There has been a great deal of debate about tax expenditures as a form of public subsidy in recent years. In practice, tax expenditures mean tax exemptions, tax deductions, lower tax rates and other similar instruments aimed at supporting specific business categories or taxpayer groups.
Finland’s benchmark tax system (basic taxation structure) was last updated in 2009. Only exception is energy taxation, which was updated separately in 2011, as part of an energy taxation reform. The tax legislation also includes tax expenditures, which deviate from the benchmark tax system. There are currently more than 180 different tax expenditures in Finland, and they are estimated at EUR 28.5 billion in 2019.
There is no universally applicable definition of a tax expenditure
Each country defines the scope of its own benchmark tax system. The definition can be made in many different ways. It requires choices that cannot be explicitly justified in one way or another. There are no clear rules of what should be included in the benchmark tax system.
Theoretical frameworks, the existing tax system or their combination can be used a basis for the definitions. In taxation, the proportion of taxpayers to which a legal provision applies can be used as a criterion of its general applicability. The higher the proportion of taxpayers covered by a tax law, the more likely is the provision part of the benchmark system. In some countries, the age of a legal provision has also been considered as a criterion of a benchmark.
A number of countries consider different tax rates as tax expenditures, while in others, they are part of the benchmark tax system. There are countries where different VAT rates are included in the benchmark tax system, whereas in Finland lower tax rates are always considered as tax expenditures. In Finland, earned income deduction is a tax expenditure, whereas in some other countries it is part of the benchmark tax system. Differences between benchmark tax systems make comparisons between country-specific tax expenditures difficult or even impossible. There are also differences between the definitions made in Finland, depending on the year in which they have been produced.
When we are considering the costs of tax expenditures, we should also take into account what they are all about. Only by doing this, can we correctly interpret the number and scope of tax expenditures. Finnish tax expenditures also include provisions that benefit taxpayers and that are not explicitly intended as subsidies. However, tax laws that only differ from the benchmark tax system because of administrative or taxation-technical reasons, are not considered tax expenditures.
Tax exemption of imputed rent is one of most important tax expenditures currently in effect. It is considered a tax expenditure because a dwelling is deemed to generate ‘housing services’ for its owner and these services are comparable with the income from other investments. The income from other investments is taxed and for this reason, the tax exemption of imputed rent is considered a tax expenditure. At the same time, tax-exempt compensations for expenses paid to employees are not considered tax expenditures even though the proportion of the compensation exceeding the actual expenses is considered as tax-exempt income. They are included in the benchmark tax system for reasons of administrative simplicity because in practice it is difficult to estimate the costs actually incurred by each taxpayer.
Updating of the benchmark tax system may change the number of tax expenditures
When defining the benchmark tax system, we must think about the tax system as a whole. When doing that, we have to consider the objectives of taxation in each tax type. We have to analyse what is taxed and why and why are some income categories tax exempt. This also provides an opportunity to review the tax rates contained in the system and find out why they have been introduced.
Updating of the benchmark tax system may also have an impact on the number of tax expenditures even if no changes were made to the legal provisions themselves. For example, when the benchmark tax system was last reviewed in 2009, the number of tax expenditures changed as the definition changed. In other words, even though no new tax expenditures were introduced, their number increased because some of the tax provisions not previously considered as tax expenditures were now interpreted as such. Under the 1998 definition, replacement reserve, credit loss reserve and guarantee reserve were part of the benchmark tax system, whereas they are now considered tax expenditures.
The Finnish tax system should undergo an overall review from time to time. The previous update was carried out almost ten years ago, which means that a new review should perhaps be carried out in the near future. New economic phenomena, such as the platform economy, sharing economy and circulation economy, are also factors in favour of a new review as they may have an impact on the tax base. After the content of the existing tax legislation has been examined, it will be easier and more beneficial to discuss the tax base, the level of tax expenditures narrowing it and the need for tax expenditures as an alternative to direct aid schemes.