Tax Expenditures. The Big Black Box

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This article was first published by the Handelszeitung. Read the full op-ed (in German) here.

According to the federal financial statements 2016, tax expenditures in Switzerland reduced government revenues by 21 to 25 billion Swiss francs. This amounts to 31 to 37 percent of the country’s federal income. The exact figure is not available. Nonetheless, one thing is clear: a lot of money is at stake.

All the more alarming is the dismal lack of transparency. The last comprehensive federal report on tax expenditures dates back to 2011. It identifies more than 100 exceptions from tax rules in the form of deductions, exemptions, reduced rates, and other measures. For a third of the expenditures it provides an estimate of the resulting revenue foregone. The federal government loses out on e.g. 1.3 billion francs due to deductions for life insurances, 900 million due to commuting costs and external meals, and 830 million for the deduction of contributions to voluntary pension savings.

The fragmentary estimates are based to a significant extent on 2005 figures from the canton of Bern, extrapolated to Switzerland. For the remaining cantons, federal authorities largely lack the data. A few numbers have been added since the publication in 2011, including tax reductions of 1.6 billion francs in the context of regional policy, as well as exemptions from the petroleum tax amounting to 1.5 billion francs.

Swiss Law prescribes a critical position on tax expenditures

Whether a political objective is pursued through spending or tax expenditures has no impact on the balance of the government budget. The fact that, nonetheless, spending is subject to intense annual debates, while there are neither current nor comprehensive figures on tax expenditures, that would allow for a debate, is distressing – even more so as Swiss law prescribes a critical position on these provisions. According to the subsidies law, tax expenditures should be avoided. The federal tax administration highlights that this principle is not being adhered to, and defines tax expenditures as “hidden subsidies, that are largely withdrawn from parliamentary budget control”.

Other countries have much more robust data. The USA publishes two annual reports on tax expenditures on the federal level – one by Congress and one by the Treasury. The most recent one provides figures for 2016, as well as an annual outlook until 2020, an analysis of the distribution of the 1.4 trillion US$ in tax expenditures between firms and natural persons, as well as the distribution of specific tax expenditures along different income groups. Australia, France, Ireland, Canada, Mexico and New Zealand also report annually, Germany every two years.

Tax expenditures are frequently neither efficient nor effective

A periodic evaluation of tax expenditures is critical. As with direct spending, it is important to review which goals are pursued with which tax expenditures, how effective and efficient they are in contributing to reaching these goals, and which side effects they have. Tax expenditures can be advantageous, inter alia, where they result in lower administrative costs compared to spending measures. At the same time, they often bring along windfall gains, frequently benefit higher incomes more than lower ones, increase the complexity of the tax system and raise the tax burden on the remaining tax base. In addition, detailed international studies highlight that they are often neither effective nor efficient with regard to their stated goals.

Switzerland must shine light into this black box. The subsidies law requires a review of all financial support measures every six years. The next report by the tax administration is thus on the agenda this year. It would offer an opportunity to reduce the gap to international transparency standards on tax expenditures, to evaluate them and to lay the foundation for a tax policy debate that accounts for their significant role in tax policy.