Tax expenditures

Dr Anne Holmes, Economics

Key issue
Tax expenditures are concessions—like concessional tax rates and tax exemptions—that apply to particular activities or classes of taxpayer—so that those involved pay less tax than they would normally.
They have the same effect on the budget as expenditure but tend to be not as easily controlled. They do not appear in the budget papers but are reported by the Treasury in the annual tax expenditures statement.
Examples that have recently attracted attention include GST exemptions for food and some superannuation tax concessions.

Some background

Tax expenditures arise when the ‘normal’ tax liability is reduced in order to encourage a particular behaviour or to assist a particular group. Tax exemptions, tax deductions, tax offsets, concessional tax rates and deferrals of tax liability are examples.

Specific examples include the capital gains discount for assets held longer than 12 months, the capital gains tax exemption for the main residence, the several exemptions from GST (for example, for food, water, education) and the deductibility of gifts to certain charities.

It is sometimes difficult to identify tax expenditures. For example, the private health insurance rebate is classified as a program expense. However, non-taxation of the private health insurance rebate (which is a form of income) gives rise to a tax expenditure estimated at $1.5 billion a year.

Another example is negative gearing. This displays some characteristics of tax expenditure but it is not treated as one. This is because it is considered by Treasury to be a normal application of the principle that expenses incurred in earning assessable income are deductible.

It is difficult to measure tax expenditures. Usually they are expressed as a cost to revenue, compared with the ‘normal’ tax treatment. But this does not mean that their removal would generate a corresponding increase in revenue. That is because tax expenditures are often intended to change behaviour. With their removal, there would be another corresponding change in behaviour. For example, if the private health insurance rebate were taxable it may lead to fewer people taking out private health insurance which would in turn reduce the rebate.

There is also debate about how to define the benchmark for ‘normal’ tax treatment. For example, estimates of the tax forgone from not taxing capital gains on the family home would be irrelevant if that policy were treated as ‘normal’ rather than a concession.

Treasury Tax expenditures statement

The Treasury publishes an annual Tax expenditures statement. For 2015, it notes that 140 out of 290 tax expenditures are unquantifiable. This year’s statement does not publish a total figure, but in previous years Treasury estimated that the value of total measured tax expenditures was 7.5 per cent of GDP. By comparison, total Commonwealth revenues recorded in Budget Paper No.1 for 2015–16 were 23.5 per cent of GDP.

The case of superannuation

In the last couple of years some policy makers, academics, think tanks and media commentators have called for concessions to superannuation to be wound back.

Amongst the reasons given, advocates for reform say that the concessions are inequitable, as they are worth more to those on higher marginal tax rates. Further, they are a significant imposition on the Budget and difficult to control as their magnitude depends on decisions made by individual tax payers. And it is claimed that they are not meeting their policy objectives, like increasing savings and taking pressure off the age pension.

The tax expenditure statements show superannuation tax expenditures are among the biggest. Although well behind the capital gains tax concessions for the main residence, at $54 billion, they total about $30 billion.

Tax expenditures and programs

Tax expenditures are less transparent than program spending. They do not require annual appropriation, and are not reported in portfolio budget statements. Their target groups are often less clearly defined, and the government has less control over the cost. They are generally not established with a ‘sunset’ date, and are not regularly reviewed.

Growth in some tax expenditures

The quantum and rate of growth of tax expenditures tends not to attract the same attention in the media as do expenditures.

For instance, there has been debate in recent years about the sustainability of Medicare which is projected to increase by 14.4 per cent to $25.1 billion over the forward estimates. In contrast, the cost of three major health tax expenditures is projected to increase by 21.6 per cent to $8.3 billion over the same period. These expenditures are the exemption from income tax of the private health insurance rebate, the exemption from GST of medical and health services and the low income medicare levy exemption.

What might be done?

Because tax expenditures are targeted to particular groups or activities, attempts to end them often meet resistance. Some actions that could be taken to improve their performance might be to:

where possible, convert tax expenditures to payments
convert all deductions (for example, gifts to charities) to flat-rate rebates, so the benefit is not greater for those on higher incomes
cap the amount any individual can claim in tax expenditures at a proportion of total income or a dollar amount
introduce a schedule of reviews or sunset dates for large items
publish information about who benefits from each tax expenditure.