## _wp1407 - References

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### I. WHAT ARE TAX EXPENDITURES?
- Definition and forms
  - Government revenues foregone due to differential/preferential treatment of specific sectors, activities, regions, or agents.
  - Forms: allowances (deductions from the base), exemptions (exclusions from the base), rate relief (lower rates), credits (reductions in liability), tax deferrals (postponing payments).
- International comparisons
  - Complicated by different methodologies and benchmarks; practice is pervasive and Italy’s tax expenditures are described as “clearly elevated.”
  - Figure referenced: “Tax Expenditures in Selected Advanced Economies (Percent of GDP)” — higher values may reflect more comprehensive reporting; recent estimates for Italy are higher due to change in benchmark.

### II. WHY SHOULD TAX EXPENDITURES BE REFORMED?
- Consequences
  - Affect fairness, complexity, efficiency, and effectiveness of tax and wider fiscal systems.
- Key concerns (verbatim descriptors preserved where provided)
  - Fairness: Reductions in taxable income tend to benefit those in the highest marginal tax bracket; reduced VAT rates in Italy increase progressivity but much benefit accrues to the better off; same equity objectives could be pursued at less cost through social spending.
  - Efficiency and targeting: Can create unintended distortions (example: deduction of mortgage interest may encourage leveraged housing finance).
  - Vulnerability to lobbying: Easier to argue for tax breaks than explicit spending; tax expenditures often bypass scrutiny accorded to spending and may not require annual renewal.
- Comparison of Tax Expenditures and Direct Spending — selected trade-offs (verbatim descriptors preserved)
  - Accessibility for beneficiaries: “Simple, because of their automatic nature.” vs “More complex, requiring selection.”
  - Administrative and compliance costs: “High, if exemptions are properly monitored.” vs “Medium, due to necessity of a selection and allocation system.”
  - Equity: “Only potential taxpayers benefit, and those with the highest income often benefit the most.” vs “Discretion can provide more equitable access, enhancing targeting of beneficiaries.”
  - Footnote: “1/ This has not been the case in Italy, where the budget contains many legal rigidities.”

### III. ARE ALL TAX EXPENDITURES BAD?
- Potential advantages
  - Administrative economies of scale: deliver rewards via tax reductions without requiring spending ministries to administer substitute programs.
  - Some tax expenditures are intrinsic parts of fair/efficient tax design (example: largest single tax expenditure in Italy is a tax credit serving the same purpose as basic tax-free thresholds elsewhere).
- Caveat
  - Not all are justifiable loopholes; evaluation required to distinguish appropriate design elements from unjustified preferences.

### IV. HOW CAN TAX EXPENDITURES BE IDENTIFIED AND QUANTIFIED?
- Two-step approach
  1. Define a benchmark tax system (no consensus on benchmark definition).
     - Two main approaches:
       - Norm based on theoretical concepts of income, consumption, or value-added taxes.
       - Norm based on a country’s own tax laws, isolating differential treatment judged as tax expenditures.
     - Theoretical-norm approaches may classify as tax expenditures elements that could be considered part of tax design.
  2. Quantify budgetary cost based on actual uptake of differential treatment.
- Italy example
  - MEF report identifies and costs 720 tax expenditures amounting to about 16 percent of GDP.
  - MEF’s conceptual approach provides very extensive coverage; eliminating all identified tax expenditures would be neither feasible nor desirable.
  - Since 2010, annual State Budget documents include a list of all tax expenditures at the level of central government measured against current legislation (a narrower benchmark than used in the MEF report).

### V. ONCE IDENTIFIED, HOW SHOULD TAX EXPENDITURES BE EVALUATED?
- Need for clear and frequent evaluation to scale back those not generating benefits commensurate with their cost.
- Evaluation challenges
  - Impact on behavior is often hard to identify; even when hard, assess plausibility that response justifies cost.
- Evaluation framework — four guiding questions
  1. Does the tax expenditure promote or hinder economic efficiency? Extent of influence on taxpayer behavior (desirable vs. distortionary).
  2. Is the tax expenditure fair? Are similar individuals treated similarly? Does it account for different capacities to bear tax burden?
  3. Is the tax expenditure simple and easily administered? Includes calculation, filing, administration, enforcement, ease of evasion.
  4. Is the tax expenditure vulnerable to lobbying? Does it benefit very specific interest groups and how frequently are costs/benefits scrutinized?
- Comparative assessment
  - Also compare tax expenditures with alternative spending measures (example: dependent relative tax credit may overlap with social assistance programs).

### VI. WHAT TYPES OF TAX EXPENDITURES ARE THERE IN ITALY?
A. Personal Income Tax (PIT)
- Benchmarking issues
  - PIT is a prime redistribution instrument; comparisons use comprehensive economic income and also a dual income tax (DIT) system.
  - Many large PIT tax expenditures may be desirable parts of a normal tax system.
- Table 2 — Largest PIT tax expenditures (values preserved exactly)
  - Tax credit for wage income from employment, pensions, self-employment and similar income. Value: 37.73 (billions). Percent GDP: 2.41. Comment: “This regime is a substitute for the fact that Italy has no lower personal income tax threshold.”
  - Various financial substitute taxes (lower rates) on interests, dividends, capital gains and other forms of return. Value: 13.17 (billions). Percent GDP: 0.84. Comment: “Substitute tax regime by-passes the requirement to tax capital income according to the progressive PIT schedule by mimicking a Dual Income tax regime.”
  - Tax credit for dependent relatives. Value: 10.50 (billions). Percent GDP: 0.67. Comment: “This benefit is sometimes considered a measure of ability to pay and part of the benchmark system rather than a tax expenditure.”
  - Tax exemption (excluded from base) for contributions to welfare and pension schemes for employees. Value: 10.10 (billions). Percent GDP: 0.64. Comment: “Pension contributions are excluded and pension income is taxed. Avoids double taxation.”
  - Lower PIT rates for payment of separation allowances and "golden handshakes". Value: 5.10 (billions). Percent GDP: 0.33. Comment: “Unwinds tax progressivity that would come from what is effectively receipt of multi-year income in one period.”
  - Tax exemption (excluded from base) for compulsory contributions to welfare and pension schemes for self-employed. Value: 4.31 (billions). Percent GDP: 0.28. Comment: “Pension contributions are excluded and pension income is taxed. Avoids double taxation.”
  - Tax credit for medical expenses and health assistance services. Value: 2.36 (billions). Percent GDP: 0.15. Comment: “Considered to have welfare objective.”
  - Sum of largest PIT tax expenditures. Value: 83.26 (billions). Percent GDP: 5.32.

B. Corporate Income Tax (CIT)
- Benchmark: Concept of net business profit applied.
- Notable items and rationale
  - Largest CIT tax expenditure: measure to avoid double taxation of foreign sourced dividends.
  - Deductibility of social security costs from IRAP introduced to reduce labor tax wedge and incentivize hiring.
  - Incentives for restructuring and mergers should be weighed against alternative policy options.
  - Allowance for Corporate Equity (ACE): provides tax deduction for a notional return on additional equity, reducing incentive to use debt rather than equity, moving Italy closer to “dual income tax” neutrality.
- Table 3 — Largest CIT tax expenditures (values preserved exactly)
  - Foreign-source dividends received by a resident corporate taxpayer are 95% exempt from CIT. Value: 8.38 (billions). Percent GDP: 0.54. Comment: “Measure to avoid double taxation.”
  - Substitute tax (16 percent) for capital gains from goodwill, trademarks and other intangible assets resulting from extraordinary operations, such as restructuring and mergers. Value: 7.43 (billions). Percent GDP: 0.47. Comment: “Tax provision to promote firm dynamism and incentivize new activity.”
  - Full deduction from IRAP tax base of SSC costs related to permanent workers; full deduction from PIT and CIT tax base of IRAP on labour costs (plus partial deductability of interests costs). Value: 6.69 (billions). Percent GDP: 0.43. Comment: “Provision mainly to reduce labor tax wedge.”
  - Substitute tax for capital gains arising from "extraordinary" operations, suchs as mergers, divisions, and transfers of companies. Value: 6.40 (billions). Percent GDP: 0.41. Comment: “Measure to favor restructuring, which brings higher depreciation charges (lower taxes) from corporates in the future.”
  - Substitute tax on capital gains (lower rate) from revaluation of assets held on the balance sheet at historical cost. Value: 4.18 (billions). Percent GDP: 0.27. Comment: “Generates current revenue for the authorities in exchange for higher depreciation charges (lower taxes) from corporates in the future.”
  - Sum of largest CIT tax expenditures. Value: 33.08 (billions). Percent GDP: 2.11.
  - Footnote: “1/ Full deduction of IRAP labor costs from PIT and CIT was introduced in Law 214/2011 and is not explicitly costed in the table, which instead includes estimates based on earlier lump-sum deductions per employee.”

C. Value Added Tax (VAT)
- Benchmark and diagnostic metrics
  - Benchmark: a uniform rate with a broad base is a good benchmark; VAT is not a good instrument for externalities or redistribution.
  - Multi-rate VAT: Information requirements to operate a differential VAT regime that improves welfare are onerous; welfare objectives likely better achieved via special excise taxes or direct subsidies.
- C-efficiency and gaps — Italy estimates
  - C-efficiency estimated at around 41 percent in 2010 — revenue was 41 percent of what it would have been had the then-standard rate been applied to actual taxable consumption.
  - Compliance gap estimated at around 30 percent (studies of the Revenue Agency).
  - Implied policy gap also around 41 percent (calculations illustrative due to distinct, not fully comparable data sources).
- Illustrative revenue implications
  - Halving the compliance gap, maintaining all tax rates unchanged, would raise about 1.3 percent of GDP.
  - Halving the policy gap, keeping the standard rate unchanged, would raise about 2.7 percent of GDP.
- Note: “The policy gap can in turn be decomposed into elements reflecting rate differentiation and the operation of exemptions: Box 1 illustrates for Italy.”

### Box 1. Decomposing the IVA Policy Gap
- Decomposition identity (De Mooij and Keen, 2012)
  - (1-policy gap) = (1-exemptions)×(1-rate dispersion)
- Interpretation
  - First term captures impact of exemptions (sectors, activities).
  - Second term measures effect of non-standard VAT rates on collections (usually lower rates).
- Italy-specific inputs and implications
  - MEF report implies rate dispersion at about 0.25 percent.
  - Combined with a policy gap of 41 percent, this implies an “exemptions” gap of 0.22 percent in 2010.
- Fiscal magnitudes (percent of GDP, 2010)
  - Lost revenue due to exemptions (including those mandatory under EU rules): 2.5
  - Lost revenue due to lower rates: 2.9
  - Lost revenue due to non-compliance: 2.6
  - Actual revenue collection: just over 6 percent of GDP
  - Potential revenue, at an unchanged standard rate: 15 percent of GDP
- Comparison of MEF estimates and decomposition results
  - MEF estimate of the cost of reduced rates: 2.5 percent of GDP.
  - Box estimate of reduced rates: 2.9 percent of GDP.
  - Observation: Decomposition’s estimated cost of exempt regimes (2.5 percent of GDP) is much larger than MEF’s quantified exempt regimes (0.06 percent of GDP), likely due to unquantified miscellaneous exempt regimes (national and EC-mandated).
  - Recommendation: Both groups of exempt regimes should be scrutinized.

- Quantified VAT tax expenditures (MEF, 2011; IMF staff estimates) — largest items (values preserved)
  - VAT reduced rate (10 percent):
    - Description: Including food items, restaurants and hotels, pharmaceutical and medical products, energy products and recreational services.
    - Value (billions): 24.60
    - Percent GDP: 1.57
  - VAT reduced rate (4 percent):
    - Description: Including food items, books and newspapers, and school and company canteens.
    - Value (billions): 14.60
    - Percent GDP: 0.93
  - VAT Exemptions — Italy Specific:
    - Special regime/s for agricultural producers: Value (billions) 0.31; Percent GDP 0.02
    - Special regime for publishing sector: Value (billions) 0.24; Percent GDP 0.02
    - Special regime for tobacco and match producers / Supplies of goods to (solely) charitable, educational or research bodies: Value (billions) 0.17; Percent GDP 0.01
    - Exemption for funeral services: Value (billions) 0.12; Percent GDP: 0.01
    - Miscellaneous other regimes (EC regulations including financial sector, travel agencies, used cars, secondhand goods, antiques, sales by auction etc.): (no disaggregated value provided)
  - Sum of largest VAT tax expenditures:
    - Value (billions): 40.04
    - Percent GDP: 2.56

- Quantified excise tax expenditures (MEF, 2011; IMF staff estimates)
  - Reduced excise tax for public transport companies:
    - Value (billions): 1.67
    - Percent GDP: 0.11
    - Comment: Sectoral benefits.
  - Reduced excise tax for agricultural sector:
    - Value (billions): 0.96
    - Percent GDP: 0.06
    - Comment: Sectoral benefits.
  - Tax exemption for houses with monthly energy consumption between 3 and 120 KWH:
    - Value (billions): 0.55
    - Percent GDP: 0.04
  - Sum of largest Excise tax expenditures:
    - Value (billions): 3.17
    - Percent GDP: 0.20

- Illustrative table of tax expenditures for priority review (selected items)
  - VAT Reduced Rates:
    - Value (billions): 39.20
    - Percent GDP: 2.50
    - Comment: Not all of this can be saved, but some reduced rates could be eliminated and others harmonized. Expenditure programs may be needed to offset some redistributive impact.
  - VAT Exempt Regimes...:
    - Percent GDP: 2.5
    - Comment: Top-down estimate. Some are EC requirements.
  - Fuel excise tax exemptions and reduced rates:
    - Value (billions): 3.17
    - Percent GDP: 0.20
    - Comment: Accelerated structural reforms could provide alternative support to productivity.
  - Income tax credit for medical expenses and health assistance services:
    - Value (billions): 2.36
    - Percent GDP: 0.15
    - Comment: Objectives potentially better achieved by spending program.
  - Income tax credit for interest paid on mortgage for principal residence (or construction of principle residence):
    - Value (billions): 1.34
    - Percent GDP: 0.09
    - Comment: A complete repeal could create budget difficulties for some households, so a review should proceed with caution focusing first on new mortgages.
  - Reduced income tax rates on the interest and bonuses from government securities and other forms of public debt e.g. postal bonds:
    - Value (billions): 1.38
    - Percent GDP: 0.09
    - Comment: Supports government bond market over other forms of investment.
  - CIT: substitute taxes to encourage restructuring, mergers and transfers:
    - Value (billions): 13.83
    - Percent GDP: 0.88
    - Comment: Objectives potentially better achieved through structural reforms. Estimates should be treated with caution as some may be one-off.
  - Total (illustrative):
    - Value (billions): 61.28
    - Percent GDP: 6.44

- Selected support for agricultural sector (values preserved)
  - Reduced excise tax for agricultural sector:
    - Value (billions): 0.96
    - Percent GDP: 0.06
  - Special VAT regime for agriculture:
    - Value (billions): 0.31
    - Percent GDP: 0.02
  - Reduced IRAP rate for agricultural sector:
    - Value (billions): 0.23
    - Percent GDP: 0.01
  - CIT exemption for certain agricultural cooperatives:
    - Value (billions): 0.17
    - Percent GDP: 0.01
  - Reduced transaction taxes for rural property:
    - Value (billions): 0.16
    - Percent GDP: 0.01
  - Budget Support — National funds for rural development:
    - Value (billions): 1.5
    - Percent GDP: 0.10
  - Budget Support — EC Common Agricultural Policy (mainly single payment):
    - Value (billions): 5.9
    - Percent GDP: 0.38

### Policy recommendations and procedural guidance
- Regular review and integration
  - Ideally, all tax expenditures should be regularly and systematically reviewed, just like regular government expenditures.
  - In Italy, tax expenditure reviews should be combined with spending reviews to analyze holistically government support to particular sectors, activities, regions, or agents to avoid overlapping objectives and expenditures.
- Legislative and procedural reforms
  - Consider legislating expiry clauses for all tax expenditures (especially those benefiting particular groups) to incentivize proper consideration of costs and benefits.
  - Any extension of existing tax expenditures, or granting of new ones, should only be possible as part of the annual budget process.
- Caution in aggregation and sequencing
  - Particular caution is needed in aggregating tax expenditures because the aggregate revenue gain from eliminating two tax advantages may differ from the sum of the gains from eliminating each in isolation.
  - Priority reviews should focus on tax expenditures that:
    - Are not fully quantified (e.g. VAT exempt regimes);
    - Are poorly targeted (e.g. VAT reduced rates);
    - Are better covered by expenditure programs (e.g. for medical services);
    - Benefit only certain groups that also receive spending support (e.g. reduced VAT and excise tax for public transport companies and agriculture);
    - Are distortionary (e.g. preferential treatment for government bonds).
  - Savings from reforms will not equal the total estimate of the tax expenditure cost if replacement by better-targeted spending programs is needed or if reductions are partial.

### Annex summary — identifying and quantifying tax expenditures
- Defining a benchmark tax system — three approaches (OECD, 2010b)
  1. Conceptual approach: uses an “optimal” tax system as the norm based on theoretical concepts of income, consumption, or value-added taxes.
  2. Legal approach: uses a country’s own tax laws as a basis to define the benchmark, isolating differential or preferential treatment judged as tax expenditures.
  3. Expenditure subsidy approach: seeks to cost only differential or preferential treatment that is clearly analogous to an expenditure subsidy.
- Methods to quantify costs
  1. Foregone revenue method: estimate of loss in government revenue due to the tax expenditure, based on the actual uptake of the differential or preferential treatment.
  2. Earned revenue method: estimate of additional revenue that would accrue from elimination of the tax expenditure, taking into account behavioral changes.
  3. Equivalent direct expenditure method: estimates the cost of replacing the tax expenditure with a direct expenditure (subsidy) outside the tax system.

*Source: _wp1407 - References (extracted content).*

### References .............................................................................................................

### _wp1407 - References

### I. WHAT ARE TAX EXPENDITURES?
- Definition: Government revenues foregone due to differential/preferential treatment of specific sectors, activities, regions, or agents.
- Forms: allowances (deductions from the base), exemptions (exclusions from the base), rate relief (lower rates), credits (reductions in liability), tax deferrals (postponing payments).
- International comparisons: Complicated by different methodologies and benchmarks; practice is pervasive and Italy’s tax expenditures are described as “clearly elevated.”
- Figure: “Tax Expenditures in Selected Advanced Economies (Percent of GDP)” — note that higher values may arise from more comprehensive reporting; recent estimates for Italy are higher due to change in benchmark.

### II. WHY SHOULD TAX EXPENDITURES BE REFORMED?
- Consequences for fairness, complexity, efficiency, and effectiveness of tax and wider fiscal systems.
- Key concerns:
  - Fairness: Reductions in taxable income tend to benefit those in the highest marginal tax bracket; reduced VAT rates in Italy increase progressivity but much benefit accrues to the better off; same equity objectives could be pursued at less cost through social spending.
  - Efficiency and targeting: Can create unintended distortions (example: deduction of mortgage interest may encourage leveraged housing finance).
  - Vulnerability to lobbying: Easier to argue for tax breaks than explicit spending; tax expenditures often bypass scrutiny accorded to spending and may not require annual renewal.
- Comparison table: “Comparison of Tax Expenditures and Direct Spending” — summarized trade-offs (accessibility, administrative and compliance costs, possible abuses, flexibility, transparency and accountability, expenditure control, equity).
  - Example entries (verbatim descriptors preserved):
    - Accessibility for beneficiaries: “Simple, because of their automatic nature.” vs “More complex, requiring selection.”
    - Administrative and compliance costs: “High, if exemptions are properly monitored.” vs “Medium, due to necessity of a selection and allocation system.”
    - Equity: “Only potential taxpayers benefit, and those with the highest income often benefit the most.” vs “Discretion can provide more equitable access, enhancing targeting of beneficiaries.”
  - Footnote: “1/ This has not been the case in Italy, where the budget contains many legal rigidities.”

### III. ARE ALL TAX EXPENDITURES BAD?
- Not necessarily. Potential advantages:
  - Administrative economies of scale: deliver rewards via tax reductions without requiring spending ministries to administer substitute programs.
  - Some tax expenditures are intrinsic parts of fair/efficient tax design (example: largest single tax expenditure in Italy is a tax credit serving the same purpose as basic tax-free thresholds elsewhere).
- Caveat: Not all are justifiable loopholes; evaluation required to distinguish appropriate design elements from unjustified preferences.

### IV. HOW CAN TAX EXPENDITURES BE IDENTIFIED AND QUANTIFIED?
- Step 1: Define a benchmark tax system (no consensus on benchmark definition).
  - Two main approaches:
    - Norm based on theoretical concepts of income, consumption, or value-added taxes.
    - Norm based on a country’s own tax laws, isolating differential treatment judged as tax expenditures.
  - Theoretical-norm approaches may classify as tax expenditures elements that could be considered part of tax design.
  - See Annex I for detailed description.
- Step 2: Quantify budgetary cost based on actual uptake of differential treatment.
- Italy example:
  - MEF report identifies and costs 720 tax expenditures amounting to about 16 percent of GDP.
  - MEF’s conceptual approach provides very extensive coverage; eliminating all identified tax expenditures would be neither feasible nor desirable.
  - Since 2010, annual State Budget documents include a list of all tax expenditures at the level of central government measured against current legislation (a narrower benchmark than used in the MEF report).

### V. ONCE IDENTIFIED, HOW SHOULD TAX EXPENDITURES BE EVALUATED?
- Need for clear and frequent evaluation to scale back those not generating benefits commensurate with their cost.
- Evaluation challenges: Impact on behavior is often hard to identify; even when hard, assess plausibility that response justifies cost.
- Evaluation framework (four guiding questions):
  1. Does the tax expenditure promote or hinder economic efficiency? Extent of influence on taxpayer behavior (desirable vs. distortionary).
  2. Is the tax expenditure fair? Are similar individuals treated similarly? Does it account for different capacities to bear tax burden?
  3. Is the tax expenditure simple and easily administered? Includes calculation, filing, administration, enforcement, ease of evasion.
  4. Is the tax expenditure vulnerable to lobbying? Does it benefit very specific interest groups and how frequently are costs/benefits scrutinized?
- Also compare tax expenditures with alternative spending measures (example: dependent relative tax credit may overlap with social assistance programs).

### VI. WHAT TYPES OF TAX EXPENDITURES ARE THERE IN ITALY?
A. Personal Income Tax (PIT)
- Benchmarking: Difficult because PIT is a prime redistribution instrument; comparisons use comprehensive economic income and also a dual income tax (DIT) system (progressive labor income, low single-rate capital income).
- Many large PIT tax expenditures may be desirable parts of a normal tax system.
- Table 2 summary: Largest PIT tax expenditures collectively worth over 5 percent of GDP.
- Largest PIT items (table entries preserved exactly):
  - Tax credit for wage income from employment, pensions, self-employment and similar income. Value: 37.73 (billions). Percent GDP: 2.41. Comment: “This regime is a substitute for the fact that Italy has no lower personal income tax threshold.”
  - Various financial substitute taxes (lower rates) on interests, dividends, capital gains and other forms of return. Value: 13.17 (billions). Percent GDP: 0.84. Comment: “Substitute tax regime by-passes the requirement to tax capital income according to the progressive PIT schedule by mimicking a Dual Income tax regime.”
  - Tax credit for dependent relatives. Value: 10.50 (billions). Percent GDP: 0.67. Comment: “This benefit is sometimes considered a measure of ability to pay and part of the benchmark system rather than a tax expenditure.”
  - Tax exemption (excluded from base) for contributions to welfare and pension schemes for employees. Value: 10.10 (billions). Percent GDP: 0.64. Comment: “Pension contributions are excluded and pension income is taxed. Avoids double taxation.”
  - Lower PIT rates for payment of separation allowances and "golden handshakes". Value: 5.10 (billions). Percent GDP: 0.33. Comment: “Unwinds tax progressivity that would come from what is effectively receipt of multi-year income in one period.”
  - Tax exemption (excluded from base) for compulsory contributions to welfare and pension schemes for self-employed. Value: 4.31 (billions). Percent GDP: 0.28. Comment: “Pension contributions are excluded and pension income is taxed. Avoids double taxation.”
  - Tax credit for medical expenses and health assistance services. Value: 2.36 (billions). Percent GDP: 0.15. Comment: “Considered to have welfare objective.”
  - Sum of largest PIT tax expenditures. Value: 83.26 (billions). Percent GDP: 5.32.

B. Corporate Income Tax (CIT)
- Benchmark: Concept of net business profit applied.
- Notable points:
  - Largest CIT tax expenditure: measure to avoid double taxation of foreign sourced dividends.
  - Measures like deductibility of social security costs from IRAP introduced to reduce labor tax wedge and incentivize hiring.
  - Other CIT tax expenditures (incentives for restructuring and mergers) should be weighed against alternative policy options (e.g., streamlining court processes).
  - Allowance for Corporate Equity (ACE): provides tax deduction for a notional return on additional equity, reduces incentive to use debt rather than equity, moves Italy closer to “dual income tax” neutrality.
- Table 3 summary: Largest CIT tax expenditures (values preserved exactly):
  - Foreign-source dividends received by a resident corporate taxpayer are 95% exempt from CIT. Value: 8.38 (billions). Percent GDP: 0.54. Comment: “Measure to avoid double taxation.”
  - Substitute tax (16 percent) for capital gains from goodwill, trademarks and other intangible assets resulting from extraordinary operations, such as restructuring and mergers. Value: 7.43 (billions). Percent GDP: 0.47. Comment: “Tax provision to promote firm dynamism and incentivize new activity.”
  - Full deduction from IRAP tax base of SSC costs related to permanent workers; full deduction from PIT and CIT tax base of IRAP on labour costs (plus partial deductability of interests costs). Value: 6.69 (billions). Percent GDP: 0.43. Comment: “Provision mainly to reduce labor tax wedge.”
  - Substitute tax for capital gains arising from "extraordinary" operations, suchs as mergers, divisions, and transfers of companies. Value: 6.40 (billions). Percent GDP: 0.41. Comment: “Measure to favor restructuring, which brings higher depreciation charges (lower taxes) from corporates in the future.”
  - Substitute tax on capital gains (lower rate) from revaluation of assets held on the balance sheet at historical cost. Value: 4.18 (billions). Percent GDP: 0.27. Comment: “Generates current revenue for the authorities in exchange for higher depreciation charges (lower taxes) from corporates in the future.”
  - Sum of largest CIT tax expenditures. Value: 33.08 (billions). Percent GDP: 2.11.
  - Footnote: “1/ Full deduction of IRAP labor costs from PIT and CIT was introduced in Law 214/2011 and is not explicitly costed in the table, which instead includes estimates based on earlier lump-sum deductions per employee.”

C. Value Added Tax (VAT)
- Benchmark: A uniform rate with a broad base is a good benchmark; VAT is not a good instrument for externalities or redistribution.
- Multi-rate VAT: Information requirements to operate a differential VAT regime that improves welfare are onerous; welfare objectives likely better achieved via special excise taxes or direct subsidies.
- C-efficiency concept:
  - C-efficiency shortfall from 100 percent can be decomposed into compliance gap and “policy gap” (extent consumption not taxed at standard rate).
  - Italy estimates:
    - C-efficiency estimated at around 41 percent in 2010 — revenue was 41 percent of what it would have been had the then-standard rate been applied to actual taxable consumption.
    - Compliance gap estimated at around 30 percent (studies of the Revenue Agency).
    - Implied policy gap also around 41 percent (calculations illustrative due to distinct, not fully comparable data sources).
  - Illustrative revenue implications:
    - Halving the compliance gap, maintaining all tax rates unchanged, would raise about 1.3 percent of GDP.
    - Halving the policy gap, keeping the standard rate unchanged, would raise about 2.7 percent of GDP.
  - Note: “The policy gap can in turn be decomposed into elements reflecting rate differentiation and the operation of exemptions: Box 1 illustrates for Italy.”

*Source: _wp1407 - References (extracted content).*

### Box 1. Decomposing the IVA Policy Gap

### Box 1. Decomposing the IVA Policy Gap

### Decomposition framework and headline Italy results
- Decomposition identity (De Mooij and Keen, 2012):
  - (1-policy gap) = (1-exemptions)×(1-rate dispersion)
- Interpretation:
  - First term captures impact of exemptions (sectors, activities).
  - Second term measures effect of non-standard VAT rates on collections (usually lower rates).
- Italy-specific inputs and implications:
  - MEF report implies rate dispersion at about 0.25 percent.
  - Combined with a policy gap of 41 percent, this implies an “exemptions” gap of 0.22 percent in 2010.
- Fiscal magnitudes (percent of GDP, 2010):
  - Lost revenue due to exemptions (including those mandatory under EU rules): 2.5
  - Lost revenue due to lower rates: 2.9
  - Lost revenue due to non-compliance: 2.6
  - Actual revenue collection: just over 6 percent of GDP
  - Potential revenue, at an unchanged standard rate: 15 percent of GDP
- Note:
  - C-efficiency is the ratio of VAT revenues to the product of the standard VAT rate and consumption.

### Comparison of MEF estimates and decomposition results
- MEF report and box differences:
  - MEF estimate of the cost of reduced rates: 2.5 percent of GDP.
  - Box estimate of reduced rates: 2.9 percent of GDP.
  - Footnote: The MEF estimate differs slightly from the Box 1 estimate due to differences in the estimated base of taxable consumption.
- Observation:
  - The decomposition’s estimated cost of exempt regimes (2.5 percent of GDP) is much larger than MEF’s quantified exempt regimes (0.06 percent of GDP), likely due to unquantified miscellaneous exempt regimes (national and EC-mandated).
  - Recommendation: Both groups of exempt regimes should be scrutinized.

### Quantified VAT tax expenditures (MEF, 2011; IMF staff estimates)
- Summary of largest VAT tax expenditures (values preserved as in source):
  - VAT reduced rate (10 percent):
    - Description: Including food items, restaurants and hotels, pharmaceutical and medical products, energy products and recreational services.
    - Value (billions): 24.60
    - Percent GDP: 1.57
  - VAT reduced rate (4 percent):
    - Description: Including food items, books and newspapers, and school and company canteens.
    - Value (billions): 14.60
    - Percent GDP: 0.93
  - VAT Exemptions — Italy Specific:
    - Special regime/s for agricultural producers: Value (billions) 0.31; Percent GDP 0.02
    - Special regime for publishing sector: Value (billions) 0.24; Percent GDP 0.02
    - Special regime for tobacco and match producers / Supplies of goods to (solely) charitable, educational or research bodies: Value (billions) 0.17; Percent GDP 0.01
    - Exemption for funeral services: Value (billions) 0.12; Percent GDP 0.01
    - Miscellaneous other regimes (EC regulations including financial sector, travel agencies, used cars, secondhand goods, antiques, sales by auction etc.): (no disaggregated value provided)
  - Sum of largest VAT tax expenditures:
    - Value (billions): 40.04
    - Percent GDP: 2.56

### Quantified excise tax expenditures (MEF, 2011; IMF staff estimates)
- Summary of largest excise tax expenditures:
  - Reduced excise tax for public transport companies:
    - Value (billions): 1.67
    - Percent GDP: 0.11
    - Comment: Sectoral benefits.
  - Reduced excise tax for agricultural sector:
    - Value (billions): 0.96
    - Percent GDP: 0.06
    - Comment: Sectoral benefits.
  - Tax exemption for houses with monthly energy consumption between 3 and 120 KWH:
    - Value (billions): 0.55
    - Percent GDP: 0.04
  - Sum of largest Excise tax expenditures:
    - Value (billions): 3.17
    - Percent GDP: 0.20

### Illustrative table of tax expenditures for priority review (selected items)
- Items and illustrative values (sources: MEF, 2011; IMF staff estimates):
  - VAT Reduced Rates:
    - Value (billions): 39.20
    - Percent GDP: 2.50
    - Comment: Not all of this can be saved, but some reduced rates could be eliminated and others harmonized. Expenditure programs may be needed to offset some redistributive impact.
  - VAT Exempt Regimes...:
    - Percent GDP: 2.5
    - Comment: Top-down estimate. Some are EC requirements.
  - Fuel excise tax exemptions and reduced rates:
    - Value (billions): 3.17
    - Percent GDP: 0.20
    - Comment: Accelerated structural reforms could provide alternative support to productivity.
  - Income tax credit for medical expenses and health assistance services:
    - Value (billions): 2.36
    - Percent GDP: 0.15
    - Comment: Objectives potentially better achieved by spending program.
  - Income tax credit for interest paid on mortgage for principal residence (or construction of principle residence):
    - Value (billions): 1.34
    - Percent GDP: 0.09
    - Comment: A complete repeal could create budget difficulties for some households, so a review should proceed with caution focusing first on new mortgages.
  - Reduced income tax rates on the interest and bonuses from government securities and other forms of public debt e.g. postal bonds:
    - Value (billions): 1.38
    - Percent GDP: 0.09
    - Comment: Supports government bond market over other forms of investment.
  - CIT: substitute taxes to encourage restructuring, mergers and transfers:
    - Value (billions): 13.83
    - Percent GDP: 0.88
    - Comment: Objectives potentially better achieved through structural reforms. Estimates should be treated with caution as some may be one-off.
  - Total (illustrative):
    - Value (billions): 61.28
    - Percent GDP: 6.44

### Selected support for agricultural sector (values preserved)
- Tax expenditures and budget support (sources: MEF (2011), Ministero delle Politiche Agricole e Forestali (2013)):
  - Reduced excise tax for agricultural sector:
    - Value (billions): 0.96
    - Percent GDP: 0.06
  - Special VAT regime for agriculture:
    - Value (billions): 0.31
    - Percent GDP: 0.02
  - Reduced IRAP rate for agricultural sector:
    - Value (billions): 0.23
    - Percent GDP: 0.01
  - CIT exemption for certain agricultural cooperatives:
    - Value (billions): 0.17
    - Percent GDP: 0.01
  - Reduced transaction taxes for rural property:
    - Value (billions): 0.16
    - Percent GDP: 0.01
  - Budget Support — National funds for rural development:
    - Value (billions): 1.5
    - Percent GDP: 0.10
  - Budget Support — EC Common Agricultural Policy (mainly single payment):
    - Value (billions): 5.9
    - Percent GDP: 0.38

### Policy recommendations and procedural guidance
- Regular review and integration:
  - Ideally, all tax expenditures should be regularly and systematically reviewed, just like regular government expenditures.
  - In Italy, tax expenditure reviews should be combined with spending reviews to analyze holistically government support to particular sectors, activities, regions, or agents to avoid overlapping objectives and expenditures.
- Legislative and procedural reforms:
  - Consider legislating expiry clauses for all tax expenditures (especially those benefiting particular groups) to incentivize proper consideration of costs and benefits.
  - Any extension of existing tax expenditures, or granting of new ones, should only be possible as part of the annual budget process.
- Caution in aggregation and sequencing:
  - Particular caution is needed in aggregating tax expenditures because the aggregate revenue gain from eliminating two tax advantages may differ from the sum of the gains from eliminating each in isolation.
  - Priority reviews should focus on tax expenditures that:
    - Are not fully quantified (e.g. VAT exempt regimes);
    - Are poorly targeted (e.g. VAT reduced rates);
    - Are better covered by expenditure programs (e.g. for medical services);
    - Benefit only certain groups that also receive spending support (e.g. reduced VAT and excise tax for public transport companies and agriculture);
    - Are distortionary (e.g. preferential treatment for government bonds).
  - Savings from reforms will not equal the total estimate of the tax expenditure cost if replacement by better-targeted spending programs is needed or if reductions are partial.

### Annex summary — identifying and quantifying tax expenditures
- Defining a benchmark tax system (OECD, 2010b) — three approaches:
  1. Conceptual approach: uses an “optimal” tax system as the norm based on theoretical concepts of income, consumption, or value-added taxes.
  2. Legal approach: uses a country’s own tax laws as a basis to define the benchmark, isolating differential or preferential treatment judged as tax expenditures.
  3. Expenditure subsidy approach: seeks to cost only differential or preferential treatment that is clearly analogous to an expenditure subsidy.
- Methods to quantify costs:
  1. Foregone revenue method: estimate of loss in government revenue due to the tax expenditure, based on the actual uptake of the differential or preferential treatment.
  2. Earned revenue method: estimate of additional revenue that would accrue from elimination of the tax expenditure, taking into account behavioral changes.
  3. Equivalent direct expenditure method: estimates the cost of replacing the tax expenditure with a direct expenditure (subsidy) outside the tax system.

*Source: Box 1, _wp1407 - Box 1. Decomposing the IVA Policy Gap (IMF staff summary of MEF, 2011 and IMF analyses)._*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2014/_wp1407.pdf_