• This research is part of a multi-year, tax- Tax Expenditures: Concept expenditure analysis by TRD. and Framework for Analysis • Goal: To provide in-depth analysis to the Legislature and the Executive. Thomas F. Pogue • Part of TRD's ongoing responsibility to analyze Presented to New Mexico's tax structure to help inform tax New Mexico Tax Research Institute policy decision making. 6 th Annual Tax Policy Conference April 30, 2009 1 2 1
Topics to be discussed: – The tax expenditure concept The Tax Expenditure Concept – Estimating tax expenditures – Evaluating tax expenditures – Comparison with other policy instruments 3 4 2
• Tax expenditures • Tax expenditures (TE) arise when governments pursue objectives by altering • are the result of tax preferences – lower tax codes rather than with other policy taxes – for taxpayers who meet specified instruments such as direct spending, criteria. regulation, loans, and grants. • These may be exclusions, exemptions, deductions, credits or special rates • essentially spend revenues that the tax system would otherwise generate. 5 6 3
• Examples of NM tax expenditures: • Tax expenditures fall into two categories: – Medical services deductions from GRT – Incentives for businesses or individuals to – Tax holiday sales deductible from GRT engage in specified activities – Solar market development credit • attending college, entering work force, saving for – Land conservation incentives credit retirement, purchasing health insurance, producing – Rural jobs tax credit specified products, investing in specified technologies. – Research and development small business tax credit – Affordable housing tax credit – Etc., etc., etc. – funding for taxpayers with specified characteristics • elderly, blind, military veterans, low-income workers, owners of small or new businesses. 7 8 4
• Tax expenditures are defined and • Baseline taxes should be consistent with measured with reference to baseline standard tax principles: taxes. – Fair – Baseline taxes define the revenue raising (or – Economically neutral purely tax) part of the tax code. – Transparent – Tax expenditures are deviations from the – Low costs of administration, compliance, and baseline tax system enforcement. 9 10 5
• Baseline definitions differ across taxes: • But application of these principles typically – Income tax: all real income from all sources does not yield a unique baseline for a tax. • Adjust for ability to pay, e.g. standard income tax deductions • Tradeoffs are required because the • Adjust for costs of administration, e.g. tax capital gains on realized instead of accrual basis principles conflict with one another. • Integrate corporation and personal income taxes? • E.g. Tax that minimizes compliance and – Gross receipts or retail sales tax: final sales of administration costs may not be fair all goods and services. • Adjust for costs of administration, e.g. no – Example: lump sum tax compensating tax on small dollar imports 11 12 6
• Exclusions from a baseline for • Baseline definitions differ across taxes: – ability to pay • e.g. standard deductions – Property tax: current market value of all real – high administrative compliance costs property, regardless of how used or where • e.g. accrued but unrealized capital gains located. are not tax expenditures, i.e. Do not reflect – Highway user tax: measures of or proxies for decisions to use the tax system to pursue highway wear and damages, congestion, and specific objectives. environmental damages. 13 14 7
• A tax expenditures budget (TEB) is a set of estimates of tax expenditures. • Why prepare/publish a TEB? – TE support specific activities just as do direct Estimating Tax Expenditures expenditures – a TEB shows revenue allocated to support specified activities – a TEB aids decision making about taxes and spending 15 16 8
• TE estimates cannot be aggregated because TE depend on the existence and use of other preferences • E.g. taxpayers itemize deductions only if the total of all itemized deductions exceeds their standard deductions. Evaluating Tax Expenditures – Eliminating any deduction, e.g. state & local taxes, reduces the number of taxpayers who itemize. – With fewer taxpayers itemizing deductions, TE due to other deductions, e.g. mortgage interest, shrink. – And the revenue gain from eliminating deduction of state-local taxes will exceed the TE attributed to that deduction. 17 18 9
• Direct changes triggered by a TE take two • To evaluate a TE, we must determine forms: – how it changes resource allocation and – changes made in response to a TE income distribution, and • For example, health insurance purchased because – whether the changes are an improvement of an income tax credit • Ideally, evaluation should determine whether the – changes that necessarily follow from the TE has brought about the best possible revenue loss due to the TE: outcomes. • other tax revenues increase • borrowing increases • and spending decreases. 19 20 10
• Evaluation criteria can be stated as two • These direct changes generate further questions: indirect changes that – First, when a TE increases production of a commodity – affect economic choices other than those or service, targeted by the TE is the additional production more valuable – are especially difficult to trace and to take into than the private-sector and/or government production that is necessarily forgone? account. – Second, when a TE changes the distribution of • As a practical matter, evaluations of TE tend to income, is the change fair or otherwise appropriate? focus on the direct changes they precipitate . 21 22 11
• Evaluating TE requires difficult-to-obtain • The first condition requires that the TE increase the total value of production and difficult to interpret data: – Just increasing the level of some activity, e.g. solar – The criteria for evaluating TE are at once energy production, is not sufficient. simple in concept and difficult to apply. Example: if a tax credit for solar energy production is offset by – decreases in other government activities, does the • TE should also be compared to other value of any increase in solar energy production policy instruments to determine which is exceed the value of forgone government activities? – increases in other taxes, does the value of any more effective in achieving objectives. increase in solar energy production exceed the value of private-sector production necessarily lost because of those tax increases? • If neither condition is met, the credit reduces the total value of production and makes the state worse off. 23 24 12
Advantages of tax expenditures • Tax systems can link government with virtually all economic agents: Comparison with Other – TE utilize these built-in links – TE greatest comparative advantage is in Policy Instruments implementing policies • to transfer income to individuals and businesses • or to influence and subsidize their choices. 25 26 13
Advantages of tax expenditures Disadvantages of tax expenditures • TE are better for changing private behavior • Unless a TE has an expiration date, it continues indefinitely – until action is taken to repeal it. • TE respond more readily to changing activity levels and economic conditions • Tax expenditures do not receive the • TE decentralize decision making oversight and fine tuning that direct – Taxpayers decide whether and how much to respond spending programs often receive. to the preference. – This decentralization may provide managerial or informational advantages. 27 28 14
Disadvantages of tax expenditures Disadvantages of tax expenditures • Except for estimates of revenue loss, data • TE are not well suited to providing public and reports on overall effects of TE are goods, such as such national defense and not routinely available. a judicial system, that cannot be produced by action of individuals and businesses. • TE may not allow as much discretion and flexibility as a spending program. • TE add to the complexity of the tax system, raise admin. & compliance costs – Writing such detailed targeting into the tax code would greatly complicate it. 29 30 15
• Tax expenditure budgets can be useful, but preparing and using such reports requires understanding the TE concept. • TE should be evaluated by the same criteria as direct spending, do they Conclusions – lead to a more equitable distribution of income? – shift production from less valuable to more valuable products? – increase the real incomes of the state’s residents? 31 32 16
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