Tax- or royalty-based financial instruments

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The second main type of substantive treasure-based instrument involves those which are based not on direct cash transfers, but rather on indirect transfers mediated through the tax system, or in some countries, through the use of royalty systems designed to capture natural resource rents. In these systems, a government can forego tax or royalty income they would otherwise have collected from an individual, organization or firm, which serves as an incentive to targets to undertake the activity receiving favourable tax treatment; or, in the case of tools which increase taxes on certain kinds of activity, to not undertake that activity or to undertake less of it.

Tax- and royalty-based expenditures

Tax expenditures or ‘tax incentives’ come in many kinds. Maslove defines them as ‘special provisions in the tax law providing for preferred treatment and consequently resulting in revenue losses (or gains)’ (Maslove 1978; Surrey 1979). These can be ‘paid in advance’ and can be carried forward for numbers of years and, like cash-based schemes, can be ‘matched’ by other sources of funds, range in size and significance, and can be used in conjunction with other instruments.

Different subtypes exist depending on ‘where’ government tax revenue is forgone. Tax incentives generally involve deductions from corporate or personal income, meaning their actual effect on a target group is determined by the marginal rate of taxation individual persons or firms must pay. Their effect therefore varies from group to group. Tax credits on the other hand are direct deductions from taxes owed and therefore their size is the same regardless of the tax rates individual taxpayers face. Tax credits are typically the only ones which can be ‘negative’, in the sense that they can be used to push a taxpayer’s tax load beyond zero so that a refund (or real cash transfer) may ensue. However, most tax expenditures will only push a taxpayer’s taxes to zero, meaning their effect also remains conditional on the amount of taxes targets pay.

These same schemes can also be developed with transfers from non-taxbased revenue in mind, such as resource royalty payments or other forms of economic rents. Governments can, for example, promote oil and gas exploration by allowing energy companies to write off some portion of their exploration costs against royalties they would otherwise have to pay.

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