, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS PETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | MACROECON , INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS TRADE, INVESTMENT AND COMPETITIVENESS PETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | MACROECON Incentives Database Prosperity Insight Series sustainable investment: the World Bank Corporate Income Tax Findings from 40 economies covered by to promote environmentally click here for direct access. available at http://reproducibility.worldbank.org, Corporate income tax incentives A verified reproducibility package for this publication is MACROECON | TRADE, INVESTMENT AND COMPETITIVENESS Corporate income tax incentives | to promote environmentally TRADE, INVESTMENT AND COMPETITIVENESS sustainable investment: Findings from 40 economies covered by the World Bank Corporate Income Tax Incentives Database | PETITIVENESS A verified reproducibility package for this publication is available at http://reproducibility.worldbank.org, click here for direct access. © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. The boundaries, colors, denominations, links/footnotes and other information shown in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The citation of works authored by others does not mean the World Bank endorses the views expressed by those authors or the content of their works. Nothing herein shall constitute or be construed or considered to be a limitation upon or waiver of the privileges and immunities of The World Bank, all of which are specifically reserved. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522- 2625; e-mail: pubrights@worldbank.org. Cover photo: iStock Man As Thep Document photos: iStock Man As Thep TABLE OF CONTENTS Acronyms v Acknowledgements vi Executive Summary 01 1. Introduction 03 2. Data and methodology 09 Corporate Income Tax Incentives Database 09 Approach for analyzing incentives related to the green agenda 12 3. Data analysis 14 Trends across economies 14 Trends by economy 16 Trends by region 19 Trends by income level 20 Trends by tax instrument 22 4. Areas for future research 26 Annexes 29 References 38 CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT v Prosperity Insight Acronyms CIT corporate income tax COVID-19 coronavirus disease 2019 EU European Union GHG greenhouse gas emissions MNEs multinational enterprises R&D research and development CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT vi Prosperity Insight Acknowledgements This paper is an output of the Investment Climate Unit, under the Finance, Competitiveness and Innovation Global Practice of the World Bank. The paper is co-authored by Benjamin Kett, Hania Kronfol, Eduardo Antonio Jimenez Sandoval, Caroline Schimanski, and Victor Steenbergen. The authors are grateful to Luisa Dressler, Rajiv Kumar, Aart Kraay, and Marizade Oca León for their thoughtful comments and feedback on drafts of the paper. Mona Haddad, Global Director for Trade, Investment Climate, and Competitiveness, and Asya Akhlaque, Practice Manager of the Global Investment Climate Unit, provided guidance and supervision. The responsibility for any data and/or opinion expressed in this paper remains exclusively that of the authors. The core analytics of this paper draws on data from the World Bank Corporate Income Tax Incentives Database developed by the Investment Climate Unit, in collaboration with the Fiscal Policy and Sustainable Growth Unit of the Economic Policy Global Practice. The development of the Corporate Income Tax Incentives Database was led and managed by Hania Kronfol, with a core team comprising Rajiv Kumar, Caroline Schimanski, Eduardo Antonio Jimenez Sandoval, and Victor Steenbergen. Extended team members supporting the data collection efforts covered by this note include Tereza Palanská, Ana Cristina Sierra Hernandez, Fayçal Sawadogo, Nicholas Chan, Tamar Matiashvili, and Jan Mareš. The paper benefited from support provided by the Umbrella Facility for the Competitiveness for Jobs & Economic Transformation trust fund that receives contributions from Austria, Norway and USAID. The World Bank Corporate Income Tax Incentives Database was developed with support from the ACP Business Friendly Program, an Intra-ACP action funded by the European Union (EU) and the Organisation of African, Caribbean and Pacific States (OACPS) and implemented by the World Bank, UNIDO and ITC. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT vii Prosperity Insight CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 1 Prosperity Insight ES. EXECUTIVE SUMMARY The aftermath of the COVID-19 crisis motivated a renewed drive for governments around the world to increase transformative green investments, both to support the economic recovery and to set out on a more sustainable future. Given the key role of the private sector in reaching environmental goals and a range of market failures at play, there is an urgent need to better understand the role of government policy in shaping environmentally sustainable investment. Leveraging a new World Bank Database, this paper focuses on corporate income tax (CIT) incentives as one policy instrument that governments can use to influence environmentally sustainable investment. The Database systematically captures information on CIT incentives used by a wide range of 40 economies over 2009 to 2020. The paper advances a framework to take stock of CIT incentives across two interrelated policy objectives: stimulating investment in green sectors and processes; and/or encouraging divestment from dirty sectors. It distinguishes three categories of CIT incentives related to the green agenda: (i) green process-oriented incentives, which support environmentally sustainable production processes (e.g., less emission-intensive steel production); (ii) green sector-oriented incentives, whose sector or output support environmental sustainability (e.g., manufacturing of batteries for electric vehicles); and (iii) incentives for polluting (or “dirty”) sectors, referring to sectors or outputs that are counterproductive to environmentally sustainable objectives (e.g., fossil fuel- based energy production). CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 2 Prosperity Insight By homing in on CIT incentives related to the green economies (averaging 9 percent and 6 percent agenda, this paper offers novel insights on how, of total CIT incentives, respectively). Over 2009 where and when these instruments are being used to 2020, high-income economies exhibit a as a first step to understanding their potentially modest upward trend in the proportion of green wider role in influencing environmental objectives incentives, while green incentives in developing (positively and/or negatively). The following key economies remain relatively stagnant. findings emerge based on the analysis of 40 • Polluting incentives are considerably more economies covered by the World Bank Database: prevalent in developing economies compared to • CIT incentives for polluting sectors are high-income economies (averaging 10 percent significantly more prevalent than those of total CIT incentives compared to 5 percent, supporting environmental sustainability. respectively). The trend shows a decline in Between 2009 to 2020, on average, only developing economies over time, whereas high- around 3 percent of total CIT incentives income economies experienced a spike in 2011, are green sector-oriented and similarly, 3 followed by a steady decline thereafter. percent are green process-oriented. Both • These averages, however, mask significant are overshadowed by incentives for polluting heterogeneity across economies. sectors, which account for an average of Approximately one-third of the economies 10 percent of total CIT incentives. There is covered in the Database do not offer any green a decline in the share of polluting incentives incentives, while in six economies, green in recent years (2017 to 2020), whereas the incentives comprise at least 10 percent of total share of green incentives remains relatively CIT incentives. stable over time. • Many economies show potentially misaligned or • Accelerated depreciation, tax holidays, and contradictory policy objectives in their incentive reduced tax rates account for the vast majority regime, simultaneously offering both green and (over 85 percent) of green incentives. Overall, polluting incentives. Of the 40 economies, only both green and polluting incentives are roughly 4 offer green incentives and correspondingly evenly split between profit-based instruments do not offer any polluting incentives. More (which are determined as a percentage than half (21 economies) offer more polluting reduction of firm profit, like tax holidays and incentives than green incentives. reduced tax rates) and cost-based instruments (which reduce the after-tax cost of capital The paper proposes new directions for much- expenditures, like accelerated depreciation needed research to evaluate the impact of and investment tax credits). Despite good tax incentives on environmentally sustainable practice policy being to shift away from profit- investment, especially in developing economies, based to cost-based instruments, there is and to investigate the relationship between green in fact a slight trend toward increased use of tax incentives and other government policies. profit-based incentives. • High-income economies offer a higher share of green incentives compared to developing CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 3 Prosperity Insight 1. INTRODUCTION Environmental sustainability is becoming an prospects at the economy level. Nonetheless, increasingly pressing global priority as economies global greenhouse gas emissions continue to rise, are forced to face the finitude of Earth’s resources threatening catastrophic climate change (UNEP and negative outcomes at both a local and global 2019). In the absence of mitigation, climate change level. For example, it has become clear that the may reduce global GDP by up to 18 percent by mid- ability to reduce carbon emissions and adapt to century, according to a 2021 study by the Swiss Re climate change is directly related to development Institute (Swiss Re Institute 2021). CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 4 Prosperity Insight Cognizant of the risks, governments have As low- and middle-income economies have committed to a green transition through their followed the path of industrialization taken by high- Nationally Determined Contributions (NDCs), a income economies, the resulting rise in energy climate action plan to cut emissions and adapt to use and in consumption of food and materials has climate impacts. To further promote environmental intensified emissions. At the same time, the private sustainability, it is also necessary to address factors sector is directly affected by climate change and such as waste management, water supply, reducing natural disasters, posing significant risks to future non-greenhouse pollution, and protecting nature. economic growth and development. Across the spectrum of sustainable activities, The private sector can also be an important part governments are faced with renewed urgency to of the solution. For example, MNEs can impose increase transformative green investments. sustainability standards or encourage green The private sector is a major contributor to technology transfers by providing access to more negative environmental outcomes. With respect advanced, low-carbon technology that in turn can to climate change, industry accounts for nearly cascade to millions of producers to instigate a 30 percent of greenhouse gas (GHG) emissions reduction in emissions. There is growing recognition globally from energy consumption and industrial that a new approach is needed— one that leverages processes (figure 1.1). the private sector to mitigate environmental impacts and capitalizes on green growth opportunities. Figure 1.1: Global greenhouse gas emissions by sector, 2020 %) .6% %) .75 l (7.2 Livesto l3 s (0 ica tal em Stee me ck & m ch tro and Agr ous ) pe % icu ) err (1 Iron anure (5 l& % Ri .6 co ltu n-f ica (0 ce ac ) ral No lp b % em pu (0.5 cu to s Ch oils lti & & .8%) y Cr er iner va d op o p t Fo 4.1 Ene Pa ach ion bu De rg yu fo M rn % 1. re se in % 3% sta i n 0.6 g tio In ry 1 3. Cr Gr pla n 2. ust 5% o nd as sla nd 1 2% er i du Oth str Lan nd 0 .4% Agriculture, y dfil ls 1 .1% 24 Was .9 Forestry & tewa ter 1 % .2% .3% Land Use Chemic Was 18.4% als 2.2 te % 3.2% Cement 3% Industry 5.2% Energy 73.2% 1.7% Fishing 6.2% ulture & in Agric Energy rt 1 rgy Roa ene d Tran o from n 5.8% sp ort 1 sp o n s o 1.9% ssi cti an emi produ Tr itive Fug el fu % ed 7.8 En e 5% t rgy u 17. Av ca n se in buildings iat lo io io al st n Un bu Sh ail ( line 1. R ipe 9% ip 0.4 (0. m P co pi % 3% ng ) 1. Com Resid gs (10.9 7% build mer entia in ) cial l (6.6 % %) ) Source: Ritchie, Roser, and Rosado 2020. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 5 Prosperity Insight Investment for environmental sustainability is evolution over time, and potential implications of beset by market failures. While some benefits may their adoption remain limited. Second, the usage accrue to the investor, such as a lower electricity bill of corporate income tax incentives is controversial. once solar panels have been installed, many of the The evidence of the effectiveness of tax incentives benefits are dispersed across others in the market for promoting investment is mixed, while the risks and society at large. For example, lower emissions of exacerbating a “race to the bottom” in global tax may make a city less polluted as well as contribute to rates are substantial. A first step to evaluating their slowing down the change in global temperatures— effectiveness is to understand how, when, and by benefits that are experienced by many. Similarly, an whom they are used. Third, the availability of new early-stage investor in a risky technology benefits data on CIT incentives provides an opportunity to future investors who can observe the viability of map the use of these instruments. The World Bank this investment and enter the market with more has developed a Corporate Income Tax Incentives confidence of success later on. While businesses Database covering a wide range of 40 economies invest up to the point where risk-adjusted private over the period 2009 to 2020 at a unique level marginal benefits equal private marginal costs, of detail. The Database was conceived with a a socially desirable level of investment would broad aim of looking at different tax incentives incorporate total marginal benefits (public plus instruments and their conditionalities. It allows the private), raising the acceptable marginal costs and landscape of these instruments to be mapped by leading to higher investment in environmentally taking stock of the type and generosity of corporate sustainable products and processes. income tax incentives offered across economies, along with their objectives and conditions, as well Given the market failures associated with as how such variables change over time. environmentally sustainable investment, and the key role of the private sector in reaching The World Bank Corporate Income Tax Incentives environmental goals, it is important to develop a Database fills an important data gap. Before this better understanding of how government policy resource was developed, there was no such database may influence such investment either in the positive that systematically captured detailed information or negative direction. Governments have numerous on CIT incentives offered in both developed and tools available to them, such as regulation, direct developing economies in a comparative format with and indirect subsidies, investing directly through a time dimension. Data gaps related to this type of public enterprises, and tax policy. information are particularly large for developing economies, which use tax incentives widely but do This paper focuses on corporate income tax (CIT) not typically maintain a budgetary record of such incentives as one tool that governments use to incentives in the form of detailed statements of influence environmentally sustainable investment. revenue foregone. There are several reasons for this focus. First, this particular policy tool is widely and increasingly Existing inventories of tax incentives consist either used (Andersen, Kett, and von Uexkull 2018). of global tax guides in narrative format (with varying However, despite the widespread policy attention level of detail across economies), or databases on these incentives instruments, analytics on their specific to certain sectors (such as mining) or prevalence, eligibility criteria, design features, specific categories (such as incentives for research CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 6 Prosperity Insight and development, R&D). A few initiatives are steel production, manufacturing of cement using moving in the direction of more comprehensive alternative cement chemistries, recycling of comparable data, notably the Organisation of byproducts). This channel is defined as “green Economic Co-operation and Development’s process-oriented” investment. Second, incentives Investment Tax Incentives Database (Celani, can promote investment in sectors whose Dressler, and Wermelinger 2022; OECD 2022), output facilitates environmental sustainability which includes an outcome condition related (for example, manufacturing of batteries for to “improving environmental outcomes.”1 The electric vehicles, waste management services, coverage of the OECD database, however, is limited manufacture of low carbon technologies). This to developing economies (with 52 economies as of channel is termed “green sector-oriented” its update in 2022) and it does not have extended investment. The key distinction is between backward-looking time series data to inform making products that themselves contribute research on trends over time. to environmental sustainability versus output that may not have a usage related to the Another notable global database that relates environment but can be produced in a way to this topic and more broadly aims to promote (process) that is consistent with environmental transparency on tax expenditures is the Global Tax sustainability. Third, incentives can potentially be Expenditures Database (GTED), launched in 2021 counterproductive to environmentally sustainable by the Council on Economic Policies (CEP) and the outcomes by supporting polluting sectors (for German Development Institute/ Deutsches Institut example, fossil fuel-based energy production). In für Entwicklungspolitik (DIE).2 The GTED covers a this conceptual view, incentives are relevant across wide range of economies from 1990 onwards. It two interrelated policy objectives: stimulating relies solely on official information published by investment in green sectors and processes; and/ national governments. The GTED distinguishes tax or encouraging divestment from dirty sectors by expenditures with environmental goals,3 although streamlining or removing incentives supporting with limited detail and limited coverage that is tilted these sectors.4 toward high-income, industrialized economies. Green incentives can be related to the locational The coverage and format of the Corporate versus behavioral classification as described Income Tax Incentives Database provide a unique in Kronfol and Steenbergen (2020). Location opportunity to home in on aspects related to incentives aim to “help switch a firm’s decision environmental sustainability— analyzing trends from “do not invest” to “invest” or to “motivate over time and across different regions and the firm to invest in one location over another.” In income groups. Leveraging the Database, this the former case, for green incentives, this would paper distinguishes three key channels through correspond to increasing the expected level of which investment incentives can influence profitability of a firm to help it become profitable, environmentally sustainable investment (see hence ensuring an investment generating a figure 1.2). First, incentives can aim to improve green output will occur when it otherwise would the environmental sustainability of production not have done so. The motivation for this type of processes (for example, less emission-intensive incentive could relate to, for example, technology 1. This is captured in the database in terms of “promoting the low-carbon energy transition,” “protect[ing] environmental quality,” and “improv[ing] environmental impact.” 2. See https://gted.net/. 3. These goals include aiming to “mitigate greenhouse gas emissions, promote energy efficiency, promote renewable energy, protect biodiversity or support adaptation to climate change.” Tax expenditures are measured in terms of “revenue forgone.” 4. Throughout this paper, “green” incentives refer to the combination of both “green process-oriented” incentives and “green sector-oriented” incentives. The terms “polluting” incentives and incentives for “polluting sectors” are used interchangeably. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 7 Prosperity Insight market failures such as positive externalities of benefits. This analysis aims to capture this type innovation and adoption, or network externalities. of incentives under the green process-oriented Alternatively, in the latter case, economies could category. Additionally, behavioral incentives can use tax incentives to compete for internationally induce companies to adjust the output toward mobile green investment that would be profitable more environmentally sustainable products and without the incentive but is looking to find the most services (which would come under the category of profitable location. The former could lead to an green sector-oriented incentives). overall increase in green investment globally, while At the same time, tax incentives can be used the latter would predominantly reshuffle investment to support polluting or “dirty” sectors such as among economies. Both would come under the “mining and quarrying” and “manufacture of coke category of green sector-oriented incentives. and refined petroleum products,” and in turn Behavioral incentives aim “to stimulate firms’ use encourage investment that hurts environmental of specific inputs/factors of production …or raise sustainability. In this vein, polluting incentives types of outputs … by lowering their user costs” supporting fossil fuel production and consumption (Kronfol and Steenbergen 2020). In the case of can stand as an obstacle to more sustainable green incentives, this could mean adjusting the environmental outcomes.5 input costs related to production processes, such as lowering the cost of installing solar panels. This relates to the question of Pigovian pricing, which aims to adjust prices to better reflect the wider benefits to society that go beyond the private Figure 1.2: Classification of green and polluting incentives Green process-oriented incentives Green sector-oriented incentives • CIT incentives aimed at improving the • CIT incentives aimed at economic activities GREEN environmental sustainability of production whose output facilitates environmental INCENTIVES processes (e.g., less emission-intensive steel sustainability (e.g., manufacturing of batteries production, recycling of byproducts) for electric vehicles) Incentives for polluting sectors POLLUTING INCENTIVES • CIT incentives supporting emissions-intensive industries (e.g., reduced tax rates to mining sector) Source: World Bank classification for this paper. Note: CIT = corporate income tax. 5. According to data from the OECD and the International Energy Agency (IEA), the fiscal cost of broader government support for fossil fuels almost doubled in 2022 to reach more than USD 1.4 trillion as governments across the OECD and partner countries introduced initiatives to mitigate high energy costs on households and firms. See: OECD (2023), OECD Inventory of Support Measures for Fossil Fuels 2023, OECD Publishing, https://doi.org/10.1787/87dc4a55-en. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 8 Prosperity Insight This paper examines trends across three the paper does not address the revenue cost categories of corporate income tax incentives— implications of particular incentives or the cost- green sector-oriented incentives, green process- benefit evaluation, which is important for evaluating oriented incentives, and incentives for polluting the success of particular incentives. For example, sectors—to take stock of how these instruments one specific broad-based or generous incentive are being adopted across economies as a first may have much higher revenue costs than many step to understanding their potentially wider role other incentives grouped together. This analysis, in influencing environmental objectives (positively however, could serve as a key component of a and/or negatively). While this paper’s focus is future research agenda (see section 4 for a more corporate income tax incentives, it is important to in-depth discussion). note that the paper does not make the claim that Section 2 presents an overview of the Corporate this particular policy tool is preferable or more Income Tax Incentives Database and elaborates important than other possible tools to incentivize the approach taken for classifying and analyzing environmentally sustainable investment or to incentives related to environmental sustainability. incentivize polluting investment.6 Other such tools Section 3 presents the analysis and results. should be the focus of other parallel and future Section 4 concludes with potential avenues for research workstreams; some possibilities are future research. discussed at the end of this paper. Furthermore, 6. Other tools not covered by this paper that may be used to influence environmentally sustainable investment could include excise taxes, customs taxes, fuel subsidies, direct/indirect subsidies, higher taxes for polluting sectors or processes as a tax “disincentive,” and regulations, among many others. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 9 Prosperity Insight 2. DATA AND METHODOLOGY World Bank Corporate Income Tax Incentives Database The analysis in this paper leverages a new Corporate incentives and tax parameters for economies over Income Tax Incentives Database constructed by the time, and to capture the conditions and generosity World Bank. This Database aims to systematically of each of the incentives. The information is sourced report the availability of corporate income tax from publicly available tax summaries from major CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 10 Prosperity Insight tax accounting firms, national laws and regulations, is publicly available and can be accessed through other existing publicly available databases, and the Reproducibility Package of this paper. data from World Bank operational engagements. The analysis presented in this paper covers 40 The Database was compiled by World Bank Group economies across a range of different regions and staff and consultants through desk research. income groups from 2009 to 2020 (see table 2.1 More detailed documentation of this Database for a breakdown). Expansion to a wider range of (including its scope and structure) is presented in economies and expanded time series is underway.7 appendix A. A streamlined version of the Database Table 2.1: Economy coverage by income group and region Region Developing economies High-income economies East Asia and Pacific China; Fiji; Philippines Australia; Japan; New Zealand Czech Republic; Germany; Gibraltar; Albania; Kosovo; North Macedonia; Europe and Central Asia Ireland; Netherlands; Norway; United Russian Federation; Serbia Kingdom Brazil; Colombia; El Salvador; Haiti; Latin America and Caribbean Chile Mexico; Panama; Peru Middle East and North Africa Egypt, Arab Rep.; Iraq South Asia India; Nepal; Sri Lanka Angola; Congo, Dem. Rep.; Côte d’Ivoire; Sub-Saharan Africa Ethiopia; Ghana; Mauritius; Nigeria; South Africa; Zimbabwe Source: World Bank based on Corporate Income Tax Incentives Database. Note: Income level classification as defined in 2020 using World Bank income cutoffs. Table 2.2 presents the key tax incentives included in to the awarding of this incentives (such as location the Database. A full list of the specific instruments or firm size), and the magnitude of the incentive is presented in Table A.2 in Appendix A. For each (such as the number of years for tax holidays or incentive in the Database, information is also value of the reduced tax rate). provided for both any conditions that are attached 7. The initial sample of 40 economies was selected to support different objectives, including to help design the Database template to accommodate different tax incentives regimes; to support ongoing or strategic operational World Bank engagements; and to support research efforts in terms of representation. Specifically on the latter, emphasis was placed on including a mix of high-income and developing economies, varied regional representation, large and small economies, varying development levels, and different tax haven status. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 11 Prosperity Insight Table 2.2: Key Types of incentives covered by the Corporate Income Tax Incentives Database Tax incentive type Details A tax rule which reduces the corporate income tax rate on all or part of Tax Holiday/Tax Exemption the firm’s income to zero percent indefinitely or for a limited period. Any exception lowering the CIT rate below the statutory CIT rate level, Profit-based though not complete elimination of the CIT liability. In the Database, Reduced Tax Rate this encompasses a reduced CIT rate, reduced tax liability, and/or a percentage reduced taxable income. Allows firms to tax income received from certain activities associated Patent Box with research and development (R&D), patents, innovation, and inventions at a lower rate than other income. Any depreciation approach employed in accounting for income tax considerations, enabling higher deductions for depreciation expenses. Accelerated Depreciation Includes specification in Database for: plant/machinery; buildings; intangible assets; computer/data processing equipment; motor Cost-based vehicles; office equipment/furniture; other. A deduction of a percentage of expenses from chargeable income that in turn leads to a lower tax liability. With few exceptions, the Database Tax Deduction only captures deductions of more than 100% (e.g., double deductions of R&D expenditures).8 Tax Credit An amount by which the final tax liability can be reduced. An option that losses in one year can be offset against profits in the Other Extended Loss Carry Forward/ Backward next/previous x year(s) to reduce the profits and thereby the tax liability in the following/previous x year(s). Source: World Bank. based on Corporate Income Tax Incentives Database Note: CIT = corporate income tax; R&D = research and development. Additionally, the Database classifies incentives A few key caveats should be highlighted regarding based on the structure for delivering the reward the information captured by the Database: or benefit as progressive, sequential, selection, • The focus is on de jure elements of the number cumulative, or the absence of a special structure.9 and design of incentives offered. It captures Because this structure can have implications on the count of different CIT incentives (not the how the incentive is counted, World Bank staff uptake of these incentives nor their fiscal elaborated an approach—to ensure systematization costs). That said, the number and proportion of and avoid double counting—that is summarized in incentives offered can provide insights into the appendix A. level of complexity of the incentives regime and 8. See Appendix A for additional details. 9. Progressive: In the context of incentives, progressive refers to the varying level of generosity that firms receive based on specific criteria such as income, investment, or employment. Sequential: Sequential incentives are those that follow a specific sequence or progression over a set period of time. Selection: Some countries offer incentive packages that provide firms with a choice between two or more incentives. Cumulative: In the context of tax parameters or tax incentives, the term “cumulative” refers to those elements that are part of a dynamic collection of varying tax parameters or incentives, where their respective generosity is aggregated. No special structure: The primary feature of this type of incentives is that they are rewarded within the corresponding fiscal year as the firm meets the necessary requirements. This represents the most straightforward and simple structure for incentives. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 12 Prosperity Insight potentially reflect government prioritization of • The Database prioritizes systematization a certain sector, activity, policy objective, and over detail for comparative insights. Specific so on. In the context of this paper, though, it is economy-level nuances may not be captured.10 important to highlight that the count measure • The Database is based on incentives in the means that a very narrowly defined green public domain and does not capture specific incentive or one with limited uptake is given data on case-by-case incentives.11 the same weight as a very broadly defined incentive or one with very high uptake. Approach for Analyzing Incentives Related to the Green Agenda As discussed in the Introduction, this paper makes To identify incentives that are consistent with the distinction between green process-oriented promoting green processes, the analysis reviews incentives, green sector-oriented incentives, two potential conditions. The first is an explicit and incentives for polluting sectors as channels environmental purpose stated in the summary through which these incentives can influence or title of the law under which the incentive is environmentally sustainable investment. The provided. The second is the inclusion of any of a set green classifications are based on the European of keywords relating to environmental sustainability Union (EU) taxonomy for sustainable activities.12 such as solar, wind, hydro, renewable, and so on. Further elaboration on how each of these While broader incentives related, for example, to categorizations were applied by leveraging the research and development (R&D), may feasibly Corporate Income Tax Incentives Database is be applied to environmental aims, these are not contained in appendix B. included in this count. The analysis aims to focus more deliberately on incentives that are specifically Green Process-Oriented Incentives targeting pro-environmental aims. The categorization of “green process-oriented incentives” in this paper refers to actions that Green Sector-Oriented Incentives improve the environmental sustainability of a The categorization of “green sector-oriented production process or product (for example, incentives” is used to describe an output of less emission-intensive production of steel, production that facilitates environmental manufacturing of cement using alternative cement sustainability (for example, manufacturing of chemistries). The emphasis is on taking existing batteries for electric vehicles). The key distinction production and rendering it more environmentally between green process-oriented and green sector- sustainable, while the output itself does not have to oriented is that the former relates to how something contribute directly to environmental goals. is made, whereas the latter relates to the purpose of the output. 10. Moreover, as the data is piloted across different analytic needs and the coverage expanded, entries may be re-evaluated and updated to ensure accuracy and consistency. This ongoing quality assurance process is especially pertinent since the data is manually compiled. Although high- level trends are often unchanged, updates/revisions to the Database could result in some variation across different versions at the economy or incentive level. 11. The Database does, however, note when special arrangements and/or additional reviews are included in legislation/regulations/policy. 12. The taxonomy covers economic activities that (1) contribute substantially to climate change mitigation by supporting the stabilization of greenhouse gas concentrations to prevent human-induced interference with the climate, and/or (2) economic activities that contribute substantially to climate change adaptation by reducing (the risk of) adverse impacts on the economic activity itself and/or on people, nature, and assets. See https://finance.ec.europa.eu/system/files/2020-03/200309-sustainable-finance- teg-final-report-taxonomy_en.pdf for additional information. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 13 Prosperity Insight The analysis identifies these green sector-oriented incentives as those incentives that specifically target “green” sectors (leveraging the classification and definitions from the EU taxonomy for sustainable activities) based on the sector classification in the World Bank Corporate Income Tax Incentives Database benefitting from that incentive. Examples of “green” sectors include electricity generation from renewable energy, afforestation, and manufacturing of products that help to transition to a low-carbon economy (such as batteries and electronic vehicles). It also includes some sectors that have a broader environment purpose, such as water supply, sewerage, and waste management and remediation. Green process-oriented incentives and green sector-oriented incentives are defined as being mutually exclusive, with the sector definition taking precedence over the process definition. Incentives for Polluting Sectors This category is defined similarly to green sector- oriented incentives, but rather than exploiting sectoral conditions that target “green” sectors, this paper and accompanying analysis instead identify “polluting” sectors. This type of incentive would be contrary to the promotion of environmentally sustainable investment. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 14 Prosperity Insight 3. DATA ANALYSIS Trends Across Economies Figure 3.1 presents the prevalence of green considered green sector-oriented, green process- corporate income tax incentives as well as those oriented, or supporting polluting sectors across all supporting polluting sectors over time. The 40 economies. Green sector-oriented incentives bars show the fraction of all incentives that are have the lowest prevalence, at 2.6 percent of CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 15 Prosperity Insight the total share of incentives, followed by green sustainability, the share of incentives for green process-oriented incentives, at 3.4 percent. Both ends remains relatively stable across the period— are dominated by the presence of incentives for in contrast, there is evidence of a reduction in the polluting sectors, which average about 9.5 percent share of incentives for polluting sectors in recent of total incentives. In terms of dynamics, despite years (2017 onward). the growing policy attention on environmental Figure 3.1: Prevalence of green and polluting incentives (as a share of total CIT incentives), across economies, 2009-20 12% 2500 10% 2000 Percentage of total CIT incentives Total number of CIT incentives 8% 1500 6% 1000 4% 500 2% 0% 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 % of incentives that are green sector- oriented % of incentives that are green process-oriented % of incentives for polluting sectors Total number of incentives Source: World Bank based on the Corporate Income Tax Incentives Database. Note: CIT = corporate income tax. Although the proportion of incentives is a helpful These trends imply that incentives for polluting metric to gauge the relative importance of incentives sectors remain significantly more prevalent than related to environmental objectives, it does not those supporting environmental sustainability. address how the number of incentives changes.13 This is consistent with economies not wanting to To provide some context, the black line in figure 3.1 disrupt existing sectors while still trying to promote also presents the total number of incentives offered new green sectors and increase the environmental across time (read on the righthand axis). Overall, sustainability of production processes. CIT incentives are becoming more prevalent, increasing from 1,434 in 2009 to 2,265 in 2020. 13. It is important to again note that this analysis does not speak to the revenue costs associated with these incentives. For example, one specific incentive could have higher revenue costs than all the others combined, depending on its particular design/applicability. While this current analysis does not estimate these costs, it will be a critical part of the future research agenda. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 16 Prosperity Insight Trends By Economy Global averages mask significant heterogeneity not have any green incentives (0 percent). At the across economies. Figure 3.2 presents all other end of the spectrum, in 6 economies, green economies in the Database ranked by the joint incentives make up at least 10 percent of total prevalence of green process-oriented and green CIT incentives. Chile has the largest share, at 25 sector-oriented incentives averaged across all percent of all CIT incentives. years. About one-third of economies (13) do Figure 3.2: Prevalence of green incentives (as a share of total CIT incentives), by economy 30% Percentage of total CIT incentives 25% 20% 15% 10% 5% 0% Mauritius Ireland Russian Federation Kosovo Mexico Cote D'ivoire Chile Panama North Macedonia Ethiopia Albania Nigeria Australia Ghana Angol a Serbia South Africa Sri Lanka Col ombia China Congo, Dem. Rep. Egypt, A rab Rep. Nepal Brazil Czech Republic Germany Norway Fiji Haiti United Kingdom El Salvador Gibral tar Netherlands Phil ippines Iraq New Zeal and Japan Peru Zimbabwe India % of incentives that are green sector- oriented % of incentives that are green process-oriented Source: World Bank based on the Corporate Income Tax Incentives Database. Note: Calculated as an average across 2009–20. CIT = corporate income tax. Figure 3.3 presents economies ranked by the percent, respectively. While the difference in the prevalence of incentives supporting polluting averages of incentives with different goals in figure sectors (averaged across all years). In this case, 3.1 is partially driven by the extreme cases of Iraq only 10 economies do not have such incentives and and Peru, it is clear that the difference is broad 4 economies have a prevalence of about 20 percent based, with a wide range of economies offering or higher as a share of total CIT incentives. Iraq and more polluting incentives than green incentives. Peru take the top positions, with 36 percent and 47 CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 17 Prosperity Insight Figure 3.3: Prevalence of polluting incentives (as a share of total CIT incentives), by economy 50% (as a % of total CIT incentives) Share of polluting incentives 40% 30% 20% 10% 0% Haiti Germany United Kingdom Gibral tar Mauritius Phil ippines Ireland Russian Federation Peru Kosovo Mexico Cote D'ivoire Chile Zimbabwe Serbia Panama North Macedonia Australia Albania South Africa Col ombia Sri Lanka China Angol a Ghana India Nigeria Ethiopia Congo, Dem. Rep. Egypt, A rab Rep. Nepal Brazil Czech Republic Fiji Norway El Salvador Netherlands New Zeal and Iraq Japan Source: World Bank based on the Corporate Income Tax Incentives Database. Note: Calculated as an average across 2009–20. CIT = corporate income tax. Given the variation in tax instruments available to include both green process-oriented and green governments, and the complexity of the political sector-oriented incentives. Any economy that process for deciding these incentives, economies does not sit on the x-axis is offering incentives with may provide incentives that are misaligned or potentially contradictory environmental aims, while potentially contradictory in terms of their aims economies that sit above the 45-degree line offer and/or outcomes. An economy that offers green more polluting incentives than green incentives. incentives and polluting incentives risks creating Of the 40 economies, only 4 offer green incentives an inconsistent, complicated, tax policy framework and correspondingly do not offer any polluting that may detract from the broader goal of incentives. More than half (21 economies) offer environmental sustainability. more polluting incentives than green incentives. Brazil, the outlier in the top- right hand corner, is an Figure 3.4 presents all economies in the sample, extreme case, offering 47 polluting incentives and with the average number of green incentives (across only 24 green incentives. all years) on the x-axis, and the average number of polluting incentives on the y-axis. Green incentives CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 18 Prosperity Insight Figure 3.4: Comparison of green and polluting CIT incentives, by economy 50 45 Average number of polluting incentives 40 35 30 25 20 15 10 5 0 0 5 10 15 20 25 Average number of green incentives Source: World Bank based on the Corporate Income Tax Incentives Database. Note: Each dot represents an economy in the Database. Calculated as an average across 2009–20. The previous three figures display economy in 10 economies, did not change in 13 economies, averages across time but do not address changes and decreased in 17 economies, with the greatest throughout the period. Figure C.1 in appendix C changes seen in the Democratic Republic of Congo, presents the change in incentive provisions for the Arab Republic of Egypt, and India. Therefore, the combination of green sector-oriented and while green incentives and polluting incentives process- oriented incentives between 2009 and remain fairly constant over time, this hides a large 2020. Considerable differences in economies degree of heterogeneity where some economies are apparent. The prevalence of green incentives (such as Zimbabwe) are reducing both, while others over the period decreased in 9 economies, did (such as Ghana) are increasing both. not change in 15 economies, and increased in Overall, the aggregate patterns in the average 16 economies. These increases, however, were number of incentives provided mask stories relatively minor, amounting to less than or equal to that vary greatly across economies. While more 10 percent as a share of total incentives for 14 of economies are increasing green incentives than the 16 economies (the exceptions were Gibraltar decreasing them, these increasing economies and Norway). remain the minority as a fraction of all economies. Figure C.2 presents the same plot but for the Similarly, while more economies are decreasing prevalence of polluting incentives. The prevalence incentives for polluting sectors, 10 economies are of incentives supporting polluting sectors increased acting in the opposite direction. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 19 Prosperity Insight Trends By Region While regional results should only be treated as America and Caribbean region display the highest indicative due to limited data coverage (see table share of green incentives, typically about 8 percent 2.1 for an overview of the 40 economies sampled), on average, as compared to Sub-Saharan Africa, the data reveal marked differences across regions which ranges between 2 percent and 4 percent. in terms of their use of green incentives. Figure Most regions show a roughly increasing (while 3.5 displays the prevalence of the combination of noisy) trend, with the exception of Latin America green sector- oriented and green process-oriented and the Caribbean, where the trend is slightly incentives across time and within each of the main decreasing over time. regions. The East Asia and Pacific region and Latin Figure 3.5: Prevalence of green incentives (as a share of total CIT incentives), by region, 2009–20 10% 9% 8% (as a % of total CIT incentives) Share of green incentives 7% 6% 5% 4% 3% 2% 1% 0% East Asia and Pacific Europe and Central Latin America and South Asia Sub-Saharan A frica Asia Caribbean 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: World Bank based on the Corporate Income Tax Incentives Database. Notes: CIT = corporate income tax. The Middle East and North Africa region is not reported in this chart, as only two economies—Egypt and Iraq—are included in the sample. As displayed in figure 3.6, trends in tax incentives a decline from 2011 onward. Europe and Central for polluting sectors are clearly decreasing in only Asia, and Sub-Saharan Africa show roughly flat three of the six regions: East Asia and Pacific, profiles over time. South Asia, and Latin America and Caribbean show CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 20 Prosperity Insight Figure 3.6: Prevalence of polluting incentives (as a share of total CIT incentives), by region, 2009-20 14% 12% (as a % of total CIT incentives) Share of polluting incentives 10% 8% 6% 4% 2% 0% East Asia and Pacific Europe and Central Latin America and South Asia Sub-Saharan A frica Asia Caribbean 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: World Bank based on the Corporate Income Tax Incentives Database. Notes: CIT = corporate income tax. The Middle East and North Africa region is not reported in this chart as only two economies—Egypt and Iraq—are included in the sample. Trends By Income Level The two figures that follow take a similar approach green incentives averaging 9 percent of total CIT to the regional analysis but instead break down incentives over the period compared to 6 percent the data by income grouping, covering developing in developing economies. High income economies economies and high-income economies. Figure show a slight increasing trend over time, whereas 3.7 presents green sector-oriented and green incentives in developing economies stay largely flat process-oriented incentives. High-income throughout the period. economies display a higher propensity for offering CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 21 Prosperity Insight Figure 3.7: Prevalence of green incentives (as a share of total CIT incentives), by income group, 2009-20 10% 9% 8% (as a % of total CIT incentives) Share of green incentives 7% 6% 5% 4% 3% 2% 1% 0% Developing economies High- Income economies 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: World Bank based on the Corporate Income Tax Incentives Database. Note: CIT = corporate income tax. Figure 3.8: Prevalence of polluting incentives (as a share of total CIT incentives), by income group, 2009-20 12% 10% (as a % of total CIT incentives) Share of polluting incentives 8% 6% 4% 2% 0% Developing economies High- Income economies 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: World Bank based on the Corporate Income Tax Incentives Database. Note: CIT = corporate income tax. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 22 Prosperity Insight As shown in figure 3.8, polluting incentives are stable. In high-income economies, the trend more prevalent in developing economies than in shows a more noticeable decline following a high-income economies. In developing economies, spike in 2011. The consistently higher proportion polluting incentives average 10 percent as a of polluting incentives over time in developing proportion of total CIT incentives over the period economies is perhaps reflecting prioritization to compared to 5 percent in high income economies. support development of energy production and The trend declines slightly in developing economies to attract investment and jobs independent of the over time, although the levels are generally quite environmental costs. Trends By Tax Instrument The Corporate Income Tax Incentives Database accounts for around 47 percent of green incentives, provides a breakdown of incentives by tax tax holidays 35 percent, and reduced tax rates 11 “instrument,” which can be aggregated to seven percent. Tax deductions, however, play a gradually key types: tax holidays, tax credits, extended increasing role from 2015 onward, reaching 9 loss carry forward/backward, patent boxes, percent in 2020. The remaining tax instruments are reduced tax rates, tax deductions, and accelerated negligible as a proportion of total green incentives. depreciation. Figure 3.9 shows the breakdown of Figure 3.10 presents the same plot but for polluting green sector-oriented and green process-oriented sectors. The patterns largely mirror those for incentives into these tax instruments.14 Three tax green incentives, although tax deductions remain instruments account for the vast majority (over negligible throughout. 85%) of green incentives: accelerated depreciation Figure 3.9: Prevalence of different CIT instruments for green incentives 100% Share (as % of total green incentives) 80% 60% 40% 20% 0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Accelarated depreciation Tax holiday Reduced tax rate Tax deduction Tax credit Extended loss carry forw ard/backward Patent box Source: World Bank based on Corporate Income Tax Incentives Database. 14. Because the CIT covered in the Database must fall into one of these categories, the total adds up to 100 percent. See appendix A for additional information regarding treatment for counting and classifying different structures of incentives. For example, the type of incentive for “sequential” incentives is coded by the first incentive in the sequence. (If the incentive is structured such that a tax holiday is followed by a reduced rate, it would be exhibited solely as a tax holiday). CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 23 Prosperity Insight Figure 3.10: Prevalence of different CIT instruments for polluting incentives 100% Share (as % of total green incentives) 80% 60% 40% 20% 0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Accelarated depreciation Tax holiday Reduced tax rate Tax deduction Tax credit Extended loss carry forw ard/backward Patent box Source: World Bank based on Corporate Income Tax Incentives Database. The Database also allows us to zoom in on the years in 2020. In contrast, tax holidays for polluting generosity of particular incentives. Figure 3.11 incentives have the shortest durations. While the takes tax holidays as a specific example, plotting average length was 7 years in 2009, it declined to the average number of years of tax holidays for just 4 years by 2020. green sector-oriented, green process- oriented, It is worth repeating here that this analysis does polluting, and all other incentives.15 All lines trend not speak to the costs or expenditures of taxes downward over time, meaning that tax holidays are incentives. A tax holiday with a medium length of tax becoming less generous over time. Green process- exemption but that applies to a wide range of firms oriented incentives are notable for having the most may well be more costly to the taxpayer than a very generous average length of tax holidays, offering long holiday that has very strict conditionalities. 18 years on average in 2009 and decreasing to 11 15. It is important to note that, at this level of disaggregation, the majority of economies do not offer any of each specific tax instrument (in this case, tax holidays) related to environmental sustainability. For example, only 5 economies offer green sector-oriented tax holidays, and the reduction in 2016 is largely due to Ghana reducing the number of years from 7 to 5 and Sri Lanka removing green sector-oriented tax holidays entirely. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 24 Prosperity Insight Figure 3.11: Average length of tax holidays for green, polluting, and other CIT incentives, 2009-20 20 18 16 Average length of tax holiday 14 (number of years) 12 10 8 6 4 2 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Green sector-oriented incentives Green process-oriented incentives Pol luting incentives Other incentives Source: World Bank based on Corporate Income Tax Incentives Database. Note: Cases of indefinite tax holidays are excluded from the calculation of tax holiday length. Profit-Based Versus Cost-Based are to use incentives, they should shift away from Incentives profit-based to cost- based instruments, which are An alternative distinction often made in the tax more clearly linked to policy goals (Andersen, Kett, incentives literature is “profit-based” versus “cost- and von Uexkull 2018). Cost-based instruments based” incentives. Profit-based incentives are include accelerated depreciation, tax credits, and generally considered to have significant limitations tax deductions. because they lower the tax rate for any amount Figure 3.12 classifies the types of incentives as of profit earned by the firm and hence heavily profit-based versus cost-based instruments and favor firms with high profits and the least need presents them for green and polluting incentives. for government support. This type of incentive The two panels show that overall, incentives are can also motivate firms to profit-shift to evade roughly even split between the two types. taxes (IMF et al. 2015). Profit-based instruments include reduced tax rates and tax holidays. In Despite good practice policy being to shift away contrast, cost- based incentives lower the cost of from profit- based to cost-based instruments, inputs or production factors and hence typically actual practice does not appear to be trending depend on the size of the firm’s investment. It is in this direction.16 There is in fact, a slight trend therefore often recommended that if economies toward more profit-based incentives. 16. As is the case with all investment incentives, cost-based instruments are not always warranted, cost-effective, or without risks. For example, patent boxes, which provide lower tax rates on the income of activities associated with R&D, patents, innovation, and inventions, can end up being an incentive for the location of patents, with minimal impact on the actual underlying R&D. This can lead to the shifting of profits into economies with lower tax rates and can enhance harmful tax competition. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 25 Prosperity Insight Figure 3.12: Average length of tax holidays for green, polluting, and other CIT incentives, 2009-20 a. Green Incentives b. Polluting Incentives 100% 100% Share (as a percentage of polluting incentives) Share (as a percentage of green incentives) 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Cost-based Profit-based Cost-based Profit-based Source: World Bank based on Corporate Income Tax Incentives Database. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 26 Prosperity Insight 4. AREAS FOR FUTURE RESEARCH This paper presents new data to map the landscape much additional research is needed to inform of corporate income tax incentives—by taking policymaking. The CIT Incentives Database can stock of their prevalence and design features be leveraged to help assess the impact of these across economies and over time—as a first step to instruments (including their design features) on exploring the role of these instruments in supporting green outcomes and their interaction with other environmentally sustainable investment. But government instruments. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 27 Prosperity Insight Analyzing the Effect of Green Taxation on Relating Green Tax Incentives To Other Environmentally Sustainable Investment Policies For many developing economies, FDI provides a While this paper describes many characteristics source of investment that is relatively stable, and of economies’ CIT incentives policies related to not limited by the financial constraints of domestic the green agenda, it does not speak to the relative investment. It can also bring technological know- revenue costs of different policies and instruments. how and lead to positive spillover effects on the Future work should aim to develop average and local economy. Research linking FDI and tax marginal effective tax rates and to consider the incentives has shown mixed results, in part due costs of these incentives with complementary data. to data limitations. Identifying a causal impact Moreover, as mentioned in the Introduction, CIT requires a stringent specification (for example, incentives are just one of many government policies incorporating a wide set of fixed effects), which in that could stimulate environmentally sustainable turn places greater importance on the variation in investment. Although CIT incentives are being used incentives across time for each economy-sector. to some extent across regions and income levels to The new Database created by the World Bank support environmentally sustainable investment, provides an exciting opportunity to reevaluate this it is not necessarily clear that this policy tool is linkage because the longer timeframe specifically the optimal choice to promote the green agenda. addresses a key data limitation, and more detailed Tax incentives can be costly to the public purse, coverage of incentives allows for a more refined and the cost-benefit trade-off is often poorly empirical strategy. evaluated (James 2014; Kronfol and Steenbergen 2020; Kusek and Silva 2018). Furthermore, Lines of investigation include evaluating whether when tax incentives do not directly target market economies with more green incentives attract failures, they can risk distorting market incentives more investment in related sectors, and whether in a way that leads to unexpected side effects, there is any substitution away from other sectors and tax incentives can lead to internationally or whether investments overall also increase. FDI competitive behavior that adds pressure to a “race data will be required at the sectoral level. In this to the bottom.” Given the importance of the green regard, fDi Markets17, as well as data from the agenda, the role that private sector investment Bureau of Economic Analysis, have previously been plays, and the risks of firms not internalizing the used effectively. Other sectoral or even firm-level benefits of greener investments, there is a case for outcomes could potentially be investigated using governments to intervene in the private sector. But interactions between sector/firm characteristics these interventions can take different forms, such and national/sectoral green incentives practices, a as direct subsidies and regulations. Governments methodology made popular by Rajan and Zingales need to review their existing policies to consider (1998). This would require the use of cross-country the suitability, risks, and impact if CIT incentives firm or sector data, such as making use of the Orbis are provided. international firm database. 17. fDi Markets: https://www.fdimarkets.com/ CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 28 Prosperity Insight To evaluate which, or which combination, of Consideration of direct and indirect subsidies will these policies is most effective, a broader effort also be important. This might take the form of to document the prevalence of these alternative grants to startups working on green technologies policies will be necessary. Once the different (such as carbon capture); innovation hubs/parks policy tools are well documented, studying the with subsidized rent/specialized facilities focused overlap either in a complementary or contradictory on developing an ecosystem for green innovation; direction would be a helpful next step, promoting unit subsidies to produce goods that facilitate the consistent usage of policy tools to achieve environmental sustainability such as solar panels; environmental sustainability. and so on. Incentives such as fuel subsidies are very common and can act in the other direction, Environmental regulations are one such policy, boosting consumption and hence emissions. legally limiting certain actions as opposed to incentivizing different behaviors. Examples include More broadly, an analysis of the relationship limiting the carbon content of goods, the volume between the incentives that an economy provides, of polluting materials emitted from a production and its environmental context or objectives would process, or methane emissions from landfills. be valuable. For example, do economies with Compliance can, however, impose administrative higher levels of pollution or carbon emissions adopt costs (such as unnecessarily opaque or redundant more incentives consistent with environmental practices) as well as monetary costs (such as sustainability? Alternatively, do economies with purchase of equipment and consultancy services) deeper climate change targets, based on their that may discourage investment. Hence, striking intended Nationally Determined Contributions the right balance between regulatory burden (INDCs), have more such incentives? and ease of compliance is an important factor influencing private investment. Governments are increasingly deploying tools such as risk- based regulation to improve compliance with environmental requirements. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 29 Prosperity Insight APPENDIX A: THE WORLD BANK CORPORATE INCOME TAX INCENTIVES DATABASE The World Bank Corporate Income Tax Incentives Tax incentives are always defined in relation to their Database was developed by the Investment established “benchmark tax system” (the general Climate Unit of the Finance, Competitiveness rules and conditions that apply to most firms). To and Innovation Global Practice, in collaboration identify which measures can be considered tax with the Fiscal Policy and Sustainable Growth incentives, three main criteria are used (IFC 2014). Unit of the Economic Policy Global Practice.18 Qualifying measures: This Database aims to systematically report the availability of corporate income tax incentives • Apply only to a subset of taxpayers that qualify and tax parameters for economies over time and according to a targeted set of criteria (such as to capture the conditions and generosity of each companies located in export- processing zones); of the incentives. It covers both high-income and developing economies with time series data, • Are designed to induce a change in firms’ starting from 2009. economic activity (such as to encourage a firm to set up in a particular location, or to invest SCOPE more in research and development); and Because tax incentives interact with the underlying tax system, the Corporate Income Tax Incentives • Represent an exception and a departure Database collects information across two from standard national tax conventions dimensions of the tax system: and benchmarks (for example, they include tax holidays, which no economy regards as • Corporate Tax Parameters. This dataset standard). establishes the benchmark corporate tax system present in the economy and includes Data are collected on 7 corporate tax parameters underlying tax parameters such as the and 13 CIT categories as listed in tables A.1 and A.2, statutory corporate income tax (CIT) rate, the respectively. The scope of the Database is limited threshold for paying CIT, loss carried forward, to those corporate tax parameters and incentives and standard depreciation rates (table A.1). most commonly offered by economies and used by firms or of particular interest to policy makers • Corporate Income Tax Incentives. This dataset and researchers—acknowledging that the list of tax focuses on tax incentive types, such as tax parameters and tax incentives for which data are holidays, reduced tax rates, and accelerated collected in this Database is not an exhaustive list. depreciation, that provide favorable conditions compared to the benchmark (table A.2). 18. The Database initiative was led and overseen by Hania Kronfol, with support from a core team comprising Rajiv Kumar, Caroline Schimanski, Eduardo Antonio Jimenez Sandoval, and Victor Steenbergen. Extended team members supporting the data collection efforts covered by this note include Tereza Palanská, Ana Cristina Sierra Hernandez, Fayçal Sawadogo, Nicholas Chan, Tamar Matiashvili, and Jan Mareš. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 30 Prosperity Insight The Database captures data on conditions To allow for a more systematic analysis of tax applicable to the benchmark and the incentives parameters and tax incentives across firms, offered and their generosity. The benchmark tax the Database includes ISIC Rev.4 codes for parameters are not necessarily universal but, sector-based incentives.19 Regarding generosity, in some cases, can be attached to particular information is collected to gauge the magnitude conditions. Tax incentives are often granted to of the incentive (such as number of years of tax firms based on fulfilling conditions related to firm holidays or loss carry forward, the standard/ characteristics (for instance, based on certain higher/reduced tax rate or depreciation rate, or the sectors or locations); firm size (for example, small, amount of a flat CIT in the respective currency), see medium, large); or performance requirements table A.3. (such as sales growth, export share, job creation). Table A.1: Key variables of the Corporate Tax Parameters Data Set Underlying Corporate Tax Parameters • Statutory CIT Rate • Threshold for Paying CIT • Loss Carry Forward • Loss Carry Backward • Other Additional Tax Rate on Profits (e.g., municipality tax, provincial tax) • Standard Depreciation Rate • Standard Depreciation/Capital Allowance/Amortization Rate (plant/machinery; buildings; intangible assets; computer/data processing equipment; motor vehicles; office equipment/furniture; other) Table A.2: Key variables of the Corporate Income Tax Incentives Data Set Tax Incentive Types • Tax Holiday/Tax Exemption • Reduced CIT Rate • Reduced Other Additional Tax Rate on Profits (e.g., municipality tax, provincial tax) • Percentage Reduced Taxable Income • Percentage Reduced Tax Liability • Tax Deduction >100%20 • Tax Credit • Patent Box • Extended Loss Carry Forward • Extended Loss Carry Backward • Tax Payment Deferral/Delay • Early Tax Refund • Accelerated Depreciation/Capital Allowance Rate/Super-amortization/Write-off (plant/machinery; buildings; intangible assets; computer/data processing equipment; motor vehicles; office equipment/furniture; other) Source: World Bank based on the Corporate Income Tax Incentives Database. Note: CIT = corporate income tax. 19. ISIC Rev.4 codes are generally collected at the 2-digit level. If sector-based conditions are at the 3-digit or 4-digit level, however, such information is collected as well. 20. Tax deductions of 100% or less are only included in exceptional cases if they are part of a progressive, sequential, selection or cumulative set. See explanation under “Accounting for the structure of incentives.” CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 31 Prosperity Insight Table A.3: Condition and generosity variables of the Corporate Tax Parameters and Corporate Tax Incentives Data Sets Tax Incentive Conditions • Firm characteristics ° Sector-based (ISIC Rev4 code) ° Location-based (e.g., regions, municipality, city) ° Relocation (e.g., existing business moving to another location in the economy) ° Special economic zones/export processing zones/special economic development areas ° Incorporation type (e.g., private, limited liability, stock listed, state-owned) ° HQ (international /regional) ° Domestic firm only ° MNC only ° Foreign shareholder/foreign investor/foreign firm ° Economy of parent company, economy of the foreign investor ° New Incorporation/business starting/construction date (no date, between dates, before/after date) ° Existing firm/construction project (excluding new firms/construction projects) • Firm size (e.g., profit, assets, turnover/sales, # employees) ° Firm performance requirements ° Investment/construction requirement (e.g., minimum/maximum amount, investment in sector X) ° Performance requirement (e.g., sales, inputs, workforce) ° Export/Import related ° Climate/environment-related (e.g., renewable energy, energy efficiency) ° R&D-, innovation-, or intellectual property-related expenses/investments ° Benefits for employees (extra health insurance, work from home, extra leave, etc.) ° Employee training-related ° Diversity (including gender, race, religion, disability, youth, indigenous, other minority groups) ° Ownership share/(No) change in share-related ° Change in nature of business/diversification of production ° Domestic requirement (e.g., domestic/local: production, inputs, workforce, development) • Digitalizing business operations (paper to digital, in-person to digital) • Special arrangements/additional reviews • Other Generosity • Number of years • Tax rate/depreciation rate/ capital allowance rate • Tax on taxable income/revenue/ specific income • Amount/share • Other (description) Source: World Bank based on the Corporate Income Tax Incentives Database. Note: HQ = headquarters; MNC = multinational corporation; R&D = research and development. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 32 Prosperity Insight DATA SOURCES years and then receive a reduced tax rate for the subsequent four years. Another example The Database is compiled primarily by codifying could be a depreciation schedule where the information from publicly available tax summaries depreciation percentage changes over a series from tax accounting firms (including, for example, of years (for example, 50 percent in the first Ernst and Young and PricewaterhouseCoopers), year, 20 percent in the second year, and 10 in addition to primary sources, as needed, by percent for the following three years). reviewing the tax and investment laws directly, as well as other publicly available secondary sources. 4. Selection: Some economies offer incentive In limited cases, accounting firm staff or World packages that provide firms with a choice Bank regional colleagues are contacted to help between two or more incentives. For instance, provide additional information or clarification. firms may have the option to select between Accuracy and replicability of the data collection are a tax deduction, a tax credit, or accelerated verified through randomized cross-checks across depreciation. In some cases, firms can choose economy entries. from different packages that include multiple parameters or incentives. Therefore, it is not simply a choice between individual parameters ACCOUNTING FOR THE STRUCTURE OF or incentives, but rather a selection among INCENTIVES: SEQUENTIAL, SELECTION, various packages of parameters or incentives PROGRESSIVE, AND CUMULATIVE available to the firm. The Database specifies the structure through which 5. Cumulative: Cumulative incentives refer to the CIT incentive benefit is conferred, classified as those elements that are part of a dynamic one of the following: collection of varying tax parameters or incentives, where their respective generosity 1. No special structure: The primary feature is aggregated. This collection is subject to of this type of incentives is that they are variation because different tax parameters and rewarded within the corresponding fiscal year incentives possess distinct conditions, and a as the firm meets the necessary requirements. company can only accumulate the generosity This represents the most straightforward and of those elements for which it meets the simple structure for incentives. conditions. Unlike progressivity, sequence, or selection, the conditions within a cumulative 2. Progressive: Progressive refers to incentives set can differ. For instance, if there are 10 with a varying level of generosity that firms can different tax incentives, each offering a two- receive based on meeting specific criteria or year tax holiday, a firm would need to aggregate thresholds—such as those relating to income, them as 10 multiplied by 2 years, resulting in investment, or employment. For instance, as a a total of 20 years, provided the firm meets firm invests more or employs more people, the the conditions for all the tax incentives that level of generosity increases. potentially contribute to the cumulative set.21 3. Sequential: Sequential incentives are those Given different possible structures, World Bank that follow a specific sequence or progression staff devised and applied a counting logic to over a set period. For example, a company classify whether incentives are identified as may be granted a tax holiday for the first three 21. This approach is only applied if it is not feasible/practical to calculate all the different combinations of the cumulative benefits conferred to a firm fulfilling the conditions of a varying set of tax parameters or tax incentive given the number of variations. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 33 Prosperity Insight distinct—to avoid double counting and ensure planned for forthcoming publication through the consistency when referencing the number of World Bank Development Data Hub. incentives offered. While there are additional rules Key features of the streamlined CIT Incentives for specific circumstances, the counting approach Database are summarized below. is summarized as follows: • The streamlined version organizes and • Incentives without any special structure are systematizes the 26 distinct conditions of counted as an individual incentive. the underlying Database—summarizing and • Each bracket within a progressive incentive is presenting the total number of conditions by counted individually as a separate incentive. type. For sector-specific conditions, detailed information is included, ranging from the • Sequential incentives, regardless of the ISIC chapter level (one digit) down to the number of sequences involved, are treated as more granular ISIC four-digit level, with the a single incentive. information standardized based on the details • For selection, when multiple options are provided by the original sources. In instances offered as incentives, the choice is counted as where there are Special Economic Zone an individual incentive. conditions or location-specific conditions, the streamlined Database also incorporates more • Cumulative incentives are classified as individual detailed information on the specifics of the incentives; however, there is a limit of five location. Some incentives require additional reduced rates based on the generosity values. contextual information to complement the conditions. This supplementary information is provided under the “condition description” STREAMLINED CIT INCENTIVES variable of the streamlined Database. DATABASE Additionally, detailed information on key parameters, such as generosity, applicable Given the complexity and high level of detail of the years, rates, and descriptions provide insights CIT Incentives Database, the Investment Climate into the application of generosity. unit developed a reduced or “streamlined” version of the Database for external use —to faciliate • For incentives with special structures, the descriptive and statistical analysis. The streamlined streamlined Database provides information version aims to make the data more accessible on the minimum, maximum, and average rates to researchers and other external parties by to describe the generosity across various tax highlighting the main characteristics of incentives. breaks and periods. For sequential incentives, It presents a subset of the data in a summarized, details on the generosity of the first break, and more user-friendly format focusing on the type, along with the total number of years of structure, and conditions of the incentives. generosity, are also included. The streamlined Database, together with a • Finally, the sources used to compile the glossary of variables and more comprehensive information are included in the streamlined documentation, is publicly available as part of version, with corresponding links provided to the Reproducibility Package of this paper, and is facilitate direct access to the original data sources. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 34 Prosperity Insight APPENDIX B: IDENTIFYING INCENTIVES RELATED TO ENVIRONMENTAL SUSTAINABILITY FROM THE CORPORATE INCOME TAX INCENTIVES DATABASE GREEN PROCESS-ORIENTED INCENTIVES GREEN SECTOR-ORIENTED INCENTIVES Green process-oriented incentives are identified on Green sector-oriented incentives must have a the basis of fulfilling either one of two conditions condition that includes specific sectors relating to in the Corporate Income Tax Incentives Database: environmental sustainability (drawn from the EU taxonomy for sustainable activities):22 1. An explicit environmental condition: Reflects an explicit climate/environmental/green purpose 1. ISIC code E. Water supply; sewerage, waste stated in the law or title of the incentive. These management and remediation activities. conditions are identified manually. 2. Non-ISIC “own categorized” sectors 2. A keyword search followed by a qualitative “renewable energy generation” and (manual) verification for relevance. Key “environmental protection.” words include: solar, wind, hydro, renewable, biofuel, recycl, eco-, ecol, green, emission, If both green sector-oriented and green process- environment, organic, pollution, carbon, CO2, oriented conditions are fulfilled, then the incentive conservation, geothermal, electric car. is classified as a green sector-oriented incentive. These incentives can also be conditioned on other These incentives should not be conditioned non-environmental sectors as long as not all on specific sectors relating to environmental sectors are eligible. sustainability. That is, if both green sector and green process conditions are fulfilled, then the incentive is considered to be a sector-oriented incentive, not a process-oriented incentive. 22. See https://finance.ec.europa.eu/system/files/2020-03/200309-sustainable-finance-teg-final-report-taxonomy_en.pdf. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 35 Prosperity Insight INCENTIVES FOR POLLUTING / ENVIRONMENTALLY DE GRADING SECTORS This type of incentive must have an eligibility condition for a “polluting” sector/activity: 1. A “polluting” activity, such as “stumping and clearing of lands” 2. A “polluting” sector (sectors defined by ISIC codes): a. B. Mining and quarrying; 05-Mining of coal and lignite; 06-Extraction of crude petroleum and natural gas; 07-Mining of metal ores; 08-Other mining and quarrying; 09-Mining support service activities b. C.19-Manufacture of coke and refined petroleum products; 20–Manufacture of chemicals and chemical products; 22– Manufacture of rubber and plastics products; 2394-Manufacture of cement, lime and plaster; 2395-Manufacture of articles of concrete, cement and plaster; 241-Manufacture of basic iron and steel c. D. Electricity; gas, steam and air conditioning supply; 35-Electricity, gas, steam and air conditioning supply The incentives must also not satisfy a green sector-oriented or green process-oriented condition. CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 36 Prosperity Insight Figure C.1: Change in the prevalence of green incentives (as a share of total CIT incentives), by economy, 2009–20 2020 POLLUTING INCENTIVES BETWEEN 2009 AND CHANGE IN PREVALENCE OF GREEN AND APPENDIX C: Change in share of green incentives (as a % of total CIT incentives) -20% -15% -10% 10% 15% 20% 25% 30% -5% 0% 5% Chile United Kingdom Zimbabwe Serbia China India Brazil El Salvador Cote D'ivoire Ethiopia Congo, Dem. Rep. Peru Russian Federation Egypt, A rab Rep. Panama Czech Republic Iraq Nigeria Kosovo Australia Haiti North Macedonia Japan Nepal Mexico Phil ippines South Africa Fiji Ireland Netherlands Col ombia Sri Lanka Ghana New Zeal and Mauritius Angol a Germany Norway Gibral tar CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 37 Prosperity Insight Figure C.2: Change in the prevalence of polluting incentives (as a share of total CIT incentives), by economy, 2009–20 Change in share of polluting incentives (as a % of total CIT incentives) -10% 10% 15% 20% -5% 0% 5% Congo, Dem. Rep. Egypt, A rab Rep. India Nigeria Cote D'ivoire United Kingdom Mexico Zimbabwe Fiji Sri Lanka Brazil South Africa New Zeal and Iraq Col ombia Nepal Chile Serbia El Salvador Haiti North Macedonia Germany Australia Czech Republic Netherlands Japan Kosovo Norway Panama China Phil ippines Mauritius Ireland Angol a Ethiopia Russian Federation Ghana Peru Gibral tar CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT 38 Prosperity Insight References Andersen, Maria R., Benjamin R. Kett, and Erik von Uexkull. 2018. “Corporate Tax Incentives and FDI in Developing Countries.” In Global Investment Competitiveness Report 2017/18: Foreign Investor Perspectives and Policy Implications. Washington, DC: World Bank. 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Global Environmental Outlook 6: Healthy Planet, Healthy People. Nairobi: UNEP. Prosperity Insight CORPORATE INCOME TAX INCENTIVES TO PROMOTE ENVIRONMENTALLY SUSTAINABLE INVESTMENT , INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS 40 PETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | MACROECON , INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS PETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | TRADE, INVESTMENT AND COMPETITIVENESS | MACROECON