Tax expenditures, tax morale, and tax compliance: implications for the fiscal contract

Rarely included in analyses of tax morale or tax compliance, tax expenditures are nevertheless a central component of modern tax systems. The term refers to preferential tax treatments in favour of specific groups, companies, economic sectors or activities. Governments use them to pursue a wide range of public policy goals, such as attracting investments, promote pension savings or incentivise low-carbon technologies. As shown by the Global Tax Expenditures Database (GTED), the worldwide average of reported revenue forgone from tax expenditures stands at 3.7 percent of GDP and roughly a quarter of actual tax revenue. However, the available information on tax expenditures is patchy. Many tax expenditures are implemented without any public debate or scrutiny. From the information that exists, it can be said that the measures often fail to achieve their stated goals. Worse, they may even produce negative externalities on third actors, and their distributional effect can be highly regressive. This combination of budgetary relevance, limited transparency, and distributional effects raise several questions: do tax expenditures affect perceptions of fairness? Do they weaken tax morale and tax compliance? And ultimately, do they undermine the implicit fiscal contract? This paper proposes to rearticulate the concepts of tax morale, tax compliance, and the fiscal contract through the lens of tax expenditures in developing countries. It uses data from the GTED and the Global Tax Expenditures Transparency Index (GTETI), preliminary survey results from four case studies (Colombia, Morocco, Uganda, Zimbabwe) and a thorough review of the available literature to show that the governance set-up underlying tax expenditures as well as the associated perceptions of taxpayers can shape fiscal legitimacy and therefore affect the state’s ability to mobilise resources sustainably. The paper also calls for revising the governance framework for tax expenditures and highlights alternative policy levers for achieving comparable economic or social objectives.