Tax Expenditure Budgets: Concepts and Challenges for Implementation by Luiz Villela, Andrea Lemgruber and Michael Jorratt published by IDB (4/2010).
“Tax expenditures, understood to be the revenue that is foregone by the application of benefits or special tax regimes, are one of the many tools that governments have available for public policy implementation. Their use is designed to foster and encourage certain economic sectors, activities, regions, or agents. Tax expenditures are often referred to as “foregone revenue” since they can be considered as the way by which the treasury desists, either partially or totally, from applying the general tax regime to pursue a higher objective of political economy or social policy.
The concept of tax expenditures arose at the beginning of the 1960s, practically simultaneously in Germany and the United States. These were the first countries to report tax expenditure budgets to enhance transparency in public activities carried out via this method, in the same way they reported direct public spending in the regular budget process. Later, during the 1980s, the practice was extended to virtually all countries in the Organization for Economic Co-operation and Development (OECD) and to a few developing countries.
The international community’s demands for greater transparency in fiscal policy, together with the growing tendency to use tax benefits—especially in those developing countries seeking investment—led to an increased interest in tax expenditures throughout the world. In 1998, the International Monetary Fund (IMF) published its Manual on Fiscal Transparency, which, along with the OECD’s recommendations on tax expenditures, contributed to not only disseminate the subject matter but also to emphasize the need for various countries to consider it when designing their budget.
In spite of such efforts, however, tax expenditures have hardly been studied, especially in developing countries. There is a need to develop a more systematic analysis for assessing the level of tax expenditures and for creating a harmonized methodology that supports comparative studies across countries. In the Latin American and Caribbean (LAC) region especially—a region that has used tax expenditures as a tool for attracting investment—this theme is fundamental for understanding the granting of incentives and their effects. Here, countries seek policy proposals with greater basis on technical studies that simultaneously promote an increase in fiscal transparency.
There are four main themes that show the importance of improving tax expenditure analysis. The first of these is the measurement of tax expenditures; certain conclusions might be drawn from its analysis concerning the magnitude of state action in each country. A tax expenditure is a commitment of fiscal resources as valid as any other component of public spending, and recognized as such in fiscal accounts. One interesting implication of tax expenditure measurement, therefore, is that it enables comparisons of the size of the state in various countries to be updated…”
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