Governments throughout the world use tax expenditure – that is, tax exemptions or subsidies – as a policy instrument to promote economic growth and social development. But how do you guarantee the proper use and good administration of tax expenditure? This paper from the World Bank suggests that significant improvements in the management of public finances can be achieved by extending the standard principles for sound budget management beyond cash expenditures, so that they also apply to tax expenditures and contingent liabilities.
In many countries, part of government fiscal activity may go unnoticed because it is hidden in the form of revenue foregone and does not appear explicitly as spending. Such activity is known as ‘tax expenditure’. If used properly, tax expenditures can play an important role in implementing government policy priorities. However, the assessment of tax expenditure policies and programmes is often complicated by inadequate reporting and accounting practices, particularly in developing and transition countries. This lack of scrutiny is in contrast to the scrutiny generally applied to the spending side of government finances. In these situations, it is difficult to evaluate the cost, efficiency, and equity impact of tax expenditures and the extent to which resources could be rationalised or better allocated to strengthen government finances and to support progress toward broader social and economic objectives.
The book considers conceptual and methodological issues relating to tax expenditures and a framework for evaluating costs and benefits of tax expenditures. With an overview of the concept and country practices with reference to ten OECD countries in the first chapter, the book also includes:
- Chapter 2: An introduction to a framework for evaluation of policies which was applied successfully in Canada.
- Chapter 3: Tax expenditure in Australia.
- Chapter 4 and 7: Experiences from Belgium and the United States, specifically how an analysis of tax expenditure can contribute to the tax policy debate and shed light on trade-offs with direct spending programmes.
- Chapter 5: Detailed descriptions of the estimations models used in Canada and cost-benefit evaluation methods for policy assessment.
- Chapter 6: The history of the tax expenditure debate and recent experience of budgeting the cost in the Netherlands.
- Chapter 8 to 10: The recent experiences of two transition countries, China and Poland.
Putting policy options in place for strategic and prudent management of tax expenditures may appear to be a time-consuming and difficult task. Many developing as well as industrial countries find it challenging enough to establish good policy options for strategic and prudent management of the budget alone. However:
- Management of the budget, contingent liabilities and tax expenditures share a common ground.
- For tax expenditures, there would be several methodological and technical issues, including collecting the information on existing tax expenditures, estimating their fiscal and broader socio-economic effects and incorporating the information into government policy analysis and documents.
- Working on these issues can become part of the evolving fiscal management processes, a by-product rather than a prerequisite of reform.
- The challenges of managing tax expenditures and possible fiscal and overall socio-economic risks, however, are important arguments in favour of minimising their use.
- In countries with less developed fiscal institutions and government institutional capacity, the use of tax expenditures may best be limited to cases of rectifying market failures.
