluation.

← 2.  Examples of market failures affecting investment include: externalities (e.g., knowledge spillovers from research and development), public goods (e.g., infrastructure underprovided by private markets), coordination failures (e.g., industries requiring simultaneous investments across supply chains), market power and economies of scale (e.g., high fixed-cost industries where entry barriers prevent competition), and capital market imperfections (e.g., credit constraints limiting SME investment), information asymmetries (e.g. If firms lack adequate knowledge about investment opportunities or financing options). Other distortions may include for example capital flight due to international tax competition (e.g. affecting mobile capital), investment suppression during economic downturns (Wen, 2020[45]), or sectoral path-dependencies where initial scale is needed for long-term viability.

← 3.  Gillingham and Sweeney (2010[8]) provide an analytical framework and review of market failures and policy instruments relevant to renewable energy; Armitage, Bakhtian and Jaffe (2023[46]) review the literature and new policy instruments addressing innovation market failures affecting development of climate technologies; the OECD (2023[35]) provides a typology of the different categories and kinds of investment incentives that governments have at their disposal for dealing with market failures.

← 4.  See Criscuolo et al. (2022[47]) for a discussion of the common pitfalls of targeted industrial policies, such as information asymmetries, capture or rent-seeking and general equilibrium effects.

← 5.  If weak underlying conditions – such as economic and political instability, poor infrastructure or lack of skills – are the main barriers to foreign investment, tax incentives alone are unlikely to be effective, as most firms will only commit long-term resources when a strong business case exists. Some may invest despite weak investment conditions, in which case tax relief may not be needed, while others – especially those with mobile operations – may respond only temporarily and relocate once incentives expire (Klemm, 2009[48]). Overall, evidence on additional investment effects from tax incentives remains mixed, but is generally disappointing for income-based incentives, which remain predominant in emerging and developing economies (see Design stage) (Klemm, 2009[48]; OECD, 2025[32]; OECD, 2022[49]; Andersen, Kett and von Uexkull, 2018[50]; Klemm and Van Parys, 2012[51]).

← 6.  Granger, Phillips and Warwick (2021[4]) outline questions that can help establish the rationale for a policy intervention supported by evidence.

← 7.  Comparative investment and financial metrics can be used to examine investment levels across sectors, regions, or asset types (e.g., buildings, machinery, R&D) using metrics like investment-to-GDP ratios, capital expenditure per worker or per capita, and the aggregate Tobin’s Q ratio (market value of firms divided by replacement cost of assets). Comparing these metrics to national averages or peer economies over time can reveal potential underinvestment areas. Firm-level metrics on corporate investment, profitability, financial leverage, and cost of capital (e.g., capital expenditure to sales, profit margins, operating cash flow, Tobin’s Q ratio) can provide deeper insights (see for instance, OECD (2023[52]), Sonali and Volodymyr (2017[53]), Bank of England (2016[54]) and OECD (2015[55])).

← 8.  FDI performance analysis can be used to benchmark FDI inflows overall or by sector against peer economies can reveal competitiveness issues. Shift-share analysis, for instance, may help distinguish whether FDI changes are due to global trends, industry composition, or the country's relative performance compared to peers (see applications for FDI and trade: Lee, Cheong and Kim, (2009[56]), Cheptea, Gaulier and Zignago (2005[57]) and Bas et al. (2015[58])).

← 9.  Binding constraint diagnostic tools can be used to identify key constraints on investment in sectors or regions. Growth Diagnostics, for instance, applies a decision tree to explore constraints affecting investment returns (e.g., poor infrastructure, inadequate human capital), financing conditions (e.g., weak financial systems), or appropriability of returns (e.g., corruption, weak property rights)(see Hausmann, Rodrik and Velasco (2005[59]) and Ianchovichina and Gooptu (2007[60])).

← 10.  Business surveys: Collect representative firm-level data and insights on operations, performance, and business challenges to understand the microeconomic environment affecting investment and business activity (see the World Bank (2024[61]) and the Bank of England (2024[62])).

← 11.  Econometric methods can be used to estimate deviations from expected investment levels using models like the accelerator model (investment as a function of desired capital stock changes) and the neoclassical model (investment as a function of the cost of capital). Econometric techniques can also be employed to analyse FDI patterns and determinants at the economy or sector level (see Barkbu et al. (2015[63]), Kopp (2018[64]), IMF (2015[65]), OECD (2023[52]), Maur, Nedeljkovic and Uexkull (2022[66]), Mistura and Roulet (2019[67]))

← 12.  See the OECD Policy Framework for Investment (OECD, 2015[68]) for guidance on a whole-of-government approach to investment climate reforms for development, and the OECD FDI Qualities Toolkit (OECD, 2022[69]) for more specific guidance on policy and institutional reforms to maximise benefits of investment.

← 13.  For instance, when considering policies to stimulate emerging and energy-efficient technologies, a narrow focus on electricity generation support may overlook more broader solutions that address both supply- and demand-side factors, such as environmental taxation or regulatory incentives (IMF, 2012[70]; Gillingham and Sweeney, 2010[8]; Dressler and Warwick, 2025[71]).

← 14.  See Criscuolo et al. (2022[72]) for a recent review of the effectiveness of different industrial policy instruments in OECD countries, building on a new analytical framework for industrial policy. Supply-push instruments that seek to improve firm performance (“within” firm instruments), such as tax incentives, are specifically addressed.

← 15.  Examples of mechanisms used to control tax expenditures include capping total tax expenditures as a percentage of GDP over a specified period, restricting their annual growth in their aggregate size, or integrating them into ministerial or sectoral budget ceilings. Additionally, some frameworks require new tax expenditures to be offset by compensatory revenue measures to safeguard medium-term budget targets (IMF, 2018[13]).

← 16.  See also Kronfol and Steenbergen (2020[73]), Granger, Phillips and Warwick (2021[4]).

← 17.  Quantification and monetisation of benefits can be done using methods such as shadow pricing (e.g. valuing environmental impacts using market-based instruments), the cost of alternatives (e.g. estimating the cost of achieving similar outcomes through public delivery, such as training programmes or income support), or revealed/stated preference methods (e.g. estimating willingness to pay for cleaner air or improved public services).

← 18.  For information on various tax expenditure approaches, see World Bank (2024[5]), the ADB (2023[74]), the IMF (Beer et al., 2022[15]; Heady and Mansour, 2019[18]), the IMF-OECD-UN-World Bank (2015[75]).

← 19.  In some cases, revenue losses from tax incentives can be estimated using simple formulas based on available information about the tax base and applicable tax rate. to deduct 100 USD from its taxable income, and the relevant tax rate is 20%, the estimated revenue loss would be 20 USD (Heady and Mansour, 2019[18]). Other simple practical examples – covering capital allowances, VAT exemptions, and customs reliefs – are available in Granger, McNabb and Parekh (2022[76]), the ADB (2023[74]) and World Bank (2024[5]).

← 20.  Corporate microsimulation models simulate how changes in tax parameters affect firms' tax liabilities, using tax return or firm-level data. Forward-looking indicators – such as average and marginal effective tax rates (EATRs and EMTRs) – can also support ex-ante assessments and have the added advantage of not requiring taxpayer-level data, making them particularly suitable for countries with lower resources (ADB, 2023[74]; Clark and Skrok, 2019[23]). Practical guidance and illustrative applications are available from the World Bank (2024[5]), ADB (2023[74]), Gascon et al. (forthcoming[77]) and Phillips, Tyskerud and Warwick (2021[78]). See also Celani, Dressler and Hanappi (2023[87]) for a methodological framework to compute forward-looking EATRs.

← 21.  This typically involves inflating each dollar of public revenue forgone by an estimated measure of the MCPF. As estimating the MCPF can be complex and context-specific, practitioners may, in the absence of country-specific estimates, refer to values reported in the literature. For advanced economies, a lower bound of 1.2 is commonly suggested (Elgin, Torul and Türk, 2022[79]). Given the uncertainty surrounding appropriate MCPF values, sensitivity analysis using alternative assumptions is recommended. For further practical guidance and references to country-level MCPF estimates, see World Bank (2024[5]), IMF-OECD-UN-World Bank (2015[2]), Bastani (2023[80]) and Elgin, Torul and Türk (2022[79]).

← 22.  Where returns are already high or investment levels have been sustained without incentives – historically or relative to peer countries or sectors – the risk of redundancy is greater. Conversely, incentives may be more likely to generate additionality where expected returns are close to the cost of capital or where baseline investment is low (Kronfol and Steenbergen, 2020[73]).

← 23.  Simple disaggregated statistics on potential beneficiaries (e.g. by sex, age, education, type of contract, or region) can offer an initial indication of possible distributional impacts. Environmental-economic statistics can also be used to obtain insights on several potential environmental impacts of incentivised industries (UN; EU; FAO; OECD; The World Bank, 2017[81]). At the project or policy level, environmental impact assessments and strategic environmental assessments can help inform about potential ecological risks associated with incentivised projects and activities. Guidance on these tools is available from World Bank et al. (2010[82]), OECD (2006[83]) and IAIA (2024[84]).

← 24.  This involves establishing hypothesis about causal relationships to explain how the incentives are expected to influence the behaviours of relevant actors and how these changes, in turn, are expected to affect outcomes, both directly and indirectly, in the short and longer terms (Beer et al., 2022[15]).

← 25.  For example, input-output and CGE models can be used to analyse interdependencies between sectors and agents in an economy, helping to understand spillover effects, resource reallocations, and the overall welfare impacts of policy interventions. These models can be extended to account for environmental impacts as well (US EPA, 2025[85]).

← 26.  See CIAT & UN (2018[11]) for practical guidance on drafting tax incentives legislation, including a more extensive discussion on the favourable arguments for placing the legal rules providing the incentive in the tax code.

← 27.  See CIAT & UN (2018[11]) for a discussion on the roles of the various authorities.

← 28.  By facilitating information exchange and co-operation, they can help mitigate strategic investor behaviour – such as firms seeking to play jurisdictions against one another – enable capacity building, including in cost-benefit analysis, and support institutional reforms to curb abuse and improve oversight of tax incentives.