The theme of tax expenses (so-called tax expenditures) has been at the center of the debate for several years now, especially when it comes to tax reform. The Meloni government's tax bill is no exception. The government's goal is to lower the tax burden. As? It starts with the reduction of rates, which will drop from 4 to 3 to arrive (by the end of the term) at the flat tax for everyone. But to do that you need money. And, as we know, the blanket is short. Therefore, to raise the necessary resources for the revision of the personal income tax, the idea is to start an energetic pruning of the over 600 tax shipments, that is, the deductions and tax deductions that Italian taxpayers can enjoy and which cost the State almost 130 billion. But according to theObservatory for Italian Public Accounts led by Giampaolo Galli, the most substantial deductions, those for income from work and family expenses (55 billion a year for the 2020 tax period), cannot really be used to finance the Irpef reform, nor for the move towards a flat tax. The others deductions, however, such as those for health care or education costs, or those for building renovation costs, have a much lower weight and their reorganization would certainly greatly simplify the tax structure, but would not be able to recover the necessary resources to cover a possible reform. Furthermore, for these deductions, it is noted that the deductible expenses grow, but less than proportionally with respect to income.
The CPI Observatory asks a simple question: Can Irpef tax expenses be changed? The answer is not obvious. Because if on the one hand any changes to these deductions could help simplify the tax (if the number of concessions were reduced), on the other they would have some marginal negative effect on redistribution and a relatively limited impact on public accounts. But let's see the Observatory's analysis in detail.
What are tax expenses
The fiscal delegation, approved by the Meloni government last year 16 March 2023, provides for a gradual reform of the tax system through the issue of implementing decrees within the next 18 months. The bill identifies four (not new) principles around which to build the structure of the new Italian tax system:
- the stimulus to economic growth (to be achieved by increasing the efficiency of the tax system and reducing the tax burden on the use of production factors);
- rationalization and simplification of the tax system (for example, rationalization of micro-taxes with an administrative cost disproportionate to the revenue generated);
- maintaining the progressivity of the tax system;
- the reduction of tax avoidance and evasion.
The art. 5 of the delegation is the most important part as regards the backbone of the Italian tax system: it identifies a gradual transition towards a single rate system (flat tax) in compliance with progressivity, also through the rearrangement of deductions and tax deductions (better known as "tax expenditures" or tax expenditures), taking into account the purposes for which they were introduced. Among these purposes, the text of the delegation mentions the composition of the family unit and the raising of children, the protection of the home, health and education, energy efficiency and anti-seismic improvements to buildings.
The government has repeatedly referred to tax expenditures as a source of funding for the revision of the Irpef. Tax expenditures (nearly 600) are defined in the report of the Commission for the preparation of the annual report on tax expenditures as all "measures which reduce or postpone the revenue for a specific group of taxpayers or an economic activity with respect to a reference rule which represents the benchmark”. This report also specifies that the reference benchmark is the one established by the legal system in force (current tax law), therefore, case by case, it must be determined whether or not a measure constitutes a tax relief, as a "deviation" from the current system.
Breakdown of tax expenses for each tax
The relevance of tax expenditures in the Italian tax system is evident, according to the Observatory, from the data reported in the Programmatic report on tax expenditures, attached to the Nadef 2022, where a snapshot of the current situation in the field of tax expenditures and the forecasts relating to the 2023. Table 1 summarizes the number and weight of the tax expense for each taxlimited to state taxes. For 2022, the lost revenue will reach 82,6 billion (corresponding to 4,3% of GDP and almost 15% of total tax revenue), of which 42 billion (51% of the total) only in the area Personal income tax. Government forecasts for 2023 speak of a drop of 4 billion compared to last year, essentially concentrated in the category of tax credits introduced following the pandemic.
As can be seen in Table 2, tax expenditures are recorded on the basis of the relevant fiscal year, ie the one for which they are recorded, while the effects in terms of lower revenue fall on the following year.
The numbers are slightly different from Table 1 as regards i state taxes. Overall, for 2022, total tax expenditures (as the sum of tax and local ones) amount to 128,6 billion of lower revenue, or 6,8% of the GDP trend of the Nadef 2022. For 2023, on the other hand, despite the increase in the number of categories relating to tax expenditures, the loss of revenue should be reduced by 3 billion euros (half a percentage point of GDP). However, it remains important weight of the tax expenses relating to'Irpef (41,7 billion for 2023) compared to the total reported in Table 2 (125,6 billion), settling at 33,2%.
Tax expenses in the context of personal income tax
The government has dusted off the idea of funding part of the tax reform through tax expenditure reviews. A good idea? Based on Table 2, the complete zeroing of tax expenditures would allow a recovery of about 6 points of GDP of revenue, which could be used to reduce the tax burden. But according to the Observatory it is a simplistic and misleading view. If we focus on personal income tax, part of the progressivity of Irpef is determined precisely by the presence of deductions and deductions, which would become even more important if the government really wanted to transform Irpef into a flat tax with a single tax rate on personal income.
Furthermore, it is necessary to distinguish between the tax expenditure which contributes to defining the structure of the tax and the many other additional concessions. In the case of personal tax deductions, the two most relevant categories (those that determine a qualitative differentiation of income from work and those that recognize the differences between taxpayers based on the characteristics of the family nucleus) are an integral part of the tax and amount to a total of 55,5 billion euros, i.e. 77% of the total income tax deductions.
The main income tax deductions
In particular, the deductions for pensions, employment and income assimilated allow the application of a concept of qualitative income discrimination, favoring work over other types of income. In addition, this deduction also manages to distinguish between dependent and self-employed work, taking into consideration the difference in the treatment of income production costs which for self-employed workers, at least partially, reduces taxable income, while this does not happen for employees.
Le family deductions take into account the variation in the individual's ability to pay based on the number of dependent family members. The data reported in Table 3 show that this item has a significant weight (11,9 billion) but it is necessary to underline that since 2022 it has undergone radical changes with the introduction of the single and universal allowance for dependent children. In spite of these recent changes (which have transformed a "fiscal expense" into a transfer to households, which instead constitutes real public expenditure paid by INPS), this discussion underlines how the "non-modifiable" deductions, as an integral part of the tax, make up a large part of the lost Irpef revenue, while the remaining part that could be modified would guarantee less than one point of GDP (about 16 billion) for a radical reform of the Irpef.
Irpef deductions: effects in terms of wages
But what do these other Irpef deductions refer to and what effects do they produce in redistributive terms? To characterize these tax expenditures, the Observatory proposes an analysis on the latest data relating to the 2021 Irpef declarations (tax year 2020). Fig. 1 shows the relationship between the amount of average deductible expense (calculated on the basis of the number of taxpayers who present the single type of deductible expense) and gross income.
From Fig. 1 it is evident that as income increases, all deductible expenses increase, but there are large differences between the individual categories. For example, total deductible expenses at 19% (including first home loans, education, healthcare expenses, funeral expenses, personal care expenses, etc.) grow much faster as income increases, mainly driven by education expenses, represented from the rightmost curve in the graph. For low incomes, within 20 euros, education costs are considered an "inferior" asset; after 20 euros, on the other hand, these expenses grow rapidly compared to income, exceeding 2.500 euros per year over 80 euros of gross income. For all expenditure categories, the percentage growth in average expenditure is lower than the percentage growth in income.
The effect of deductions on the progressivity of the tax
To evaluate the effect of deductions on progressivity of the tax, it is necessary to study the trend of the effective deduction as income increases. In this case, from the MEF data, it can be seen how much of the expenses shown in Fig. 1 are then concretely transformed into deductions for taxpayers. In order to have a positive impact on the progressiveness of the tax, it is necessary that the deductions grow less than proportionally to the increase in income, with more favorable treatment therefore for lower incomes. This "property" can be studied following two paths: the first considers the trend of effective deductions as income increases, while the second shows the variation of deductions as a percentage of gross tax compared to income. The MEF data combine all the deductions by broad categories and therefore only an "aggregate" analysis is possible.
Fig. 2 shows how the deductions for restructuring costs and for energy saving grow faster than the income of the deductions linked to deductible charges at 19% (64% of which is represented by health care costs).
However, in Fig. 3 it is clear that, for all categories, i poorer tax payers have a gross tax lower than the value of the deduction: as income increases, the weight of the deduction rapidly tends to zero and it is possible that, for taxpayers with relatively low incomes, these deductions compete with deductions for work and for family loads.
A similar argument can also be made with regard to the distribution of deductions by income class. Fig. 4 shows how most of the deductions for pensions, work and household expenses (called "non-usable" in the graph) are concentrated in the lowest income classes. Instead, the other deductions (which include all other deductible expenses) follow a more heterogeneous distribution. The two central brackets (between 15 and 50 thousand euros of income) benefit from most of the deductions (66% of the total), while the lowest incomes can take advantage of 11% of the total and the open bracket of the highest incomes absorbs 23% of other deductions.
