evaluation of tax expenditures department of finance ... · evaluation of tax expenditures ....

32
Evaluation of Tax Expenditures Department of Finance Guidelines and Case Study Examples Presentation to TCD MSc in Economic Policy Studies, 11 December 2015 Brendan O’Connor, Economics Division, Department of Finance

Upload: others

Post on 24-Jun-2020

1 views

Category:

Documents


0 download

TRANSCRIPT

Page 1: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Evaluation of Tax Expenditures Department of Finance Guidelines and Case Study Examples Presentation to TCD MSc in Economic Policy Studies, 11 December 2015 Brendan O’Connor, Economics Division, Department of Finance

Page 2: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

1. What are Tax Expenditures?

Economic issues

2. Tax Expenditure Guidelines and approach

Ex ante Ex post Proportionate approach

3. Case Studies (and CBA concepts)

Outline of presentation

Page 3: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Term first coined by Stanley Surrey • Equivalent to direct expenditures, except that spending takes place through the tax system

(Pathways to Tax Reform, 1973)

Definition in Irish legislation draws on OECD definition • Transfer of public resources • Targeted at a narrow group or activity • Reduces tax obligations with respect to a benchmark tax

Impact on the exchequer Typically pro cyclical

Fiscal Illusion - Exclusion of tax expenditures from budget process, Leads to bigger, less

efficient government, and bigger deficits (NBER, 2011) Reducing tax expenditures also offers the possibility to raise net revenues while cutting

marginal tax rates and promoting economic growth - classic tax reform!!

What are tax expenditures?

See Burman and Pharp, NBER WP 17268 (2011)

Page 4: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

What are tax expenditures – use two slides if necessary

Optimal taxation theory – principle of neutrality • Decisions (e.g. consumption, labour supply) should not be influenced by tax • By definition tax expenditures departs from neutrality • Very limited circumstances where optimal to depart from neutrality

– Internalise externality (R&D), incentivise labour supply (Mirrlees Review)

Market failure as motivation for tax expenditures • Imperfection in a market prevents achievement of economic efficiency • Situation where supply and demand do not balance at price that would apply in a

well functioning market • Positive or negative externalities, market power, information asymmetries, public

goods

Economic Issues

Page 5: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Guidelines - Background

“Though evaluation of tax expenditures may be difficult, a more serious problem may be the failure to try”. (OECD, 2010)

Background A tax-equivalent to the Public Spending Code

Builds on evaluations carried out by Department over recent years

E.g. property incentives (2011), Film (2012), R&D (2013)

Reports from Commissions on Taxation International practice in tax expenditure evaluation

Draws on the economic literature

Principles of neutrality Risk of tax capitalisation

Page 6: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Key Evaluation Questions

Ex Ante Evaluations Ex Post Evaluations

1. What objective does the tax expenditure aim to achieve?

1. Is the tax expenditure still relevant?

2. What market failure is being addressed?

2. How much did the tax expenditure cost?

3. Is a tax expenditure the best approach to address the market failure?

3. What was the impact of the tax expenditure?

4. What economic impact is the tax expenditure likely to have?

4. Was it efficient?

5. How much is it expected to cost?

Page 7: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Ex ante – 1. What’s the objective?

Essential for evaluation purposes to have clear statement of what

intervention is intended to achieve • Facilitates analysis of alternatives

Ex ante evaluation should interrogate this

• Clarity of objective • Consistency with Government policy • Does it lend itself to monitoring?

Page 8: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

2. What’s the market failure?

Rationale for intervention via tax expenditure or other intervention hinges on existence of a market failure

Market failure: a situation where, for one reason or other, the market mechanism alone cannot achieve economic efficiency

Examples include • Externalities • Public goods • Imperfect information • Market power

Ex ante evaluation needs to identify the market failure

Page 9: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

3. Is a tax expenditure the best approach?

Once the market failure is identified, the issue is one of identifying the most efficient intervention

Option analysis

Tax expenditure vs. direct subsidy vs. other intervention

Important to take account of existing instruments and how a new tax intervention would interact with these

Page 10: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Tax expenditures Direct subsidies

Cost control

Cost uncertain – depends on taxpayer participation (nature of market led intervention)

Cost capped by expenditure ceiling.

Accessibility for beneficiaries

Simple, due to their automatic (market-led) nature. Can facilitate a greater range of taxpayer choice

More complex, requiring selection/targeting

Effectiveness Make use of market knowledge. Additionality cannot be guaranteed – may finance activity that would have happened anyway

Risk of displacement of private sector.

See Villela, Lemgruber & Jorratt (2010)

Distinction between Tax Expenditures and Direct Expenditures

Page 11: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

4. What economic impact will the tax expenditure have?

Even if we establish that a market failure exists and that a tax expenditure is a better option need to think about whether it will work

Is the design right? Incidence (who benefits?) A key issue in tax expenditure analysis

Need to think about how impact will be evaluated at ex post stage

and collection of data to facilitate this

Page 12: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

5. How much will it cost?

Need to form some estimate of likely cost

Essential if a CBA is required

Most feasible approach likely to involve development of scenarios based on assumptions as to size of target population, take-up etc.

Important to put arrangements in place to collect cost data for later monitoring and evaluation purposes (lessons from R&D review)

Page 13: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Ex post – 1. Is it still relevant?

Is the objective still valid given changes since scheme inception?

Need to think about

• Developments in external environment, sectoral or market conditions • Policy changes, e.g., new programmes, regulations etc.

Analyse what these mean for the tax expenditure

Page 14: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

2. How much did it cost?

Need to establish estimates of outturn costs

For CBA need estimate of “economic cost”

• Incorporate opportunity cost of public funds • Also need to account for legacy and other costs

Page 15: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

3. What economic impact did it have?

Critical issue for ex post evaluation - what difference did the tax expenditure make?

• Did it change behaviour • Did it improve performance • Did it increase economic activity etc.

What is the counterfactual

• Surveys of beneficiaries • Econometric analysis • Randomised control trials

Focus on economic outcomes

Deadweight and displacement effects Shadow prices and opportunity costs

Page 16: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

4. Was it efficient?

Efficiency = value for money

Scheme may be effective and have met its objectives but at what

cost?

Examine unit costs e.g., cost per job created and compare with other interventions including for public expenditure programmes

Leading to consideration of possible alternatives

For costly tax expenditures address through a CBA

Page 17: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Implementing the Guidelines- Proportionate Approach

Estimated Annual Cost

Level Ex Ante Ex Post Time Limit/ Review

Between €1m and €10m

Level 1 Ex ante assessment and identification of criteria for ex post evaluation

Application of ex post criteria

Five years to review

Between €10m and €50m

Level 2 Detailed assessment – scenario based analysis or similar and statement of proposed methods and data requirements for full ex post cost-benefit analysis (CBA)

Full ex post CBA Five years to trigger review

Interim review after three years if annual costs exceed €25m

Greater than €50m

Level 3 Full ex ante CBA and statement of methods and data requirements for full ex post CBA

Use of pilot scheme if possible

Full ex post CBA Interim review after three years

Page 18: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Case Study 1: R&D Tax Credit

Evaluation took place as part of a wider review of the R&D tax credit which was published with Budget 2014

This wider review involved • Public consultation • Survey • Analysis of Revenue data • International Comparison • Econometric evaluation

Econometric evaluation focused on whether the R&D tax credit was effective in stimulating R&D expenditure by firms

Page 19: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

The R&D Tax Credit

BERD/GDP ratio converging on EU-27 • R&D tax credit introduced in 2004

• 25% credit on R&D over 2003 levels

• Payable credit if insufficient tax

liability

• Economic literature points to the role of R&D in driving economic growth and firm productivity

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Ireland EU-27

0.00

0.50

1.00

1.50

2.00

2.50

3.00

Page 20: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Market Failures & Government interventions

Arrow (1962) describes two main market failures – Positive externalities (Spillover Benefits)

• Knowledge non-rival • Partially non-excludable (imperfect patents)

– Asymmetric Information leads to under-financing

Consequence is firms underinvest in R&D relative to the societal optimum level

Role for government in correcting this (Mirrlees, IFS, 2011) But possibility for Government failure

– Deadweight – Supply of researchers inelastic. See Goolsbee (1998)

Page 21: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Methodological Approach and Data

R&D demand equation – user cost of capital approach • Involves estimating the firms’ R&D expenditure over time in

response the R&D credit and changing costs of capital • In other words – did the credit lead to more R&D?

• Methodology used in UK (HMRC) and Australia

Assembled a dataset using Revenue administrative records (on a confidential basis) matched with company accounts filed with the companies registration office (CRO).

To make it into the dataset a firm had to be observed on all the

above variables over the period 2008-2011.

Page 22: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Limitations in estimation and data availability

Of the over 700 firms using the credit in 2008 only 400 were consistently claiming in the 4 years to 2011

Of these 400 firms only 53 had necessary data in all 4 years Time period in question (crisis period) impacted on results

0

200

400

600

800

1000

1200

1400

2007 2008 2009 2010 2011

Period of observation 2008-2011

Page 23: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Learnings

The nature of the R&D activity and the operation of the R&D credit make it very difficult to evaluate

The size of the enterprise base in Ireland makes generating an adequate sample size difficult where missing data exists

Evaluation of tax expenditures should be planned ex-ante to allow for necessary data to be collected

Methodological paper published as IGEES working paper

Page 24: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

24

Section 481 How it operated In existence since 1987

Max of €50m per production

Income tax incentive (€50K per

investor @ marginal rate), Upfront benefit

TV, Film, Documentary, Animation

Reformed to tax credit to company (lower cost)

Case Study 2: The Film Relief 2011: €118m in expenditure, €55m cost

98 108 105

160

118

31 33 44

66

49

0

20

40

60

80

100

120

140

160

180

2007 2008 2009 2010 2011

Total Irish Expenditure

Tax Cost (€,m)

Page 25: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Case Study 2: Film Relief

Income tax relief at marginal rate High yield, low risk for investors Inefficient scheme – cost €41 per

€28 funding gap

€72

Content

€41 €100

€72

Commissioning

Body (Pay €72)

Production

Company

Investors (Pay

100)

Exchequer

(Tax loss of €41)

SPV

(pays

€72)

Page 26: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Main variables Data source Labour Expenditure Revenue Commissioners/Irish Film Board Materials and services expenditure Revenue Commissioners/Irish Film Board Multiplier CSO Tax Receipts (PAYE, USC, PRSI, VAT) Revenue Commissioners Tax Receipts (Schedule D) Dept. of Finance estimates using IBEC data

Social Welfare Savings Indecon (on behalf of IBEC)

Tax Costs Revenue Commissioners

• Assembling the dataset involved getting access to Revenue Commissioner administrative records on a confidential basis.

• Data also supplied by Irish Film Board.

• Some estimates made by Dept. Finance using own analysis and submissions received in consultation round

Data Sources

Page 27: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Public funds are financed through taxation Taxation imposes economic costs that must be recognised in CBA

Value usually greater than one, e.g. SCPF = 1 + α

Estimates for α range from 50%-100% (Honohon, 1996 and 1987), 30% (Forfas, 2003), 50% (DPER), 33% (European Commission, 2013)

Overall value depends on distribution of taxation across types of taxes

Concepts (1) – Shadow cost of public funds

Page 28: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Concept of opportunity cost Not all of wage/employment benefits are ‘additional’

Relationship between employment and unemployment not one for one

Opportunity cost - what would labour earn in absence of project?

Reduce wage benefits by the opportunity cost

Size of opportunity cost depends on occupation or economic sector

Close to 100% for high skilled workers

Generally not less than 80%

Concepts (2) – Shadow price of labour

Page 29: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Deadweight costs How much of scheme benefits would have occurred anyway

Use surveys/interviews, control/treatment groups, econometric analysis

Multiplier effects

Benefits can be increased to account for ‘indirect effects’

But not for ‘induced effects’

Sectoral output multipliers given in CSO supply and use and input-output tables (see Table 12)

Import multipliers available from same source (useful for ‘leakage’)

Concepts (3) – Deadweight and Multipliers

Page 30: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

The Model (from Economic Impact Assessment of Film Relief)

SDW = Scheme deadweight

TDW = Tax deadweight (shadow price of public funds)

v = Shadow wage rate (shadow price of labour)

Benefits

B = [1 – SDW]*[(1 – v)*B1 + (1-v )*B2 + B3] B1 = Direct wage bill + Direct Irish profits (both inclusive of taxes)

B2 = Indirect wage bill + Indirect Irish profits (both inclusive of taxes)

B3 = Tax benefits (after shadow price)

Costs

C = (1 + TDW)*Scheme Cost Scheme cost includes tax foregone, administration costs and compliance costs

Page 31: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

Finally, Sensitivity Tests

Shadow price of labour

100% 80% 60% 50% 40% 30% 20%

Deadweight

10% -€38.2m -€21.1m -€4.2m €4.1m €12.3m €20.5m €28.6m

20% -€41.8m -€26.5m -€11.6m -€4.2m €3.2m €10.4m €17.6m

35% -€47.1m -€34.7m -€22.5m -€16.5m -€10.6m -€4.7m €1.2m

40% -€48.9m -€37.4m -€26.2m -€20.7m -€15.2m -€9.7m -€4.3m

50% -€52.4m -€42.9m -€33.5m -€28.9m -€24.3m -€19.8m -€15.3m

60% -€56.0m -€48.4m -€40.9m -€37.2m -€33.5m -€29.9m -€26.3m

70% -€59.5m -€53.8m -€48.2m -€45.4m -€42.7m -€39.9m -€37.2m

Page 32: Evaluation of Tax Expenditures Department of Finance ... · Evaluation of Tax Expenditures . Department of Finance Guidelines and Case Study Examples . Presentation to TCD MSc in

End of presentation

Thank you References can be accessed via hyperlinks in soft copy of

presentation Any questions??