Tax Expenditures Deserve Far More Scrutiny

Last month, the UK government presented its Spending Review, setting out departmental budgets for the next four years. There were protections for some departments and large cuts (though smaller than expected) for others. Coming after years of previous cuts, many departmental budgets by 2019 will be only half what they were in 2009. Opinions will differ as to the necessity of these cuts but what is undeniable is that there has been a great deal of scrutiny of most public spending. As is the case in many countries, however, the discipline that is applied to public spending is notably absent for spending’s ugly sibling – tax expenditures.

The process of the Spending Review was significant. Departments were originally asked to describe how they would cut 25 or even 40 per cent from their budgets, if required to do so. Ministers and civil servants agonised over what programs they could most afford to lose. Consultants were brought in to identify what excess fat might be trimmed. Staff, service users and other stakeholders lobbied for their corners and held their breath. Then the departments had to make their case to the Treasury, going back and forth about what damage spending cuts would really cause. Ministers who settled early even got to join in the ‘star chamber’ to interrogate ministers from straggling departments.

Finally, departmental budgets were set based on tight fiscal goals and detailed projections for overall spending, as part of a plan that included delivering an overall budget surplus and cutting £12 billion from welfare spending. Departmental budgets are now largely fixed for the next four years in cash terms. What’s more, programs will of course continue to be assessed, with costs monitored closely by departments, parliamentary committees, the National Audit Office and others.

This description necessarily glosses over much of the politics and happenstance that so easily influence these choices, but nonetheless it seems fair to say that great effort has been made to cut back the least effective public spending in the UK and to tightly control departmental spending. The same cannot be said of tax expenditures (which are well introduced in an earlier CEP blog by Agustin Redonda).

Tax reliefs intended “to promote economic and social objectives” cost over £100 billion in lost revenue last year – similar in size to the UK’s health budget or total budget deficit. This includes a wide range of programs, such as those designed to encourage innovation, to help lower income families or to encourage pension saving. These are all worthy goals but this does not set them fundamentally apart from spending programs. The figure excludes the many tax breaks for which there is no official estimate of cost.

This is not to say that tax expenditures don’t have benefits and in many cases they will be good value for money and the best policy instrument to use. But, crucially, none of this loss of revenue had to be defended in the Spending Review or elsewhere. Once tax reliefs are in place – and they are usually announced by the Treasury after little if any consultation – they tend to remain in place indefinitely. Costs may rise significantly and unexpectedly but this will be uncontrolled, if even noticed or recorded at all. And the outcomes from tax expenditure will almost certainly not be tracked and no attention paid to who gains. Worst of all, where parliamentary bodies have turned their gaze on the value-for-money and processes surrounding tax reliefs, the Treasury has shot them down for intruding on its turf.

Clearly there is a world of difference between the scrutiny of expenditure and that of tax expenditure. It might be argued that tax breaks are fundamentally different from spending, but the impact on the deficit and on the distribution of incomes are equal, and either may be used to reach the same public policy goals. In the UK we have strict controls on departmental spending, a new cap on welfare spending – accompanied by substantial cuts, new fiscal rules and an independent Office for Budget Responsibility. It’s time for similar institutional change for tax expenditures.

There are many options. The government could start by setting out what each tax expenditure is intended to achieve, as well as projections for their costs. It also needs to better track those costs as well as the distributional impact of reliefs and where they might be being abused for tax avoidance. A harder job is assessing how tax expenditures perform against their intended outcomes, but this is nothing more than is asked (if still too infrequently) of spending programs.

These are all things that the Treasury and Her Majesty’s Revenue and Customs could incrementally improve. But they could be aided by institutional reform. New powers could be given to bodies like the National Audit Office, Office for Tax Simplification and Office for Budget Responsibility to review both new and existing tax reliefs. The secretive and closed process of Budgets and their accompanying legislation could be opened up, parliament given a chance to debate tax expenditure each year, and a new parliamentary committee for tax policy created. New reliefs could also come with ‘sunset clauses’ which would require review, consultation and an active decision before being extended beyond an initial period; and all reliefs thoroughly reviewed on a rolling basis.

Much can be learned from other countries. Canada, Australia and New Zealand, for example, produce annual Tax Expenditure Statements. And Canada’s new Liberal government intends to conduct a review of all tax expenditures, with a special emphasis on those that are particularly regressive. In many countries departments other than the finance ministry have much more involvement in tax expenditures, which makes the trade-offs between these and other spending more apparent.

The UK would do well to follow some of these approaches. There is great potential to improve governance through improved scrutiny of tax expenditures, and therefore to deliver better outcomes.