Tax incentives as a factor of economic growth ivana domazet and darko marjanović

Key Words
: tax incentives, investment, foreign investors, competitiveness, economic growth 
 
1. Introduction 
Tax competition occurs in a situation when the state, in creating their tax 
policies, is trying to reduce the tax burden (through the lowering of tax rates, granting 
tax incentives or abolishing certain taxes), all with the aim to prevent the outflow of 
production resources, encouraging them at the same time to enter the market. This is 
why tax competition involves strategy which the government of a country uses to 
attract foreign investments by introducing privileged tax measures. When choosing a 
potential country for investment of capital, the investors take into account a number 
1
This chapter is a part of research projects III47009 (
European integrations and social and economic 
changes in Serbian economy on the way to the EU
) and OI179015 (
Challenges and prospects of structural 
changes in Serbia: Strategic directions for economic development and harmonization with EU requirements
), 
financed by the Ministry of Science and Technological Development of the Republic of Serbia. 
2
Senior Research Associate, Institute of Economic Science, Belgrade, Serbia, 
[e-mail] 
3
Research Associate, BB Trade ad, Zrenjanin, Serbia 
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The State and the Market in Economic Development: In Pursuit of Millennium Development Goals 
94 
of other macro indicators such as political stability in the country, the national tax 
system, the state of the banking sector, infrastructure, rule of law, business law, 
conditions on the local capital market, the qualifications of the workforce, social 
responsibility etc. [Malovic, 2015, pp. 17-33]. 
The fiscal system and fiscal policy is one of the key factors in starting the 
process of improving the competitiveness of the Serbian economy. This is why it is 
essential to establish the institutional basis of the fiscal system, along the growth in the 
efficiency of tax administration and create a transparent control of public finances. In 
addition to the institutional order, for the competitiveness of the Serbian economy it 
is certainly necessary to make changes in the fiscal system which should be one of the 
factors of economic growth and development. 
One of the main tasks of each country is to increase production and exports, 
which should aim towards the achievement of stable economic growth in the long 
term. In order to make it possible, it is necessary to attract foreign direct investments. 
For this reason it is very important to create such investment climate in the country 
which would be suitable for foreign investors. Stimulating tax environment is certainly 
one of the main instruments to increase investment [Marjanovic-Radojevic, 2013, 
p.355]. In order to encourage the growing economic activity in the domestic 
environment together with attracting foreign capital, it is important to realize that 
income tax plays an important role, being one of the most important tax instruments. 
This primarily refers to a wide range of tax incentives in the system of income tax, 
which are nowadays a key determinant of tax competition. Therefore, it can be said 
that these tax incentives contributed to creation of the best possible preferential tax 
treatment for foreign investors. Many transition countries have realized that fiscal 
policy is a very powerful instrument for attracting foreign investment. During the 
1990s, Central European countries used ‘tax breaks’ for this purpose, as well as other 
fiscal incentives. As a result, there was an increase in the volume and amount of 
capital inflow, leading to the growth of the economies of these countries, thereby 
increasing their competitiveness [Domazet, 2014, pp. 217-227]. As it is known that the 
taxpayers are trying to reduce their tax liability at the lowest possible level, they have 
interest in taking advantage of tax incentives which are provided by states in the 
process of tax competition. There is a conflict of interests of the state, on the one 
hand, to attract more investments (lower tax burden), while on the other they are 
trying to collect as many resources for financing public functions (higher tax burden).