Richard Bird's new paper on Tax challenges facing developing countries comfirms my own suspicions of fiscal incentives (and by extension MFEZs) :
This is also an opportunity to deal with the idea that "tax incentives" are there to attract cross border investment. I remain of the view that the best way to do that is not through huge incentives but through "across the board" reduction in things like corporate taxes as discussed on the blog - In praise of larger and larger firms...
Conventional wisdom also seems right about what should be done with virtually all tax incentives: eliminate them. Despite their continuing popularity almost everywhere, tax incentives are usually redundant and ineffective: they reduce revenue and complicate the fiscal system without achieving their stated objectives. Even to the limited extent that some incentives are effective in inducing investors to behave differently than they would have done in response to market signals the result is often inefficient, diverting scarce resources into less than optimal uses (McLure 1999).
The political (and sometimes even theoretical) appeal of twisting the tax system into a collection of clever gimmicks that seem to do something for any good cause of which one can think is obvious. So, alas, is the grim reality of the bad things that experience has again and again demonstrated tend to happened once one starts down the tempting road. Loading more and more objectives on the tax system through incentives opens the door to inefficiency and inequity and reduces the chances that the tax system can achieve its main objective of adequately funding essential public sector activities. Tax incentives improve economic performance only if government officials are better able to decide the best types and means of production than are private investors. Since observation suggests strongly that people are likely to spend ‘other people’s (taxpayers) money’ with considerably less care than they do their own, this proposition seems inherently implausible. Excessive use of tax incentives complicates administration, facilitates evasion and encourages corruption. Once created, concessions usually prove hard to remove and tend to be enlarged at the initiative of taxpayers who lobby for more concessions or simply redefine existing concessions in unforeseen and presumably undesired ways. Get rid of them.
If one cannot simply eliminate tax incentives, I have elsewhere suggested three simple rules to reduce the damage that may be caused by poorly-designed and implemented incentives: keep them simple, keep records, and evaluate the results (Bird 2000). Alas, very few developing countries have managed to follow even such basic rules as these: the political advantages of ambiguity seem always to outweigh the potential social gains from transparency.
I strongly recommend Bird's new paper - very accessible and a pleasure to read, though undoubtedly readers will find some bits they don't agree with ( I found at least two, I am curious to see if someone can spot them!).