Practice Advice on Public Financial Management
Tax Expenditures (OECD)
Summary Advice: The OECD recommends that countries follow a set of rules for enhancing budgetary control of tax expenditures.
Main Points: Tax expenditures are exemptions, allowances, credits, rate and tax reliefs offered by the government are used by the government as a substitute for direct expenditures. More specifically, tax expenditures can be in the form of: 1) Exemptions (amounts excluded from the tax base); 2) Allowances (amounts deducted from the benchmark to arrive at the tax base); 3) Credits (amounts deducted from tax liability); 4) Rate relief (a reduced rate of tax applied to a class of tax payers or taxable transactions) and 5) Tax deferral (a relief that takes the form of a delay in paying tax). The OECD recommends the following rules for increasing the budgetary control of tax expenditures.
- Tax expenditures should be identified through comprehensive and unique benchmark taxes. A tax expenditure can then be defined as a transfer of public resources that is achieved by reducing tax obligations with respect to a benchmark tax, rather than by a direct expenditure. The identification of tax expenditures depends on the provisions of the tax law with regards to benchmark taxes and normative taxes. When it comes to estimating tax expenditures, there are three different methods:
All tax expenditures should be estimated and integrated in the documentation system in place for all significant taxes.
In cases of nominal or structural deficit, tax expenditures should either be included in the total expenditure cap or in a special tax expenditure cap.
All tax expenditures must be reviewed in the same way as regular expenditures in the annual budget process.
Tax expenditures should be assigned to individual ministries.
Tax expenditures should be subject to budgetary control in the same was as regular expenditures are.
- Revenue Forgone: the amount by which tax revenue is reduced because of the existence of a particular provision. The estimate is obtained based on a comparison of existing legislation and the legislation without the tax expenditure.
- Revenue Gain: the amount by which revenue is raised if the tax expenditure were to be abolished.
- Outlay Equivalence: the direct expenditure that would be required in pre-tax terms, to achieve the same after-tax.
The tax office may be tasked with the administration of tax expenditures. The following are the reasons why tax office should be tasked with such a duty: 1) Reduced administration costs, avoidance of unnecessary transfers of resources, and increased economies of scale; 2) Reduced incentives for tax evasion; and 3) The tax office has unique expertise in the administration of transfers and subsidies, and unique information about the characteristics of households. This expertise and information which may be relevant in the administration of tax expenditures.
However, difficulties in administration of tax expenditures from the tax office may arise because: 1) Exemptions, allowances, rate reliefs and deferrals provide benefits in proportions to the tax base of a family or a business, for instance high income households have more profit from exemption in the tax than a low income household and it only makes sense to enact a subsidy or transfer as a tax expenditure if this effect is the objective of the tax expenditure; 2) Tax credits provide equal benefits to households, regardless of the tax base, but can easily lead to negative tax liabilities, which may be difficult to administer; 3) It is important that the tax office does not become overloaded with the administration of tax expenditures, jeopardizing the primary task of collecting revenues.
- Overall, tax expenditures, whether administered by the tax office or another agency, need to be relatively stable and predictable. Subsidies and transfers that are experimental, volatile or unpredictable should be kept out of the tax system, no expenditures which are based on executive or ministerial order/decree should be classified as tax expenditures.
Source: OECD (2004). "Best Practice Guidelines - Off Budget and Tax Expenditures" 25th Annual Meeting of Senior Budget Officials, at: http://search.oecd.org/officialdocuments/displaydocumentpdf/?cote=gov/pgc/sbo%282004%296&doclanguage=en (accessed 3 January, 2013).
Page Created By: Khilola B. Zakhidova on 3 January 2013. Updated by Ian Clark on 17 January 2013. The content presented on this page is drawn directly from the source(s) cited above, and consists of direct quotations or close paraphrases. This material does not necessarily reflect the official view of the publishing organization.