The IMF has advised country authorities to roll back tax expenditures as a way to support fiscal consolidation efforts—urging them to evaluate tax expenditures according to clear criteria and assess their impact on public finances, economic efficiency, equity, and administrative and compliance costs. This paper analyzes tax expenditures in Italy, considering the extent to which tax expenditures can be considered part of an optimal tax system and possible reforms. Tax expenditures are government revenues foregone as a result of differential, or preferential, treatment of specific sectors, activities, regions, or agents. They can take many forms, including allowances (deductions from the base), exemptions (exclusions from the base), rate relief (lower rates), credits (reductions in liability) and tax deferrals (postponing payments). International comparisons are complicated by different methodologies and assessments as to what constitutes a tax expenditure, but the practice is pervasive, and tax expenditures in Italy are clearly elevated. Tax expenditures can have major consequences for the fairness, complexity, efficiency, and effectiveness of not only the tax system itself but, since they often serve purposes that might be (or are also) pursued through public spending, of the wider fiscal system.

Tax expenditures can compromise fairness. Tax expenditures can be a poor way of pursuing equity objectives: in a progressive tax system, for instance, any policy that reduces taxable income will benefit most those in the highest marginal tax bracket and convey no benefit to those out of the tax system, a potential reason for using tax credits (or spending measures) instead. The tax expenditures associated with the reduced VAT rates in Italy, for instance, in themselves increase progressivity—but much of the benefit will go to the better off, so that the same equity objectives could likely be pursued at less cost through social spending.