Tax expenditures: costs to government that are not in the Budget

Dr Anne Holmes and Hannah Gobbett, Economics

Key issue
A tax expenditure is the provision of a benefit by way of preferential treatment in the tax system. It has a similar effect on the budget to direct expenditure, but is subject to far less scrutiny. Transparency would be increased in many cases if tax expenditures were replaced with direct expenditure.

The nature and scope of tax expenditures

When the Government exempts an activity from tax, it has the same effect on the budget as if the Government had given a direct subsidy to that activity. A benefit that is provided in this way is called a tax expenditure. Treasury defines a tax expenditure as:

… a provision of the tax law that provides a benefit to a specified activity or class of taxpayer that is concessional when compared to the ‘standard’ tax treatment that would apply.

Tax exemptions, tax deductions, tax offsets, concessional tax rates and deferrals of tax liability are examples of tax expenditures.

Tax expenditures are reported in an annual statement by Treasury. In 2012–13, there were 363 tax expenditures provided under the Australian tax system, the total value of which was estimated at approximately $115 billion, or 7.5% of Gross Domestic Product (GDP). For comparison, total government direct spending in 2012–13 was about 23.5% of GDP.

Structural features of the tax system, such as being able to deduct the costs incurred in earning income, can result in large benefits to taxpayers but not be counted as tax expenditures. Negative gearing is an example. Further, Family Tax Benefit and the private health insurance rebate are regarded as direct spending.

The large tax expenditures are shown in Figure 1. There are also several items which Treasury estimates as ‘large’ but cannot quantify; for example, the income tax exemption for charitable, religious, scientific and community organisations.

Figure 1: Major measured tax expenditures, 2012–13

Tax expenditures are intended to achieve policy objectives of the Government. They are essentially the same as government spending programs. For example, the Government’s support of around $75 billion in 2013–14 for the retirement income system consisted of direct payments through the age pension (52%), payments to superannuation funds under the superannuation co-contribution scheme and low income superannuation scheme (2%), and various superannuation tax concessions (46%). Because they are administered through the taxation system, tax expenditures do not require annual appropriation bills. The Henry Review of Australia’s tax system observed that tax expenditures are less transparent and accountable than program measures, they are not subject to routine evaluation and usually there is no ‘sunset’ provision.

It might be expected that tax expenditures should be looked at in the same way as direct spending, in terms of equity, efficiency and effectiveness, simplicity and sustainability.

Source: Treasury.

Equity

Because Australia has a progressive tax system—the marginal rate of tax gets higher as income goes up—most tax expenditures deliver a higher rate of subsidy to the more affluent. Many also require that funds be spent before the claim can be made, which may be difficult for people on low incomes.

The goods and services tax (GST) is levied at a single rate, so on the face of it an exemption should affect everyone equally. However, education, health and financial services are ‘superior’ goods: people spend a greater proportion of their income on them as their income rises. More affluent people, therefore, gain more from the exemption of these services from the GST.

Kerrie Sadiq, in an Australian Tax Forum article, argues that because tax expenditures are often granted as a result of lobbying, and because they are not transparent, they are often seen as unfair.

Efficiency and effectiveness

The outcomes of tax expenditures are difficult to predict, or to measure after the event. Often the data do not exist to make an evaluation. It is hard to know if a tax expenditure has reached a target group. It also cannot be known whether it has changed behaviour—for example, increasing saving for retirement—or has simply been a windfall to people who were going to save anyway.

There is rarely any evaluation of whether a tax expenditure is the best way to achieve an outcome. If the Government’s policy is to increase the amount of educational services people consume, measures targeted to individuals and groups who are seen as under-consuming education might be preferable to a universal GST exemption.

There is simply less scrutiny of tax expenditures.

Simplicity

It is sometimes said that provision of benefits by way of tax expenditures is more efficient because the taxpayer keeps the funds rather than paying them through the tax system and then getting them back as program funds. But in fact tax deductions, rebates and so on make the tax system more complicated.

Richard Krever, in a Sydney Law Review article, argues that tax expenditures invite abuse and restructuring of income to take advantage of them. This in turn stimulates anti-avoidance measures and further gaming of the new rules.

Sustainability

Another issue is that most direct expenditures have a defined budget whereas tax expenditures are open-ended. Superannuation concessions are a particular concern in this regard.

How might things be changed?

In 1996, the Government’s Commission of Audit recommended a comprehensive review of such expenditures, with consideration given to converting those that were useful to outlay programs. No review was undertaken then, but it could be now.

If a full review is not possible, a sunset date could be decided for each category of expenditure, with a review to be undertaken at a specified time.

Alternatively, existing deductions could be converted to rebates, perhaps with maximum allowable claims, so that those on low incomes benefit equally and expenditure is better controlled. For transparency, the Australian Tax Office or Treasury could publish more analysis of statistics that are collected on who benefits and by how much from the major categories of tax expenditure.