Taxes, incentives and production: The case of Turkey

Abstract This paper investigates the effectiveness of investment incentives and corporate income taxes in influencing production and investment decisions in the Turkish electrical machinery, non-electrical machinery and transportation equipment industries. Three tax instruments are considered; the corporate income tax (CIT), the investment tax allowance (ITA), and the capital cost allowance (CCA). The results show that since there are significant capital adjustment costs, it is important to distinguish between the short, intermediate, and long-run effects associated with the tax instruments. Production decisions are relatively more responsive to changes in the ITA rate compared to changes in either the CCA or CIT rates in each of the runs. However, the ITA and CCA rates are equally cost effective in stimulating investment and superior to the CIT. The CCA and ITA rates generate investment expenditures of 1.5 to 2.5 times the loss in government revenue. Thus targeted instruments outperform the general CIT instrument. In addition, although the incentive to invest is enhanced, there is little effect on output and employment. Therefore, these tax incentives essentially after production techniques.