Reforming VAT Concessions: A Tax Expenditure Analysis

Although VAT concessions have long been viewed as sources of revenue loss, economic distortions and increased compliance and administrative costs, they have proved stubbornly resistant to removal or modification. This article suggests a new mode of analysis that could be used as a reform tool. It first applies tax expenditure analysis to VAT concessions, recognising the cost of these concessions not as “lost revenue”, but rather as notionally received and then applied revenue. Under tax expenditure analysis, concessions are treated as the equivalent of, and a substitute for, direct spending programmes. Intended to achieve a variety of equity, social and economic outcomes, VAT concessions in practice more often than not operate as unfair and inefficient spending programmes, generating significant legal and economic distortions in the tax system. The article then shows how the measurement of the cost of concessions as a proportion of potential VAT revenue can better reveal their budget impact. Ideally, VAT concessions should be replaced with fairer and more efficiently targeted alternative instruments. Improved policy and legislative design techniques can be used to target concessions more effectively where their removal is politically unattainable.