Zone Practices: Policy, Planning, and Strategy
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Making substantial changes to the regime, such as eliminating tax breaks, would send a message that the government’s other commitments on zone policy might no longer be guaranteed. Managing this issue can be a difficult balancing act. In Vietnam’s case, although FDI in the EPZs started off tax-free, the huge growth of these zones over time and the dramatic changes in Vietnam’s national economy that resulted from global integration made it necessary to significantly alter the regulatory and incentive regime. Although new master plans, regulations, and incentive structures were introduced every few years, the process followed a relatively predictable path toward greater liberalization and harmonization with the national economy. And companies that had invested in the zones under previous regimes were allowed to keep their agreed-upon tax breaks. Thus, Vietnam managed to integrate the zones with the national economy over a reltively short period, while avoiding substantial revolutions or policy reversals that might have resulted in investor uncertainty. At the level of individual zones, removing the tax incentive has had an enormous effect on the approach of zone developers, who have shifted from incentive- to service-based competition and are now touting how quickly they can process applications rather than how low the tax burden will be. Vietnam did not completely eliminate tax holidays and other fiscal incentives for foreign investors. Rather, in compliance with WTO, the country separated these incentives from the SEZ program, instead targeting them to specific industry sectors and specific lagging regions. Malaysia is another example of a country that made significant use of fiscal incentives but modified them over many decades to target the specific needs of its industrial strategy (see Box 6.8). Getting rid of fiscal incentives presents a problem of collective action; institutions of regional integration may offer an effective avenue through which to address this problem. Addressing the problem of corporate tax incentives in SEZ programs— and, more widely, in investment promotion regimes—is particularly difficult, because it presents a classic prisoner’s dilemma: Two neighboring countries would both be better off by cooperating to eliminate or regulate the provision of tax incentives to foreign investors, but each might benefit most from offering incentives while their neighbor does not. In the absence of knowledge of its neighbor’s intentions, each country will act in its own self-interest and choose to offer incentives, so they will effectively cancel each other out and transfer rents to the foreign