This blog was first published by the Center for Global Development (CGD) and the Council on Economic Policies (CEP).
In an earlier blog post, we argued that rationalizing tax expenditures (TEs)—comprising exemptions, deductions, and reduced rates providing preferential tax treatments for specific groups of individuals, regions, or sectors—is critical to enhancing the capacity of low- and low-middle income countries (LMICs) for domestic resource mobilization (DRM) and to finance development. When we wrote it, these countries were recovering from the COVID-19 pandemic and beginning to feel the effects of Russia’s war with Ukraine, which intensified over time.
In this blog, we argue that the case for streamlining and reforming TEs has become even more urgent. This urgency arises from recent developments including the decisions by the United States and the United Kingdom to significantly reduce their international aid budgets coupled with expected increases in defense spending in most major donor countries, and the unsustainable debt levels in donor countries as well as in several aid-receiving countries.
The new reality: declining international aid and high debt
In March 2025, the Trump administration announced the elimination of over 80 percent of aid programs channeled through USAID operations. The US was the largest official development assistance (ODA) contributor in absolute terms, with a strong focus on the poorest countries.
The recent reduction in the UK’s ODA from 0.5 percent to 0.3 percent of gross national income (GNI), aimed at increasing allocations for defense, adds further pressure. France and Germany have also reduced their aid budgets in recent years, and may decide on further reductions to increase military spending in the face of rising health and pension outlays. In addition, several donor nations have high debt-to-GDP ratios and have little room to raise taxes, particularly in the face of a weak growth outlook.
The recent announcement by the Trump administration to implement sweeping tariffs is likely to adversely affect the fiscal positions of donor countries. The resulting disruptions in international trade are expected to dampen global economic growth and reduce government revenues in donor countries, affecting their ability to provide aid even further.
At the same time, many LMICs are grappling with high levels of debt. According to a recent World Bank report, debt servicing costs for these economies have reached record highs, consuming a growing share of government revenues. Low-income countries spent a record USD 1.4 trillion to service their foreign debts in 2023, as interest costs climbed to a 20-year high.
With limited access to concessional financing and reduced international aid, LMICs must strengthen DRM. One underutilized strategy for that is the rationalization of TEs. According to the IMF, LMICs have the potential to increase their tax-to-GDP ratios by up to 8 percentage points through stronger public institutions and improved tax design, which includes reforming TEs.
The role of tax expenditures in public finance
TEs are widely utilized by governments globally, resulting in a significant revenue loss. According to the Global Tax Expenditures Database (GTED), on average, TEs amount to around 4 percent of GDP and 25 percent of tax revenue worldwide. These figures have remained relatively stable since 1990, the first year for which GTED provides data. Revenue forgone from TEs among LMICs, on average, stands at around 2.5 percent of GDP and 20 percent of tax revenue.
These estimates likely underestimate the true magnitude of revenue forgone, as transparency in this area is often lacking. Indeed, estimating the actual fiscal impact of TEs is challenging. The issue is not confined to LMICs; many high-income countries (HICs) also suffer from limited transparency in TE reporting. The Global Tax Expenditures Transparency Index (GTETI) reveals that both LIMCs and HICs often fall short in providing comprehensive and detailed TE reports. That said, LMICs generally lag behind HICs due to limited capacity and resources. For instance, many LMICs report only partial TE information, or only estimate the cost of a subset of their TEs.
Governments use TEs to pursue different policy objectives such as encouraging investment, boosting research and development, fostering a green economy, and addressing inequality. When benefits from TEs exceed their costs, the revenue forgone, even if significant, can be justified. However, the empirical evidence regarding the cost-effectiveness of TEs is scant, and often mixed. When it comes to the use of tax incentives for investment, for example, the evidence shows that redundancy ratios (the share of investment that would have taken place even with no tax incentive) in LMICs is around 80 percent and, in some cases, can be even higher. Additionally, TEs tend to be highly regressive, with most of the benefits accruing to the better-off. The negative distributive impact of TEs is exacerbated in countries with high levels of informality as informal workers do not pay direct taxes (very often, they do not even file tax returns) and hence, are excluded from the group of beneficiary taxpayers.
Comprehensive tax expenditure reform: a phased approach for LMICs
Comprehensive TE reform is a complex, long-term process that requires both immediate and sustained efforts. LMICs can begin with targeted short-term measures to enhance DRM, laying the groundwork for broader fiscal reforms.
- Leverage existing reviews to identify areas for action: Where available, LMICS should use existing assessments to identify TEs that are inefficient, poorly targeted, or misaligned with their development objectives. This would enable governments to identify specific areas for action and prioritize TEs in need of further evaluation and reform.
- Strengthen tax expenditure reporting: The ministry of finance (MoF) should take the lead in improving the quality, transparency, and coordination of TE reporting. This includes engaging relevant stakeholders—e.g., line ministries and investment promotion agencies—to contribute to the process. Comprehensive and accurate reporting is essential for informed decision-making and public accountability. TE reports should meet three key minimum standards:
- Regularity: Reports should be published at regular intervals;
- Transparency: All TEs should be publicly disclosed; and
- Specificity: Reports should include detailed information on each provision, including revenue forgone estimates and the policy objective it pursues.
- Define a sound communication strategy: To fully realize the potential of TE policy, the government must adopt a well-defined communication strategy—particularly around TE reporting. This can help dispel common misconceptions, such as the belief that “all tax expenditures are wasteful” or that “revenue forgone could automatically translate into revenue gains.” Governments should issue a press release upon publication of the TE report outlining its objectives and addressing potential misunderstandings. They should also ensure that all relevant stakeholders—e.g., civil society, parliamentarians, and the private sector—receive timely and tailored information to increase the likelihood of successful reform.
- Mandate ministry of finance oversight for new tax expenditures: Governments should establish an ex-ante assessment framework requiring that proposed TEs be reviewed by the MoF. This central oversight ensures alignment with national fiscal policies and broader economic goals.
By implementing these measures, LMICs can make meaningful progress in enhancing DRM in the short term, while laying the foundation for a more transparent, equitable, and efficient tax system.
Ideally, these initial reforms should be embedded within a broader, long-term strategy for comprehensive fiscal transformation. This agenda should include:
- Improving governance across the tax expenditure policy cycle. Robust governance mechanisms are essential. This includes strengthening parliamentary oversight of TEs to ensure elected officials are actively involved in scrutinizing and approving TEs. This may require institutional changes, along with investments in the capacity and technical skills of parliamentarians and their supporting bodies e.g., parliamentary budget offices. In the short term, the MoF should lead TE policy, but in the medium term the role of the parliament should be significantly reinforced.Improved data sharing protocols are critical. All stakeholders should have access to reliable and timely data on TEs to enable evidence-based analysis and accountability.
- Engaging on ex-post evaluation of tax expenditures. Systematic evaluation is vital for improving policy design. Without rigorous ex-post evaluation, it is difficult to disentangle between cost-effective provisions and those that are redundant, too costly, inefficient, or yield unintended consequences. However, such evaluations are data- and resource-intensive, posing challenges for LMICs. Support from external partners is crucial for building this capacity.
- Enhancing regional and international cooperation in the tax expenditures field. Development partners such as the International Monetary Fund, the United Nations, and the World Bank have committed to assisting developing countries in analyzing and managing TEs. The TaxDev initiative (by the Institute of Fiscal Studies and ODI) aims to improve effective tax policymaking in LMICs through partnerships with governments and researchers, with successful experiences in countries such as Ethiopia, Ghana, Uganda, and Rwanda. Regional partners—e.g., African Tax Administration Forum and Inter-American Center for Tax Administrations—and other forums such as Regional Workshops on Tax Expenditures co-organized by the Addis Tax Initiative, Center for Economic Policies, and the German Institute of Development and Sustainability, offer platforms for peer exchange and shared learning.