Tax expenditure as a problem in intergovernmental relations

Tax expenditures are well known in all countries. However, they are of low repute, not only because politicians often use them to disguise relief for interest groups in the tax code, but also because they are seen as less targeted and less efficient than direct expenditure. In this article, two hitherto neglected aspects of tax expenditures are discussed. The first of these is tax shifting and what it implies in terms of outcomes. The second and more important is the problem caused by tax expenditures in the area of intergovernmental relations, which arises from the effects of tax expenditures in the intergovernmental system. In the article, these effects are highlighted and described in detail: (1) vertical effects of tax expenditures, reflecting the impact of tax expenditures on budgets at different levels; (2) horizontal externalities, which characterize the effects of tax expenditures on budgets at the same level; and (3) the negative impact of tax expenditures on equalization processes. All of these effects are systematized in various ways; together, they present a coherent approach for later empirical country studies