Tax incentives for smart city development

Tax Incentives refer to tax reductions, exemptions or reliefs by governments to encourage private sector investors or companies to engage in projects that are relevant to smart city objectives.
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Instrument Category

  • Government Funding

Other ınstruments ın the same Category

Loan loss reserve (LLR)
National government transfers
Land pooling
Asset recycling

Relevant case study

Description

Governments could use tax reductions, exemptions or reliefs to encourage private sector investors or companies to engage in projects that are relevant to smart city objectives. For example, investment allowances could be given to firms that embark on automation or digitalisation efforts to encourage technology adoption by the private sector. Investment tax credits which encourage private sector investment in equipment such as renewable energy plants or carbon capture facilities are also a common instrument to stimulate investment in environmental sustainability projects.

Enabling Conditions and Key Considerations 

  • Clear and transparent taxation framework. Tax incentives fall below the ambit of the general taxation system, and it would be critical to have tax policies that are clear, transparent and predictable so that investors or companies can base long-term investment decisions on them.
  • Tax laws must be consistent and predictable. Smart city projects can have high upfront capital investments and long break-even periods. Predictability is particularly critical as investors would require assurance that tax laws remain favourable over the project lifespan before embarking on such investments.
  • Tax authorities must be able to enforce penalties against tax evasion acts. Incentives must be designed so that they are robust to tax evasion to avoid the government losing significant revenue from previously taxed investments as firms restructure projects to take advantage of new tax incentives. Authorities must be able to clearly identify firms who are evading taxes and take enforcement action.
  • Incentive guidelines would need to be communicated clearly to investors. Incentive guidelines must be designed and communicated clearly so that investors or firms as well as tax authorities can clearly understand the types of projects that qualify for the incentive to achieve its full benefits.
  • Periodic reviews to assess continued usefulness of tax incentives. Incentives would need to be reviewed on a periodic basis to assess if cost (foregone revenue) outweighs the benefits created by the tax incentive and if its design continues to remain effective in encouraging smart city investments. The incentive could also be pivoted to encourage investments into new specific areas.

Potential Challenges

  • Lack of experience of government officials. Government officials may have limited experience in designing such incentives and could find it difficult to design robust incentives that would achieve policy outcomes without the government forgoing taxes for investments that are commercially feasible and would have occurred anyway. For instance, local governments would need to decide between discretionary and automatic incentives. Compared to discretionary incentives, automatic incentives based on a clearly defined criteria that is publicly communicated could reduce the risk of corruption and dispute.
  • Risk of sub-optimal resource allocation. Successful tax incentives would create investments in areas in which investments would not otherwise occur. Without careful monitoring and periodic review, tax incentives may lead to too much investment in certain activities or too little investment in other non-tax favoured areas, which could be misaligned with the needs of the community.
  • Enforcement and compliance costs could be significant. Costs would be incurred by the government in enforcing the tax rules and by taxpayers in complying. The cost of enforcement relates to the initial grant of the incentive and the costs incurred in monitoring and enforcing compliance with the qualification requirements.

Potential Benefits

  • Low cost of implementation if the incentives are clearly defined. If incentives are designed so that they can be automatically applied and not discretionary, the cost of implementation for the government can be relatively low as these incentives would be applied for in the same way as other corporate tax credits in the existing taxation system without the need for additional platforms or systems to be put in place.
  • Allows a market-driven approach to assessing and implementing projects. Tax incentives are typically beneficial only when firms or investors are profitable, and the implementation of such incentives do not require significant intervention in the business. This allows investors or businesses to assess their own risks and business model viability before embarking on projects and, unlike a direct grant, incentivises them to focus on the cost effectiveness and profitability of projects and build sustainable revenue generation models.

Sources/Additional Information

Case Study

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