Recent years have seen an increase in the number of low- and middle-income countries reporting on revenue foregone from tax expenditure (e.g., tax exemptions, rate reliefs, deductions, credits and deferrals). The process of compiling a tax expenditure (TE) report creates both challenges and learning opportunities. Through the TaxDev programme, the ODI has supported this process in Rwanda and Uganda. Both countries have made progress in publishing TE reports in recent years. In our latest Working Paper, we identify eight lessons from these experiences that may help countries undertaking the same exercise.
Lesson 1: A key first step is to define a Benchmark Tax System
One of the trickiest, but most important, parts of TE reporting is to identify which measures in the tax system constitute a TE. Typically, this involves first defining the ‘benchmark tax system’, against which the estimated value of revenue foregone from any deviations is estimated. Almost all countries do this according to a ‘legal approach’, which involves examining relevant tax legislation and agreeing on the ‘standard’ features of each tax (i.e., the taxable unit, the tax base, the tax rate and the time period). Any provisions that alter those features for a particular group of taxpayers, activity or time period are subsequently identified as tax expenditures.
Lesson 2: ‘Grey areas’ can be resolved using agreed principles and criteria
This approach may sound simple, but in practice there are numerous cases where it is insufficient to define TEs. For example, provisions enshrined in international law (e.g., the Chicago Convention or Florence Agreement) are typically treated as part of the benchmark, as are reliefs used for administrative efficacy (e.g., businesses falling under VAT registration thresholds or hard-to-tax activities). Other ‘grey areas’ related to domestic policy choices or preferences can cause subjectivity to creep into the assessments. For consistency and transparency, categorising reliefs under common criteria or principles can help inform decisions about what to include in the benchmark.
Lesson 3: No matter how TEs are defined, local ownership is key
While there may be good reasons for including some provisions in the benchmark (and thus not estimating revenue foregone), a narrower definition of TE undermines transparency and precludes evaluation of the reliefs in question. Nonetheless, the process of discussing each provision and taking decisions collectively is important for establishing government-led ownership of the process. In some countries (e.g., the UK), these ambiguities are resolved by distinguishing between ‘structural’ and ‘non-structural’ reliefs, all of which are estimable, but with different expectations about their purpose.
Lesson 4: Data availability and quality determines the robustness of estimates, especially at a ‘provision’ level
Estimating revenue foregone from TEs can bring many challenges. In both Rwanda and Uganda, each started with a more limited set of estimates based on what was feasible within data and resource constraints. Technical assistance was provided by TaxDev. Estimates at the ‘provision’ level are most useful.
Lesson 5: Revenue foregone models can be tailored to suit available data and capability
For estimating revenue foregone under personal or corporate income tax, value-added-tax (VAT) or customs duty, the most useful data come from tax returns and customs declarations. However, not all countries have adopted e-filing, making it challenging to use taxpayer data for any meaningful analysis. In the case of VAT, taxpayer declarations (if available) can be combined with information from supply-and-use tables and household surveys to provide a deeper and more detailed model of the revenue foregone at each stage of the supply chain.
Lesson 6: A sustainable reporting process starts simply and improves incrementally as capacity develops
If data for some provisions are not available, or resources for undertaking analysis are inadequate, it can be better to start simply and build in complexity and additional data as the process of TE reporting evolves. While detailed and rigorous estimates would be ideal, a simpler, partial report still represents an important step forward.
Lesson 7: How estimates are presented matters
How the government communicates TEs to the public can affect perceptions. Media reports in Uganda following an early publication of TEs focused on cost and waste. Presenting aggregated revenue foregone estimates in this way focuses readers’ attention on costs rather than the TEs’ intended purposes and beneficiaries. Unclear presentation and lack of stakeholder engagement can lead to common misconceptions: for example, equating tax expenditure with tax exemptions; suggesting that revenue foregone translates 1:1 to revenue gain if a provision were to be removed; or assuming all TEs represent wasteful leakages.
Lesson 8: Publishing a TE report may spark demand for further evaluation
TE reporting represents a shift towards better transparency of public funds. Yet it says little about whether provisions meet their objectives, provide overall net benefits to society, or are the most cost-effective instrument to support policy objectives. Publishing a TE report can provide an important foundation from which governments can further scrutinise and rationalise tax expenditures, particularly where large costs are identified and/or there is an unclear or weak rationale. In both Rwanda and Uganda, the process of evaluating selected TEs has already begun.
A longer version of this blog was originally published by ODI as part of its work with The Centre for Tax Analysis in Developing Countries (TAXDEV).