The billions that the spending review forgot

New Year’s Eve is an exciting day. For, each year, it is the day that the government – without any fanfare – publishes new stats on the cost of tax expenditures. Presumably it is only coincidentally a time of year when scrutiny and column inches are likely to be limited. This is a shame, because the publication details how more than £100 billion is spent through the tax system. By any standards that’s a big sum to go unprobed. Given the backdrop of a decade-long fiscal tightening it appears even more complacent.

Tax expenditures exist where particular groups of people or companies have their tax bills lowered, for the purpose of trying to deliver economic or social objectives. They might be tax exemptions, lower rates or higher allowances, but all of them are comparable to spending programs that give money to particular groups. Last year we pointed to the considerable scale of these reliefs, and the need for reform to permanently apply some of the same scrutiny that has been brought to bear on most aspects of public spending.

The new data shows that this scale has increased still further, at the same time that many areas of spending have been reduced. Using a National Audit Office assessment of what counts as a “tax expenditure” (definitions vary, though most people would say the personal allowance, for example, doesn’t count), and looking only at the “main” reliefs listed by HMRC, we come to a total of £117 billion in 2015-16. This now exceeds any departmental budget (topping health, at £116 billion).

This figure doesn’t include the roughly £1 billion of minor reliefs. Nor does it include 218 tax reliefs for which estimates of cost are unavailable – such as the exemption of capital gains tax for inherited gains which back in 2011 was estimated at £600 million. And because of the way in which the tax system has evolved, other bonuses such as the exemption of workers over state pension age from National Insurance are (wrongly) not currently recognised as tax reliefs.

In a welcome improvement on previous releases, the HMRC stats now cover four years rather than two. This makes it even easier to see how costs have risen or fallen. Between 2012-13 and 2015-16, the total cost of tax expenditures rose by £14 billion in real terms. Of course, tax expenditures may naturally rise when the economy grows, so this increase needn’t be a result of active policy choices. A large part of this increase is down to an increase in house prices which has made the favourable tax treatment of housing (through the tax exemption of capital gains and lack of VAT on construction) more valuable. Nevertheless, it highlights an interesting contrast to the sharp cuts applied to many departmental and welfare budgets in this period.

It would be wrong to write-off this £117 billion as obviously wasted money, or to think that it can be painlessly raided. £50 billion of it is VAT exemptions and therefore highly politically sensitive. Bear in mind that the controversial 2012 budget only ever intended to close £300 million worth of these VAT reliefs. Even the more regressive measures may have positive outcomes in terms of boosting growth.

The key point is not that all tax expenditures are bad, but that there is insufficient (indeed hardly any) scrutiny, even if the cost is known and tracked. This is in stark contrast to ‘spending’. What does the £3 billion of entrepreneurs’ relief achieve and how does that compare to, say, publicly funded research, infrastructure or lower tax rates? Do we get good value for money from the £1 billion of tax relief on the inheritance of agricultural property and business assets? At present we simply have no idea.

Another big area of tax expenditure is on pensions, and here at least there is some considerable attention being given at present to whether the status quo is the best approach. We should learn in the March budget what changes, if any, are to be made to the pension tax system. There’s a strong case that income tax relief is simply a deferral of tax until pension receipt and should not be considered a tax expenditure. But even discounting that there are some very substantial reliefs, such as the uncapped NICs exemption for employer contributions (costing £10 billion in employer NICs plus perhaps another £5 billion – not in HMRC’s tables – from employee NICs) and the tax-free lump sum (formerly costed at £2.5 billion). These monumental sums might be better targeted on those who most need higher savings, or used elsewhere. The government’s review of pension taxation is the exception rather than the rule when it comes to reliefs, however, and it certainly remains to be seen whether or not it will be an example of good policy making.

Also welcome is a Labour review of not only the effectiveness of business tax reliefs but also the processes (or lack thereof) surrounding tax expenditure. But this is not an issue for any one party alone, and it would be nice to think that George Osborne – following the fiscal mandate, welfare cap and strict spending reviews – could institutionalise new tax expenditure scrutiny to deliver better policy making and fiscal rigour in future. We need to make sure that £117 billion of deliberately foregone tax is achieving whatever goals are intended, that reliefs are not supporting tax evasion and undesirable distributional outcomes, and that there aren’t alternatives – whether that be spending, broad tax cuts, or other reliefs – that achieve better value for money.