The centre for tax analysis in developing countries

Overseas Development Institue Institue for Fiscal Studies

In recent years, an increasing number of low- and middle-income countries have started reporting on the amount of revenue foregone from tax expenditure (TE), which includes tax exemptions, rate reliefs, deductions, credits or deferrals. However, the process of compiling a TE report presents both challenges and learning opportunities. Through the TaxDev programme, we have supported this process in Rwanda and Uganda, and have seen both countries make great strides in publishing TE reports. In our latest working paper, we identify eight lessons from TE reporting in Rwanda and Uganda that may help other countries undertake this exercise.

Lesson #1: adopting and publishing a definition of TE is a key first step

Arguably one of the trickiest – but most important – aspects of TE reporting begins before the report can be drafted; namely, identifying which measures in the tax system constitute a TE. These are typically found by first agreeing on a definition of the ‘benchmark tax system’, against which the estimated value of revenue foregone from any deviations (TEs) is estimated. Almost all countries do this according to a ‘legal approach’. This involves looking at the tax laws and deciding what the standard features of each tax are, thus defining to whom, on what and how they are applied (the standard taxable unit, tax base, rate and period). From that baseline (or benchmark) it should then be possible to identify any provisions that alter those key features for a particular taxpayer group, activity or time period. Taking a legal approach, these alterations (or deviations) from the norm are then identified as TEs.

Lesson #2: applying principles and criteria helps resolve ‘grey areas’

The legal approach outlined above may sound simple, but in practice there are several cases where this approach is not helpful (or at least not sufficient) to define TEs. These include provisions enshrined in international law (e.g. the Chicago Convention or the Florence Agreement) which are typically treated as part of the benchmark, and reliefs used for administrative efficacy (e.g. businesses falling under VAT registration thresholds, or hard-to-tax activities). These grey areas can sometimes cause subjectivity to creep into the process. For consistency and transparency, organising these under common criteria or principles can help inform decisions on what is or is not included in the benchmark. Documenting and publishing these criteria allows for scrutiny, challenge and re-evaluation over time (e.g. the additions included in Uganda’s latest report).

Lesson #3: while a broader TE definition is more transparent, local ownership is key – no matter how the benchmark is defined

If a provision is included in the benchmark, it is not a TE and therefore revenue foregone is not estimated. While there may be good reasons for this, a definition that is too narrow undermines transparency and can preclude any monitoring or evaluation of the reliefs in question. Nonetheless, the process of debating each grey area and taking decisions collectively is important for establishing government-led ownership of the TE report. In some countries (e.g. the UK), many of these ambiguities are resolved by drawing a distinction between ‘structural’ and ‘non-structural’ reliefs, all of which can still be estimated, but with different expectations about their purpose.

Lesson #4: data availability and quality determines the robustness of estimates, especially at ‘provision’ level

The estimation of revenue foregone from TEs is far from straightforward. Both Rwanda and Uganda started with a more limited set of estimates based on what was achievable within data and resource constraints, while TaxDev collaborated through technical assistance. Ideally, with time, prioritising estimation at the ‘provision’ level is most useful – that is, for every TE identified by tax type, recipient, goods type or activity. Depending on the availability of data, models and expertise, different approaches might be followed to achieve this.

Lesson #5: revenue foregone models can be tailored or simplified to suit available data and capability

For estimating revenue foregone under personal or corporate income tax, the most useful data comes from individual and business income tax returns. However, not all countries have yet adopted electronic filing, or they may not have a process for exempt businesses to file tax returns, making it difficult to use taxpayer data for any meaningful analysis. Under 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. Nevertheless, this requires reasonably complex micro-simulation models that might not be feasible to design or operate.

Lesson #6: a sustainable reporting process starts simply and makes incremental improvements as capacity develops

Since data for some provisions may not be available, or the resources and capabilities for undertaking the analysis are inadequate, it can often be better to start simply before building in complexity and additional data as the process of TE reporting evolves. In recent years (in Rwanda, for example), TE reports have gradually incorporated new estimates as more evidence has become available. While detailed, rigorous estimates would be ideal, a simpler, partial report is still an important step forward.

Lesson #7: the presentation of the estimates matters

The manner in which government communicates with the public about TEs can also affect perceptions. Media reports in Uganda following the early publication of TEs focused on cost and waste. Presenting aggregated revenue foregone estimates in this way focuses the reader’s attention on the cost rather than the intended purpose and beneficiaries – as opposed to the way public spending is presented in, say, the national budget. Unclear presentation and a lack of stakeholder engagement can lead to common misconceptions: for example, equating TE with tax exemptions; suggesting that revenue foregone translates 1:1 to revenue gain if the provision were removed; or assuming that all TEs represent wasteful leakages.

How TEs are presented and communicated differs across countries. The content and level of detail sometimes reflects the underlying motivation for producing a report, which could range from fulfilling a donor condition to meeting a legal requirement for parliamentary scrutiny. Nonetheless, consensus around the content of TE reports is emerging, indicating which aspects of TE reporting are most useful for public expenditure transparency. These key components include a detailed break-down of the estimated revenue foregone (e.g. by recipient, activity and tax type), the legal basis and objective of each TE, and an account of choices made regarding the benchmark system definition.

Lesson #8: using the report to drive better TE governance may spark demand for further evaluation of net benefits

TE reporting forms a key stage in achieving improved transparency of public funds. However, it still presents only one side of the coin. It says little to nothing of whether the provisions meet their objectives, provide net benefits to the economy and society as a whole, or are the most cost-effective instrument to support policy objectives. Nonetheless, the publication of a TE report can provide an important foundation from which to further scrutinise and rationalise TEs, particularly where large costs and/or an unclear or weak rationale are identified. In both Rwanda and Uganda, the process of evaluating selected TEs has already begun, and as more countries move towards publishing estimates of revenue foregone, there is likely to be increased demand for this kind of work from interested stakeholders. Ultimately, TEs are an integral part of global tax systems, but there are certainly instances where they are wasteful or poorly targeted. Cost-benefit analyses can shed light on these cases and hopefully drive better TE governance in the future.

This blog was originally published by ODI, and is reproduced here with kind permission.

Published on: 15th November 2022

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