Doctoral dissertation: Tax expenditures as government’s policy tool and economic instrument
A systematic evaluation of tax expenditures has not been accomplished in Finland.
Kuva: Wojtek Gurak (rajattu)
In addition to taking charge of financing the public sector, there are other goals that have been set to taxation. To achieve these targets, certain policy tools and economic instruments are employed: deductions, refunds, exemptions, reduced tax rates and tax deferrals. These kinds of tax reliefs are called tax expenditures. They are deviations of the normal national tax system and are used to subsidy a chosen target group.
Tax expenditures are public spending and in this sense they are fully comparable to direct budget expenditures and income transfers. The use of tax expenditures reduces tax returns, which has to be compensated by cutting public spending on increasing public debt.
According to economic theory a public subsidy may improve the effectiveness of the economy only if it corrects market failure or market deficiency. The theory has however seldom played a central role in establishing tax expenditure provisions.
The goals of this doctoral thesis are to improve common understanding of the economic and judicial relevance of tax expenditures as well as providing answer to the question: what are the characteristics of a good tax expenditure analysis?
The object of the tax expenditure analysis – that is to say, calculating, reporting and evaluating tax expenditures – is to secure the transparency and responsibility of government’s policy programs that are financed by tax expenditures. In this way it is also possible to prevent efforts to finance projects by means of tax expenditures which have not been able to pass the government budget process. Evaluation enables eliminating outdated, ineffective and poorly efficient tax expenditures and at the same time those tax expenditures that fulfill the principles of good subsidy will be identified.
In principle the evaluation process is straightforward because only basic economic questions are presented: Is the tax expenditure justified? Is it relevant? Is it well designed? Is it efficient and effective? The core of the evaluation is to measure the total benefit which is achieved on the expense of all taxpayers. Even the common interest has to be accounted for. The financial gain of the recipient is by no means a sufficient justification for the tax expenditure. A carefully designed evaluation frame is an excellent help in the evaluation process. It works as roadmap for every individual tax expenditure. The essential questions of the evaluation frame deal with effectiveness, efficiency, social justice, market failure, economic growth and strengthening entrepreneurship.
It is even possible to cut down tax expenditures with maximum limits, connecting nearby tax expenditures and substituting tax expenditures for direct expenditures.
In Finland, the number of tax expenditures has not decreased in recent years. The broadening of tax base by eliminating tax expenditures seems to be difficult. One explanation is that in the eyes of politicians tax expenditures are a tempting way to fulfill promises made before elections. Another may be the fact that a systematic evaluation of tax expenditures has not been accomplished in Finland. Because of this researchers and politicians do not have a complete picture of effectiveness and efficiency of tax expenditures. An evaluation process should be part of government program and a commitment should be made to put into practice the recommendations of the evaluation – or at least the most important ones.
At the moment tax expenditures are in a kind of turning point. Many countries have faced budget problems due to ageing population and the international economic situation. The downtrend and growing unemployment have increased public debt. In this connection governments have wanted to cut and even avoid ineffective policies, some of which are financed by tax expenditures. Simultaneously some countries have, however, launched recovery policies and business subsidies.
Another revision is that The Commission and the Court of Justice of the European Communities have clarified and tightened the interpretation regarding state aid. Because of this, EU treaties and state aid rules now instruct more clearly on taxation and the tax expenditures of member states. The changed practice has definitely restricted the member states’ sovereignty in tax issues.
Nevertheless it is worth remembering that compared to single tax expenditure, a good tax system always has better possibilities to accomplish social goals and policies. That is the reason why economic policy should concentrate on generating such circumstances which promote broad-based economic growth – not the subsidy systems. Accordingly, the strong and unanimous message of tax research literature is that the goal of finance policy should be to have as broad a tax base as possible and low tax rates.
The doctoral dissertation of LicScEcon, MAPolSc Timo Rauhanen, entitled Verotuet valtion politiikkavälineenä ja ohjauskeinona will be examined at the University of Eastern Finland, Faculty of Social Sciences and Business Studies, on May 26. The Opponents in the public examination will be Professor, Docent Reino Hjerppe of University of Helsinki and Professor Juha Lindgren of University of Vaasa. The Custos will be Professor Matti Turtiainen of University of Eastern Finland. The public examination will be held in Finnish.