Tax Expenditures, as the word might indicate, does not relate to the expenditures incurred by the Government in the collection of taxes. Rather it refers to the opportunity cost of taxing at concessional rates, or the opportunity cost of giving exemptions, deductions, rebates, deferrals credits etc. to the tax payers. Tax expenditures indicate how much more revenue could have been collected by the Government if not for such measures. In other words, it shows the extent of indirect subsidy enjoyed by the tax payers in the country.
Tax expenditures or the revenue forgone are sanctioned in the tax laws. A statement of the same, (as far as Federal / Union / Central Government is concerned) is presented to the Parliament at the time of Union Budget by way of a separate budget document titled “Statement of Revenue Foregone”. It lists the revenue impact of tax incentives or tax subsidies that are part of the tax system of the Central Government. This document also estimates the revenue to be foregone during the proposed financial year on the basis of the revenue foregone figures of the previous financial year.
The estimates and projections in the Statement of Revenue Forgone indicate the potential revenue gain that would be realized by removing exemptions, deductions and such similar measures. The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures. As the behaviour of economic agents, overall economic activity or other Government policies could change along with the elimination of such measures, the actual revenue implications could be different to that extent.
The cost of each tax concession is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the revenue foregone calculated by adding up the estimates and projections for each provision.
The assumptions and methodology adopted to estimate the revenue foregone on account of different tax incentives are indicated at the relevant places in the Revenue Forgone Statement.
Tax expenditures or revenue foregone statement was laid before Parliament for the first time during Budget 2006-07 by way of Annex-12 of the Receipts Budget 2006-07. This gave credence to the Government’s intention of bringing about transparency in the matter of tax policy and tax expenditures. The practice has been continuing since then and is submitted as a separate document since 2007-08.
Tax Expenditures is a term globally understood. The term was reportedly first coined by Stanley Surrey (1973) in his paper Pathways to tax reform: The concept of tax expenditures [(pp. 140-54) Cambridge, Massachusetts: Harvard University Press] to highlight the similarity such arrangements have with direct expenditure programmes, with spending conducted through the tax system rather than directly through government expenditure.
OECD in 2010 came out with the Report Tax Expenditures in OECD Countries detailing such expenditures in 10 OECD member countries. It was estimated that such expenditures constitute upto 10% of GDP.
Many countries follow the definition used by OECD in assessing their tax expenditures. For instance, Irish legislation describes a tax expenditure as a transfer of public resources that is achieved by:
a) Reducing tax obligations with respect to a benchmark tax rather than by direct expenditure;
b) Provisions of tax legislation that reduce or postpone revenue for a comparatively narrow population of taxpayers relative to the tax base.