• Tax incentives are widely used across Latin America and the Caribbean (LAC) to attract investment, stimulate economic growth, and create jobs.
• An IDB review of two decades of empirical evidence on the effects of tax incentives shows that, in studies using cost‑benefit analysis, most tax incentives in LAC fail to generate economic benefits large enough to justify their fiscal cost.
• The study recommends that countries consider more efficient alternatives—such as reducing trade‑related administrative costs—and strengthen government capacity to rigorously assess the costs and benefits of tax incentives before adopting them.
Tax incentives have been key policy tools provided by governments to promote investment in Latin America and the Caribbean (LAC). Across the region, tax incentives focused on investment and businesses (including corporate income tax incentives and foreign-trade tax expenditures) account for approximately 1.1% of GDP in forgone revenue.
Given their scale, a key policy question arises: are these incentives effectively promoting the country’s development goals at the lowest possible cost? This question is especially relevant where most governments in the region face limited fiscal space and increasing demands for public services.
This is why the Inter-American Development Bank carried out the study “Systematic Review of Evidence on the Impact of Tax Incentives in Latin American and Caribbean Countries.” It reviews two decades of empirical literature on the effects of tax incentives on stimulating investment, employment, and economic growth in the region. In the next paragraphs, we summarize the main findings.
Tax incentives across the LAC region differ in design and coverage, shaped by each country’s specific goals. Information on tax regulations and policies up to 2024 shows that the main sector targets in the region are manufacturing (13 countries of the 17 LAC countries), tourism (10 countries), renewable energy (10 countries), and development-related activities (10 countries). In parallel, every country offers location-based incentives, typically through special zones that focus on export-oriented activities and regional development.
Corporate tax holidays are a prominent feature and are offered in 15 of the 17 LAC countries analyzed, with Argentina and Mexico as notable exceptions. The average duration of tax holidays across the region tends to fall between 10 and 15 years. In addition, reduced corporate income tax rates are offered in 12 out of 17 LAC countries.
Investment tax credits are also commonly used to promote spending in industries such as productive investments (5 countries), research and development (R&D) (5 countries), and renewable energy projects (4 countries). Sectors that depend excessively on capital assets are often granted accelerated depreciation incentives to recover their investment expenses at a faster pace. Chile, along with Ecuador, Mexico, and Nicaragua, are known for using depreciation in new fixed assets or new projects in general.
Finally, nearly all countries in the region have special incentive regimes for companies located in underdeveloped areas or designated special zones where the policy package typically includes import and export duty exemptions, income tax incentives, and streamlined customs and administrative controls. These instruments aim to lower start‑up and operating costs for new businesses, helping to attract investment.
Nineteen out of 31 studies that quantitatively assess the impact of different types of tax incentives in LAC have applied econometric techniques. These models, in general, focus on measuring the effectiveness of tax incentives in achieving their desired objective of increasing sectoral activities. However, only five studies applied a cost-benefit analysis to measure the net economic impact of tax incentives.
Regarding the timing of evaluations, the study shows notable deficiencies within the current literature in conducting ex-ante evaluations, which take place before a tax incentive is implemented. Most studies reviewed (87%) have analyzed the impact of tax incentives after implementation (ex-post evaluation).
Across LAC, studies show mixed results on whether tax incentives effectively increase FDI and aggregate investment. Roughly half of the econometric studies report little or no measurable impact, or only modest effects on the targeted activity or sector, while the other half find a clear positive effect.
For example, studies provide evidence of the effectiveness of tax credits and income tax exemptions in the tourism sector, manufacturing and trade sectors, and the industrial sector in some countries.
However, tax holidays, reduced corporate income tax rates, tax credits, investment allowances, and accelerated depreciation are found to be less effective or not effective in other LAC countries.
Even where tax incentives appear effective, especially in attracting FDI, they rarely compensate for the fundamental factors that truly shape investment decisions, such as the underlying financial attractiveness of the activity, country risk, the quality of institutions, the availability of skilled labor, and the quality of infrastructure.
Demonstrating effectiveness does not necessarily imply that tax incentives enhance economic welfare (an issue of efficiency). For example, the tax incentive may increase the private rate of return to the owners of foreign investment, causing them to invest in activities that have a lower-than-average economic return to society. Such results will reduce the overall economic welfare of the country rather than increase it, even though the effectiveness in transferring economic resources to the targeted sector is achieved.
When efficiency is assessed through cost-benefit analysis, approximately 80% of the studies that applied such analysis found that the incentives are not efficient. This means that their social cost exceeds the estimated economic benefit. Therefore, it is imperative to extend the evaluation beyond effectiveness alone and incorporate efficiency considerations into tax incentive policy decisions.
Tax incentives fundamentally divert resources from other parts of the economy to the sectors or regions that receive preferential treatment. Therefore, in addition to the fundamental question on the efficiency of tax incentives, the incentive must also be more efficient than alternative policy instruments.
In many cases, empirical evidence increasingly shows that alternative policy tools that may directly reduce costs, simplify procedures, or minimize resource misallocation can achieve the intended objectives more effectively, efficiently, and with fewer distortions, than tax incentives.
1. Create broader mechanisms to support export-oriented firms beyond specific zones.
Infrastructure development incentives are vital for supporting export-oriented firms. Establishing export processing zones (EPZs) that are largely free of taxation of inputs as well as income taxes can create an environment conducive to industrial growth by freeing firms both from the burden of taxation and from bureaucratic customs and tax administration systems.
However, it is important to acknowledge that physical EPZs are costly to build and maintain. Initially, the EPZs in Taiwan were regarded as successful and important vehicles for promoting exports, but over time, the country’s export success became largely driven by firms operating outside these zones. In fact, over a span of 40 years, the share of Taiwan’s total exports originating from EPZs peaked at just 9% of the country’s overall export value.
The government's emphasis shifted toward other institutional arrangements to provide duty relief, such as accounts-based duty exemption, which exempted duties on inputs used for exports across the country rather than just within EPZs. These broader mechanisms played a much greater role in supporting Taiwan’s export performance and international competitiveness.
Therefore, a sustainable approach involves eventually developing an information and systems control mechanism to allow inputs to flow to firms tax-free without the need for extensive physical infrastructure. This will foster growth in the export sector, boost domestic economic activity and increase the availability of foreign currency to finance imports, thus contributing to enhanced tax collection.
2. Reducing trade administration costs has a greater impact than introducing or expanding tax incentives.
Recent studies show that, in many countries, reforming the trade environment by reducing trade-related administrative costs faced by exporters and investors could have a much larger economic impact than introducing or expanding tax incentives.
Nazif and Jenkins (2023) estimate that if countries in the Andean community improved their trade administration systems to match those of Chile or Singapore, they could save $1.25–1.5 billion annually, equivalent to 0.19–0.23% of GDP.
Similarly, Nazif and Jenkins (2025) show that the Mercosur region could achieve over $15 billion in annual net welfare gains by reducing both import and export administrative costs to the levels found in Chile and Canada.
1. Tax policies need to be evaluated on an ex-ante basis. By examining the potential impacts of tax incentives on investments before they are put into action, this approach enables policymakers to simulate scenarios effectively to reduce negative consequences and maximize the benefits of tax incentives.
2. Performing a comprehensive cost–benefit analysis. Countries should adopt a comprehensive evaluation framework that quantifies both the benefits and costs of tax incentives. Such incentives should only be implemented when the economic and social gains from higher investment stemming from such incentives clearly outweigh their fiscal costs.
3. Improve the design of tax incentives. To make an incentive more cost-effective, it should reward project owners based on the actual success of their project, rather than rely on broad, sector-wide tax breaks that simply transfer scarce public resources to the private sector and on all investments, whether new or existing.
4. Bridging the skills gap. The shortage of skills in cost-benefit analysis and applied economic welfare analysis requires a serious and sustained effort to strengthen technical capacity, along with a willingness to invest time and financial resources. Governments should prioritize designing and delivering cost-benefit analysis training programs to equip staff with the knowledge and tools needed to assess the full impact of tax incentives and make informed decisions.