Tax expenditures refer to provisions in legislation that reduce or postpone the tax liability of individuals or businesses and are generally defined as deviations from the benchmark tax system. These provisions can take several forms including tax exemptions (where certain income or transactions are not taxed at all), tax deductions (where an individual can subtract certain expenses from taxable income), tax credits (where an individual can directly reduce the tax they owe), and reduced rates (where the tax applies, but at a lower rate than the standard). As such, tax expenditures reduce government revenue relative to the benchmark of what would be owed in the absence of those provisions.
Tax expenditures can in some cases have lower administrative costs than direct expenditures, particularly when a person or business’ eligibility for a tax expenditure is determined through their tax returns. In other cases, they can necessitate a significant administrative burden. While tax expenditures can be applied to comparable policy objectives as direct expenditure, tax expenditures rarely involve direct spending by the government and therefore do not appear in expenditure reports and financial statements. This difference illustrates how two comparable ways of giving effect to a policy objective – tax expenditures and direct expenditures – can produce different results from a budgeting and fiscal control perspective.
Tax expenditures have a significant impact on public finances. Between 1990 and 2020, revenue forgone from tax expenditure globally varied between 3.3% and 4.9% of GDP, which is significant relative to fiscal balances, which have averaged a 2.2% deficit across OECD Member countries for the same period (CEPR, 2021[1]). Tax expenditures are also frequently subject to weaker legislative oversight than direct expenditure and rarely undergo comparable reviews to that of direct expenditure programmes in relation to effectiveness and efficiency.
This paper examines tax expenditures in four OECD Member countries from a budgeting and fiscal control perspective. In these case study countries, tax expenditures represent a significant share of activity, ranging from around 8% of direct expenditure to around one third in the Netherlands, with around a fifth in the United Kingdom and around 15% in Canada (note that, due to differing methodologies in calculating tax expenditure levels, one should exercise caution in comparing these figures). Each of the four case countries has a strong track record of seeking to improve budget transparency on tax expenditure. The first section highlights the relevance of tax expenditure on government budgets. It then identifies which components of a tax expenditure system are relevant to fiscal control and long-term fiscal sustainability. The second section draws on these components to analyse the practices in the four case study countries. A final section provides an overview of the key challenges and notable areas for further work and exploration.
The paper focuses on budget processes, as these are relevant to both direct expenditure and tax expenditure, including for forecasts, decision making, reporting, evaluation, and parliamentary oversight. The budget process provides a common basis to analyse key aspects of direct expenditure and tax expenditure from a fiscal control perspective. As part of its analysis, the OECD analysed budget and oversight reports, drawing on the resources of the OECD Committee of Senior Budget Officials.