Global Journal of Economic and Finance Research

This study investigates the relationship between tax exemptions and foreign direct investment (FDI) inflows in Tanzania using annual time series data covering the period 1985-2020. According to the Tanzania Investment Centre and Zanzibar Investment Promotion Authority (Zanzibar Investment Act No.10 of 2023): qualifying investment projects may benefit from fiscal incentives, including import duty relief on eligible capital goods and investment-related equipment. The study was motivated by the continued use of tax exemptions as an investment-promotion instrument despite mixed empirical evidence regarding their effectiveness in attracting foreign investment. The analysis employed the Augmented Dickey Fuller unit root test, Johansen cointegration test and Vector Error Correction Model (VECM). The unit root results showed that the variables were predominantly integrated of order one, I(1), while the Johansen test confirmed the existence of a stable long-run relationship among the variables. The VECM results indicate that tax exemption has a positive and statistically significant relationship with FDI inflows in Tanzania. Specifically, the estimated coefficient of tax exemption was 0.302402, implying that a 1 percent increase in tax exemption is associated with approximately a 0.302 percent increase in FDI, holding other factors constant. The findings therefore suggest that tax exemptions can contribute to attracting foreign investment, although the response of FDI is less than proportionate. The study concludes that tax exemptions should be used selectively and complemented by improvements in the broader investment environment. It recommends that the Government of Tanzania adopt targeted, transparent and performance based tax incentives and regularly assess the fiscal cost of exemptions against the additional investment generated.

Tax exemption, foreign direct investment, Tanzania, VECM, tax incentives.

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