Implementation challenges

Implementing the tax expenditure concept can be difficult. There are three significant challenges when:

• categorising tax expenditures;
• collecting and gathering data; and
• calculating the value of tax expenditures (Boadway, 2007).

Data collection and quantification present a unique set of challenges. However, the first issue —categorising tax expenditures — has raised the most debate and arguably presents the most significant challenge. This paper focuses on identification and puts forward a possible approach for developing a New Zealand approach to TE reporting.

An evolution of objectives

Different objectives have led to differences in how TEs are defined internationally. Objectives have evolved from an explicit spending focus towards a combined focus on spending and structural tax reform. However, recent indications suggest that best practice may involve a clear separation of these two objectives.

The original US statement released in 1967 focused on spending. The statement did not attempt to list all tax provisions that varied from a strict definition of net income. Items were excluded where quantification was impossible or where the motivation for inclusion rested solely on “theoretical tax arguments” (Surrey and Helmuth, 1969).[6] Surrey felt highly complicated or controversial items that rested on theoretical tax arguments would becloud the utility of the analysis (ibid: 530).

Other countries or organisations have been more ambitious in their approach by seeking to integrate analysis of more structural tax features. This analysis intends to answer broader questions about the structure of the tax system. These TE statements usually estimate the cost of structural tax features against a normative tax benchmark usually based on a Haig-Simons (HS) definition of income. The HS definition of income includes both consumption and any increase in accumulated wealth over the period.

The efficacy of each objective (structural tax reform or spending analysis) has been mixed. The experience of the US, which has had TEs for longer than most countries, has been instructive. Both the US Congress and Treasury publish TE estimates although each institution pursues different objectives. The U.S. Treasury's main benchmark is focussed on spending, while the Congress has historically focussed on micro tax reform.

The US Treasury temporarily moved away from an explicit spending focus, but re-established the primacy of fiscal reporting with a spending focus as the key objective under the Reagan administration. Despite this, the US Treasury has recognised that there are a number of ways to look at TEs and now report a range of figures against a series of benchmarks (JCT, 2008; GAO, 2005).

The US Congress's Joint Commission on Taxation (JCT) also publishes a TE statement. However, the JCT, as a tax body, historically saw TE statements as being more useful as a tool of tax policy (JCT, 2008: 6). The JCT has until recently continued to favour a normative benchmark built upon a broad Haig-Simon definition of income.

However, ongoing debate has led to a re-examination of JCT's approach. The JCT (2008) commented that their TE estimates had been driven off track by seemingly endless debate about what should be included in the “normal” tax base and that the statement was no longer able to advance its goals. In an attempt to improve the perceived neutrality of their analysis, the JCT has now moved to separate their TE statement's twin objectives into two groups: tax subsidies; and tax-induced structural distortions.

The OECD no longer supports the idea of a normative benchmark as definition of a normative tax base is a very political problem that may not be able to be resolved (Kraan, 2004). For this reason, the OECD suggests that a benchmark should be based on current tax practice rather than ideal tax practice. Broad-based support for tax expenditure analysis requires that estimates be viewed as both neutral and principled (JCT, 2008).

The US experience highlights the importance of clear objectives and the need to separate policy advice from fiscal reporting. TE statements can make a positive contribution, but the effectiveness of statements critically requires that descriptive reporting be clearly separated from views or advice on how the tax system should be constructed. Few countries have the resources to produce the wealth of information included in the multiple benchmarks produced by the US. However, countries with relatively limited resources can still produce effective tax expenditure estimates providing they are clear about their domestic objectives.

Source: OECD (1996); Polackova et al. (2004)

Categorising tax expenditures

Identifying tax expenditures is a categorisation exercise that can be approached in different ways. As a result, different countries have adopted different approaches. There are perhaps two broad methods that could be used. TEs could potentially be categorised by:

• first defining the benchmark (ie, what a TE isn't); or
• defining what constitutes a TE (ie, what a TE is).

Most countries have chosen to define TEs through a benchmark.