Tax Concessions and Investment Behaviour

The Government of Pakistan, like many other developing countries, has opted for tax holidays as an important fiscal measure to encourage rapid industrialisation in the backward areas. This concession is also supplemented by several other economic and non-economic measures including import duty, and depreciation allowances. Mintz (1990) discusses the efficacy of tax holidays in the presence of accelerated depreciation allowances concludes that tax holidays which are designed to increase capital formation may end up penalising capital formation. Mintz’s (1990) conclusion is based on the assumption that if the assets are long-lived, and the income tax system allows deductibility of accelerated depreciation but cannot be deferred, then the tax holidays, by preventing depreciation deduction in the early period may actually penalise investment during the tax holiday period. If on the other hand the depreciation allowance is deferred till the end of tax holiday period, the tax system is genuinely generous and provides a real incentive for capital formation.

Depreciation and Replacement Cost

The sharp rise in prices in recent years has stirred up a brisk debate on the meaning and measurement of business income. In computing income, costs of labour and material are generally reflected in current prices, but the provision made for depreciation is generally not sufficient to replace fixed assets. This paper investigates various approaches to the oroblem of providing sufficient depreciation allowance in measuring income. The relationship between written down value and the straight line inflation adjusted method of providing depreciation has been examined. Simulation technique has been used to illustrate the problem and pertinent policy implications of the use of various depreciation methods have been highlighted.