TAXATION AND FISCAL POLICY IN

LATIN AMERICA

Christian Daude OECD Economics Directorate

• Trends and tax mix in LAC

• Efficiency and equity challenges

• Tax morale and political economy of reform

Outline

0

5

10

15

20

25

30

35

40

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Diferencia (A-B) AL1 (A) OCDE (34)2 (B)

LAC’s gap in the tax burden (% of GDP) relative to the OECD has

been declining slowly since the 1990s

Main factors behind this convergence: • Economic growth • Commodity prices • Tax policy and administrative reforms

… but there is a lot of heterogeneity across countries in the

region

0 10 20 30 40

OECD (34)

LAC (18)

Guatemala

Dominican Republic

Venezuela

El Salvador

Honduras

Paraguay

Peru

Panama

Nicaragua

Colombia

Mexico

Ecuador

Chile

Costa Rica

Bolivia

Uruguay

Brazil

Argentina

Tax revenues (as per cent of GDP) in 2012

Tax to GDP ratios have increased in most LAC countries

ARG

BOL

BRA

CHL COL

CRI

DOM

ECU

SLV

GTM

HON

MEX

PAN PRY

PER

URU

VEN

NIC

5

10

15

20

25

30

35

40

5 10 15 20 25 30 35 40

20

12

1990

Mainly in the last decade

BRA ARG

URU

CHL CRI

MEX

PER

COL

DOM

SLV

VEN

GTM

ECU

HON

PAN

PRY

BOL

NIC

5

10

15

20

25

30

35

40

5 10 15 20 25 30 35 40

20

12

2000

OECD countries present a stable tax mix, while in LAC taxes

on income and profits are becoming more important

0

10

20

30

40

50

60

1990 92 94 96 98 2000 02 04 06 08 10 2012

LAC

0

10

20

30

40

50

60

1990 92 94 96 98 2000 02 04 06 08 10 2012

OCDE

… although taxes on goods and services continue to be

predominant

25.4

16.9

33.8

17.7

6.2

Impuestos sobre la renta y las utilidades Contribuciones a la seguridad social

Impuestos generales sobre el consumo Impuestos específicos sobre el consumo

Otros impuestos

33.5

26.2

20.3

10.7

9.3

AL (18) OCDE (34)

There are several reasons for these differences

• Different tax policies, but also:

• Differences in the economic structure

• Informal labour markets

• Private pension and health systems

• Evasion

Indirect tax are a significant component of tax revenues in

most LAC countries

0 10 20 30 40 50 60 70 80 90 100

OECD (34)

LAC (18)

Venezuela

Uruguay

Peru

Paraguay

Panama

Nicaragua

Mexico

Honduras

Guatemala

El Salvador

Ecuador

Dominican Republic

Costa Rica

Colombia

Chile

Brazil

Bolivia

Argentina

1000 Income and profits/Ingreso y utilidades 2000 Social security/Seguridad social

3000 Payroll/Nómina 4000 Property/Propiedad

5000 Goods and services/Bienes y servicios 6000 Other/Otros

Most LAC countries rely on highly centralized revenue structures

0 10 20 30 40 50 60 70 80 90 100

OECD

Venezuela

Uruguay

Peru

Paraguay

Panama

Nicaragua

Mexico

Honduras

Guatemala

El Salvador

Ecuador

Dominican Republic

Costa Rica

Colombia

Chile

Brazil

Bolivia

Argentina

Central governmentGobierno central

State or Regional governmentGobierno estatal o regional

Local governmentGobierno local

Social-Security FundsFondos de seguridad social

Non-renewable natural resources are an important source of

revenue in many LAC countries

0 20 40 60 80 100

Bolivia (E.P.)

Peru

Chile

Ecuador

Argentina

Colombia

Venezuela (R.B.)

Brasil

México 7.7

12.2

3.3

3.1

14.7

2.8

4.4

9.8

2.2

Como % del PIB

PEMEX

Remarkable differences in oil revenues versus mining after the crisis

0

1

2

3

4

5

6

7

8

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Minerales y metales (5 países) Hidrocarburos (7 países)

The main part of the increase in revenues is due to price

effect, not increased production

0

100

200

300

400

500

600

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Producción del petróleo crudo (ALC) Precio de petróleo crudo Producción de cobre (Chile, Perú) Precio de cobre

Examples of some challenges reflected by tax

revenue structures in LAC

• Prevalence of indirect taxation: good for economic efficiency, but creates also challenges in terms of redistribution and automatic stabilisers.

• Little revenue raising power (or capacity) and subnational level: weaker link between public service provision, taxpayers and accountability

• High natural resource dependence can translate into volatile tax bases as a source of macroeconomic instability

Fiscal policy does little to redistribute income

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60

Arg

en

tin

a

Bra

sil

Ch

ile

Co

lom

bia

Mé

xico

Pe

rú

Paí

ses

OC

DE

no

la

tin

oam

eri

can

os

Ingreso de mercado

Después de transferencias en efectivo e impuestos

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60

Ch

ile

Mé

xico

Paí

ses

OC

DE

no

la

tin

oam

eri

cano

s

Ingreso de mercado

+ Transferencias en efectivo

- Impuestos a la renta

+ Educación (especie)

+ Salud (especie)

Source: OECD (2012), Castelletti (2013)

… creating some upward, but also downward mobility

Source: Lustig and Higgins (2012)

Fiscal mobility matrix for Brazil

The tax structure reduces the size of automatic stabilisers

Source: Daude, Melguizo and Neut (2011)

Tax semi-elasticity to output (pps of GDP)

Many not well-targeted tax expenditures

Some examples:

• VAT exemptions on essential goods and reduced rates (often also on fuels, education, health expenditures, etc.) benefit the rich more than the poor (in absolute terms) and make tax administration more difficult

Example: VAT exemptions in Colombia

Many not well-targeted tax expenditures

Some examples:

• VAT exemptions on essential goods and reduced rates (often also on fuels, education, health expenditures, etc.) benefit the rich more than the poor (in absolute terms) and make tax administration more difficult

• PIT exemptions (mortgage interest payments, investment income, capital gains, etc.) combined with high minimum exemption levels reduce progressivity and revenue raising potential

Marginal PIT rates in LAC

Source: Daude, Melguizo and Neut (2011)

Marginal PIT rates in LAC compared to OECD

Tax exemptions on PIT are significant

Source: Corbacho et al (2013)

Many not well-targeted tax expenditures

Some examples:

• VAT exemptions on essential goods and reduced rates (often also on fuels, education, health expenditures, etc.) benefit the rich more than the poor (in absolute terms) and make tax administration more difficult

• PIT exemptions (mortgage interest payments, investment income, capital gains, etc.) combined with high minimum exemption levels reduce progressivity and revenue raising potential

• CIT exemptions are widespread (Free Zones, special regimes, etc.) eroding the tax base and creating deadweight losses

Generous CIT tax expenditures are common in LAC

Source: Corbacho et al (2013)

Tax evasion is high

Source: Corbacho et al (2013)

… due to lack of enforcement and low tax morale

Tax morale in Latin America and OECD countries (“Do you think cheating on taxes is justifiable?”)

0%

10%

20%

30%

40%

50%

60%

70%

OECD Latin America

Never Justifiable Justifiable

Source: Daude and Melguizo (2012)

in part because of low levels of trust in government

the perception of low quality of expenditures

ARG

BOL

BRACHLCOL

CRI DOM

ECU

SLV

GTM

HND

MEX

NIC

PAN

PRYPER

URY

VEN

y = 0.914x + 6.23R² = 0.323

6.5

7.0

7.5

8.0

8.5

9.0

9.5

1.0 1.5 2.0 2.5 3.0 3.5

Tax

Mo

rale

Satisfaction with public education

BEN

BWA

BFA

CPV

GHA

KEN

LSOLBR

MDGMWI

MLI

MOZNAM

NGASEN ZAF

TZAUGAZMB

ZWE

y = 0.383x + 2.661R² = 0.222

2.5

2.7

2.9

3.1

3.3

3.5

3.7

3.9

4.1

4.3

1.5 2.0 2.5 3.0 3.5Ta

x D

ep

artm

en

t h

as r

igh

t to

mak

e p

eo

ple

pay

Satisfaction with improving healthcare

Latin America Africa

… and poor objective results

What can be done?

Two different levels:

– Technical improvements (reforming tax administration, factura eletrónica, etc): many of these things are taking place

– Political economy aspects of reform

Reforms will be more effective if technical reforms are part of an encompassing process of fiscal reform, otherwise results will be limited and have limited legitimacy (e.g. SUNAT reform in Peru)

What can be done?

• Current situation reflects a weak social contract: low revenues, low tax morale, high evasion, informality and bad and insufficient provision of public goods

• But it is an equilibrium (political and economic forces act to maintain the status quo)

• A good understanding of the political game is needed to coordinate a better equilibrium

Reciprocity is challenging

• Often implies inter-temporal transactions: credibility and time inconsistency issues

• Uncertainty about costs and benefits of reforms

• Capture and incentives for politician: Does the State serve primarily the common interest or is it a way to capture rents?

• “how” is often as or more important as “what”

Lack of reciprocity leads to inefficient solutions

Reforms to address credibility issues often end up:

• Constitutional amendments that fix expenditures as % of GDP or the budget envelope for certain destinations (health, education, etc.)

• Earmarking of taxes to certain expenditures

This creates:

• Budgetary rigidities in economic and political terms (“devoradores”)

• Pro-cyclical fiscal policy

• Focus on input/quantity not results and quality of public goods and services.

OECD experience with reforms shows

• Clear electoral mandates matter: This requires a political system and parties that formulate their programs around the key reform challenges

• Communication and technical background work matters to reduce the influence of lobbies and pressure groups and convince the public

• Institutions and technical capacity are key for designing and implementing reforms

• Political and institutional leadership

• Time horizon: implementation and transitions take time. It is useful to build in evaluation, learning and adaptation mechanisms

• Consultation and compensating potential losers. Bundling might be useful.

TAXATION AND FISCAL POLICY IN

LATIN AMERICA

Christian Daude OECD Economics Directorate

Some useful links

LAC Revenue Stats: http://www.oecd.org/ctp/latin-america-tax-revenues-continue-to-rise-but-are-low-and-varied-among-countries-according-to-new-oecd-eclac-ciat-report.htm

OECD-LAC fiscal initiative: http://www.oecd.org/tax/tax-global/the-lac-fiscal-initiative.htm

My papers: www.christiandaude.com

IDB book: http://www.iadb.org/en/research-and-data/dia-publication-details,3185.html?id=2013

Commitment to equity project: http://www.commitmentoequity.org/