Tax expenditure

Also called: Revenue foregone · Topic: Taxation: Direct and Indirect Taxes, GST and Global Tax Issues · NCERT: Beyond NCERT

Meaning

Tax expenditure (also called revenue foregone) is the tax money the government chooses not to collect because it gives exemptions, deductions, rebates and concessions to some taxpayers.

• It works like a hidden subsidy: no money leaves the budget, but the effect is the same as giving that money as a grant.
• It matters because, unlike a grant, it is not voted by Parliament each year. Large amounts can build up quietly, narrow the tax base and keep tax revenue low.

Formula (for one taxpayer): Tax forgone = Amount of deduction or exemption × Tax rate (marginal slab rate)

Explanation

How it works

• The government has two ways to help a person, a firm or a sector:
• Spend money, such as a grant or subsidy. This shows up as expenditure in the Budget.

• Collect less tax through an exemption or a deduction. This shows up only as lower receipts.

• Both put the same amount of money in the hands of the person who gets the benefit.

• The second route is harder to see, so it is called a hidden subsidy or an indirect subsidy.

Worked example

• A taxpayer in the 30% slab claims a ₹1.5 lakh deduction.
• Tax forgone = ₹1.5 lakh × 30% = ₹45,000 (ignoring cess).
• Add this up over crores of taxpayers and you get the total tax expenditure for that deduction.
• Note: the same ₹1.5 lakh deduction saves only a small amount for someone in a low slab. It saves the most for people in the highest slab. So deductions help richer taxpayers more.

Its forms

• Exemption: some income is kept out of tax completely. Example: most farm income in India.
• Deduction: an amount is subtracted from taxable income, as in the example above.
• Rebate: an amount is cut directly from the tax payable.
• Concessional rate: a lower tax rate for some activities or regions.
• Tax holiday: a temporary full or partial exemption for new firms or new investments.
• Tax incentives: concessions meant to change behaviour, for example to draw industry to backward areas or to attract foreign investors.

Why it grows or shrinks

• It grows when:
• new incentives, holidays or deductions are added;

• existing concessions have no sunset date (an end date after which new claims are not allowed).

• It shrinks when:

• the government offers lower rates in exchange for fewer exemptions, which is the logic of the new income-tax regime;
• old incentives reach their sunset date and end.

Costs of tax expenditure

• Revenue loss: less money for health, education and capital spending.
• Distortion: firms pick a location or activity to get the tax benefit, not because it is the most efficient choice.
• Complexity: more complicated rules, more lawsuits and more disputes.
• Unfairness: most of the benefit goes to richer taxpayers and firms.
• Weak scrutiny: it is not voted each year the way spending is.

In India

Reporting

• India has reported tax expenditure every year since 2006-07 [2].
• It was first published as a separate "Statement of Revenue Foregone" [2].
• From Budget 2016-17, it became an annex to the Receipt Budget and is now called the "Statement of Revenue Impact of Tax Incentives" [2].
• The Receipt Budget is the Budget document that explains where the Centre's money comes from.

NCERT view

• Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal, says that tax incentives (for example, for industries in backward areas and for foreign investors) "further reduced the scope for raising tax revenues".

Tax holidays in law and policy

• SEZ units: income-tax holiday under Sec. 10AA. It applies only to units that started operations by 31 March 2020 (the sunset date).
• Budget 2026-27 (verify current):
• extended the IFSC-unit tax holiday from 10 to 20 years;
• gave a tax holiday until 2047 for cloud services offered from Indian data centres.

Moving away from exemptions

• Under the new regime for 2025-26, no income tax is payable on total income up to ₹12 lakh, except special-rate income such as capital gains [4].
• The idea is low rates plus few exemptions. This means less tax expenditure, simpler compliance and fewer disputes.

Why it matters for India

• The Centre's gross tax revenue is only 11.2% of GDP (BE 2026-27) [1]. BE (Budget Estimate) is the figure planned in the Budget.
• The OECD average tax-to-GDP ratio is 34.1% (2024) [3].
• Many exemptions are one reason India's tax base is narrow and its ratio is low.

Don't confuse with

• Direct (explicit) subsidy: this is money actually spent from the Budget and voted by Parliament. Tax expenditure is revenue not collected. It shows up only as lower receipts and is not voted each year.
• Tax evasion / tax avoidance: evasion is illegal, for example hiding income. Avoidance is legal, for example using loopholes. Both are losses the government did not intend. Tax expenditure is revenue the government gives up on purpose, as policy.
• Tax holiday: this is one type of tax expenditure. It is time-bound and meant for new firms or investments, such as Sec. 10AA for SEZ units. Tax expenditure is the wider term that covers all exemptions, deductions, rebates and concessions.
• Tax elasticity / buoyancy: these measure how revenue responds to GDP growth. Tax expenditure measures revenue given up through concessions. It does not measure how revenue responds to growth.

Prelims Hooks

• Tax expenditure = revenue given up through exemptions, deductions, rebates and concessions. It is a hidden subsidy and is not voted annually.
• Reported every year since 2006-07. It was first called the "Statement of Revenue Foregone" [2].
• Since Budget 2016-17, it has been the "Statement of Revenue Impact of Tax Incentives", an annex to the Receipt Budget, not the Annual Financial Statement [2].
• Trap: the Sec. 10AA SEZ income-tax holiday is available only to units that started operations by 31 March 2020.
• Tax forgone on a deduction = deduction × marginal rate. For example, ₹1.5 lakh × 30% = ₹45,000. So deductions benefit higher-slab taxpayers the most.
• New regime 2025-26: zero tax on total income up to ₹12 lakh (except special-rate income such as capital gains). The logic is lower rates in exchange for fewer exemptions [4].

Mains Points

• Hidden subsidy with weak accountability (GS-III, GS-II)
• Tax expenditure escapes the yearly vote in Parliament, unlike direct spending.
• Most of the benefit goes to richer taxpayers and firms, because deductions are worth more in higher slabs.

• Remedy: publish it regularly (already done through the Receipt Budget annex [2]), add sunset clauses, and review each incentive to check whether it achieved its aim.

• Widening the base, not raising rates

• India's Centre gross tax is 11.2% of GDP (BE 2026-27) [1], compared with an OECD average of 34.1% (2024) [3].
• Cutting exemptions widens the base, which allows moderate rates. This puts the economy on the efficient side of the Laffer curve (the idea that very high rates can reduce revenue).

• NCERT notes that rate cuts after 1991 did not raise revenue on their own. Rate cuts work only when exemptions are also removed, as the 2025-26 ₹12 lakh limit tries to do [4].

• Trade-off: investment vs revenue

• Targeted holidays, such as IFSC units (10 → 20 years) and data centres (until 2047) in Budget 2026-27, aim to attract investment and build new sectors.
• But they cost revenue, distort where firms locate and add complexity.
• The global minimum tax follows the same logic at world level. It limits a "race to the bottom", where countries keep offering bigger tax incentives to compete for investment.

Related concepts

• Tax incidence
• Laffer curve
• Tax buoyancy
• Tax elasticity
• Tax-to-GDP ratio
• Tax holiday
• Tax incentives

Read more

• Economics of taxation: incidence, revenue response, tax-to-GDP and tax expenditure