Indeed, tax revenues in Latin America are low by international standards. The IDB reports within the region that tax revenues, excluding social contributions, were about 17 percent on average of GDP in 2005. Yet, there are very large discrepancies in tax burdens across the countries and within states (at the sub-national level). They range from the low burdens of countries endowed with nonrenewable resources like Mexico and Venezuela (about 10 percent of GDP), to high levels in countries like Brazil (36 percent of GDP).
Surprisingly, Brazil’s tax-to-GDP ratio, at 36 percent of GDP in 2004, is already closer to the OECD average than that of the other Latin American countries. It is one of the most progressive systems within the region. But in some countries, such as Peru or Mexico, government revenue is much lower, usually in a range of 10-20 percent of GDP. This reflects the inability of the government to bring more dynamic sectors of the economy into the tax net.
Within some countries, typically larger federalist ones, financial disparities also exist between jurisdictions, which create large fiscal gaps for many state economies. For example Falleti (2004) points out that within Argentina, the city of Buenos Aires raises 92.7 percent of its own revenues and the province generates 56.1 percent, while other location like Catacmarca, La Rioja and Santiago del Estero only raise about 10-15 percent. These inconsistencies also exist in Brazil, Bolivia and Mexico (Wiener 2003)
Despite these differences, there are a number of common weaknesses in the tax systems across the region. First, there is heavy reliance on indirect and payroll taxes—representing about 75 percent of the total— which results in a regressive tax system. While in developed countries the tax system helps to reduce inequality, in Latin America it exacerbates it (Gomez Sabaini 2006). Evidences suggest that Latin American states dependency on indirect taxes (such as sales tax, value-added tax (VAT), or goods and services tax (GST)) which are collected by intermediaries, i.e. a retail stores, and not from the person who ultimately carries the economic burden of the tax, make consumer not “feel the cost” of the public good which they are consuming.
Second, the tax system is a source of significant distortions in resource allocation, and reduces the region’s competitiveness relative to other fast-growing regions such as East Asia. For instance, numerous tax exemptions (especially for VATs) and various taxes on financial transactions are commonplace. More generally, the structure of the tax system does not appear to be based on efficiency criteria (i.e. the collection of point of origin or the increase of personal income and property taxes to broaden the tax base).
Furthermore, Latin America is typically associated with high transaction costs for its tax policy. According to data from the World Bank’s Doing Business report (2009), tax rates for small businesses in Latin America are higher than in several other regions. In particular, taxes on profits are on average the second highest after Sub-Saharan Africa. The combination of low tax revenues and high tax rates points to the high incidence of tax evasion. Specifically, various studies have focused on micro-enterprises and their effective tax rate, which is the largest sector to evade taxes.
Finally, state’s ability to collect taxes, or their fiscal capture, is often lost to capital flight because individuals who earn higher salaries simply save in foreign banks to avoid income, payroll and social security taxes. The loss of savings within domestic banks also creates disincentives for investments within the region.
Traditional tax analysis originates from neoclassical theory of public finances, which seeks for more efficient and equitable ways to tax. The main policy proposals have been to simplify and broaden tax bases, lower income and corporate taxes (in order to encourage business development), promote reductions in trade tax rates through trade liberalization, and emphasize the widening and implication of VAT. Later on, property and income taxes are generally encouraged precisely because they are the most progressive taxes.
Two key variables are often disputed when discussing progressive tax reforms: administrative burden and political will for reforms. Often debates revolved around the administrative capacity of lower level governments to collect taxes. When equity concerns have traditionally been downplayed, international financial institutions have encourage the use of VAT. Yet, by simplify tax regimes, reducing the hurdles and the time required to comply with bureaucratic procedures is only one step to encourage better tax administrations. Governments must be clear on their tax rates for different citizens. Ending highly regressive VAT taxes is just one area. Tax systems must also rationalize the required payments and differences between large corporations and small and medium enterprises (SMEs). Furthermore, tax collection responsibilities should be shared among different levels of government.
Future policy recommendations must take into account the historical, political and institutional factors that have established durable tax collection capacity within states.
First, and for most, the region needs to move towards a progressive and less discretionary and distorted tax structure. Direct taxation using personal income, property taxes can increase the collection rates more than the VAT and commodity related taxes.
Another main challenge is to broaden the tax base, reducing reliance on the most distorting taxes, such as on exports in Argentina. Furthermore, resource cursed countries, like Mexico, Venezuela, Peru and even Panama with its revenues from the canal, also must diversity their tax base. Not because they need more resources to pay for public goods, but to encourage state building processes allowing citizen’s reliance on the governance system. The institutional development is essential for Latin American governments to be stronger in the future.
Finally, various economists agree that administration reforms—the management and collection of the taxes—are as important, if not more, as the kind of taxes (VAT, sale, personal income, property, social security, etc.) that a country chooses to collect. Particularly important is having sound enforcement mechanisms and an independent administration for managing collection and government re-distribution. The development and advocacy of autonomy revenue authorizes (ARA’s) are necessary, although they may not be effective to deter tax evaders. Especially with weak states, revenue collection authorities are more effective when they operate autonomously from the state (i.e. outside the finance ministries). In the same light, effective methods to deter evaders with serious consequences are also necessary and can be encouraged by the international community.
Alier, Max and Benedict Clements (2007) “Comments on “Fiscal Policy Reform in Latin America” by Miguel Braun” International Monetary Fund Working Paper.
Bird, Richard (1992)“Tax Reform in Latin America: A Review of Some Recent Experiments," published in Latin American Research Review (Vol. 27 No. 1).
de Mello Luiz 2009, Latin America’s public finances “Governments in Latin America have made enormous progress in improving their fiscal management in recent years. But what are the next steps?” OECD Observed.
Di John, Jonathan (2006) The Policy a Economy of Taxation and Tax Reform in Developing Countries, Research Paper No. 2006/74 United Nations University World Institute for Development Economic Research UNU-WIDER
Gomez Sabaini, Juan, 2006, “Evolución y Situación Tributaria em América Latina: Una Serie de Temas para la Discusión”, in Oscar Cetrángolo and Juan Gomez Sabaini, Tributación em América Latina: En Busca de una Nueva Agenda de Reformas (Santiago: ECLAC, United Nations).
Falleti, Tulia (2004) “Federalism and Decentralization in Argentina: Historical Background and New Intergovernmental Relations,” in Joseph Tulchin and Andrew Selee (eds.) Decentralization and Democratic Governance in Latin America, Washington, D.C.: Woodrow Wilson Center for Scholars, 2004, 67-100.
Lora, Eduardo (2008) “El futuro de los pactos fiscales en América Latina” Banco Interamericano de Desarrollo Working Paper 650.
Taliercio, Robert (2004) “Administrative Reform as Credible Commitment: The Impact of Autonomy on Revenue Authority Performance in Latin America” World Development Journal, (Vol. 32. No. 2).
Wiesner, Eduardo (2003) Fiscal Federalism in Latin America: From Entitlements to Market Inter-American Development Bank.
World Bank’s Doing Business report (2009), Latin America
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