What are tax expenditures?
TEs are included in tax legislation, but are significantly motivated by policy goals other than to raise revenue in the most efficient manner possible. Most tax law is focussed on either raising revenue or tax administration.[3] However, tax law in most countries incorporates tax provisions that are significantly motivated by non-revenue considerations such as social policy or industry policy. For instance, in New Zealand's case, there are tax provisions that specifically reduce the tax payable by film, forestry, or mining companies.
The tax expenditure concept was originally devised by Stanley Surrey an Assistant Secretary to the US Treasury in 1967. The first published list of tax expenditures was motivated by Surrey's observation that a review of US government spending examined direct expenditures, but totally disregarded policy-motivated tax deductions, despite both items having a similar effect on the size of the government deficit.
Recognising the conceptual equivalence of direct and indirect spending allows tax legislation to be divided into two parts (Brooks, 2009):
- technical tax provisions aimed at raising revenue; and
- spending programs delivered through the tax system.
Technical tax provisions (red arrow) specify the quantity and method by which revenue is collected. These provisions form the benchmark against which tax expenditures are often measured. According to the World Bank, a comprehensive technical tax benchmark includes structural tax features such as rates, the tax base, and the timing of taxes, as well as any provisions aimed at facilitating tax administration (Swift et al, 2004).
- Figure 1 - Tax expenditures
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TEs (the blue arrow) reduce revenue and like spending are equivalent to a flow from the government back to individuals. TEs reduce an individual's tax burden and usually take the form of an exemption, allowance, credit, preferential tax rate, deferral, or tax offset.[4]
Categorisation of TEs has proven difficult in practice.[5] Tax provisions are often motivated by a range of factors and may be able to be defined as either technical tax provisions or as TEs. For example, progressive tax rates could be deemed to be motivated by social objectives such as redistribution of wealth. Alternatively progressive rates could be associated with increasing tax as the ability to pay increases. One motivation seems to suggest that progressive rates are motivated by revenue raising, the other suggests they are motivated by social policy.
Notes
- [3]The stated purpose of the Income Tax Act 2007 is: “to define, and impose tax on, net income; to impose obligations concerning tax; and to set out rules for calculating tax and for satisfying the obligations imposed”.
- [4]Some reductions in tax payable would not be classified as tax expenditures. Policies, such a Working for Families, that reduce the tax payable for taxpayers, but pay the credit as a cash payment to non-taxpayers are already appropriated and recorded as direct expenditure.
- [5]The categorisation is in some ways arbitrary as a government could opt to lower all rates or reduce the average rate through targeted provisions. The categorisation is, however, still useful as it highlights parts of the tax system with a focus on spending.
