Where is the Money? Taxation Reform in Latin America

Frequent headlines about drug cartels, illegal immigration, and social friction in Latin America often overshadow other policy issues of equal importance for the region. Take, for example, taxation. In a 2012 report, “More than Revenue: Main Challenges for Taxation in Latin America and the Caribbean,” Teresa Ter-Minassian of the Inter-American Development Bank summarizes the current challenges facing tax systems in Latin America and outlines a potential road forward.

The author identifies various challenges in tax system operations and explains how existing fiscal policies are exerting a substantial burden on Latin American economies.

Ter-Minassian highlights numerous consequences, including the lack of efficiency in labor markets; the poor redistributive capacity of current tax structures; the disproportionate impact of consumption taxes on low-income populations; the poor tax enforcement and auditing procedures; and the absence of decentralized tax revenue systems.

The report focuses, in part, on the poor redistributive capacity of tax structures and explores how the lack of successful vertical equity policies have transformed Latin America into the most unequal region in the world. Part of the problem, Ter-Minassian argues, arises from the inadequate targeting of social programs and the resistance of politically powerful economic elites to the redistribution of income through taxation. The author attributes a large part of the redistributive blame to the burden that consumption taxes, such as the Value Added Tax (VAT), exert on lower-income sectors of society. Currently, Ter-Minassian explains, “the lowest quintile of the population pays nearly two and a half times more (as a percentage of its income) in VAT than the highest quintile.”

Among other reforms, the author suggests modifying the VAT to make it more equitable and efficient. To achieve this, Ter-Minassian recommends a two-pronged approach; “taxing all goods and services subject to the VAT at a unified rate, complemented by a limited number of excises on goods (such as alcohol, tobacco, and fuel products) whose consumption is to be discouraged,” and then “redistributing all or part of the additional revenues from this reform to lower income groups adversely affected by it.”

In addition to exploring short-term problems and reforms, the report also discusses broader middle to long term macroeconomic challenges facing the region. These challenges include the low national savings and investment rates, the poor investment on human capital, the return in some countries to protectionist measures, the aging population, and the region’s dependence on revenues from volatile and exhaustible resources.

Given the significant difference in political, economic, and public finance systems that exist across Latin America, it is not possible to package regional tax challenges and potential solutions into a “one-size-fits-all” approach. Ter-Minassian recognizes this and suggests viewing the report as a sketch, rather than a detailed roadmap, that lays out the broad taxation problem facing the region. The proposed reforms provide an overview of what the Inter-American Development Bank believes should be done to make tax systems in Latin America more reliable, more equitable, and more efficient. It remains to be seen what — if anything — Latin American policymakers will do to resolve these challenges.

Feature Photo: cc/Alex E. Proimos