Approach one: defining a benchmark

There is no international consensus as to how a benchmark should be defined. Attempts to categorise tax expenditures through a benchmark tax have been the subject of long-standing debate.

There are three broad approaches that New Zealand could use to build or create a benchmark. The approaches draw on:

• international best practice;
• a theoretically ideal or perfect tax structure; or
• the current (status quo) tax system.

International practice and tax policy

International reporting practice offers few workable insights that New Zealand could apply as tax design and the objectives motivating TE reporting varies from country to country. As a result, there has been limited progress on a standardised approach (OECD 2008: 7). A summary of different approaches is included in Table 2.

An optimal theoretical tax benchmark 

Applying tax theory can be challenging as there is a lack of consensus in optimal or applied taxation theory as to how a normative tax benchmark should be constructed. The concept of a normative tax base has been heavily attacked in academic literature. Boris Bittker (1969) provided an early criticism that there was no commonly accepted definition of the normal tax system as any system of taxation is an aggregation of decisions about a range of structural issues that theoretical tools such as the Haig-Simons (HS) definition[7] of income do not purport to settle.

Theoretical tax benchmarks allow the difference between a specific tax and an “ideal” tax structure to be measured. This difference, relative to a theoretical tax structure, may differ markedly from the tax that is actually forgone relative to the actual tax structure.[8] Thus, the further the theoretical tax structure moves from the current tax structure, the less useful numbers are from a fiscal perspective.

Most attempts to use a theoretical tax base have in practice been tempered by a range of practical considerations. The US Treasury takes into account a range of factors including the “generally accepted structure of income tax” (Surrey and Helmuth, 1969: 531). The Australian Treasury, which publicly provides a large amount of data on their benchmark, starts with a HS definition of income, but then tailors the benchmark to sit more closely with current tax practice (the Australian Treasury, 2008).

The current tax system as a benchmark

Thus, most countries, in forming a benchmark, rely to differing degrees on their current tax structure. This improves the quality of fiscal estimates. However, using the entire current tax system as a benchmark is not possible as doing so presents the obvious difficulty that if the entire tax system is considered part of the benchmark there would be no tax expenditures to measure.

The difficulty in communicating the wide number of choices involved in specifying a benchmark may create uncertainty about which parts of the benchmark are deemed to have theoretical support and which parts are motivated by other considerations. Australia provides comprehensive information about the structure of their tax benchmark. However, interpretation of TE benchmarks in other countries is made difficult as a result of limited or insufficient information.

One solution is to work in the other direction by first creating a tax expenditure definition.