Bridges to an Optimal Tax System

Tax systems in LAC are made up of three clear universes:

  • informality,
  • special regimes , and
  • general regimes.

In the middle of the last century, the idea of the tax policymakers was that all taxpayers should adhere to the general regime, an idea contrary to reality, while now a regime has been designed according to each situation, which has resulted contrary to simplification and proper management of the tax administration.

Current situation

Informality involves a varied sector of taxpayers in terms of income and activity, which unfortunately as a whole carries such a significant magnitude that it equals or exceeds in number the taxpayers of the formal economy[1].

In turn, the special regimes can be classified:

  • by economic magnitude (micro, small and medium-sized enterprises; individual taxpayers),
  • by economic activity (primary, transport, knowledge economy, energy, lodging, etc.) and
  • by location (border areas, inhospitable, low development, insularity, etc.).

In the end, we find the reduced general regime,[2] wherein turn we can distinguish the taxpayers who pay taxes according to the rate and the general structure, from those who have obtained specific tax benefits, especially in Income Tax , through exemptions, reduced rates, tax breaks, deferrals, accelerated amortizations, etc., which have generated the erosion of the tax base.

German tax sociology, since the 1960s, has described this process very well, which in order to achieve tax benefits, business owners allege various reasons of “public interest” of the investment to have the public opinion on their side, when in fact they only pursue their “particular interest” of maximizing their income and in LAC with the aggravating circumstance “a posteriori”, in many cases, of organizing the flight of capital to developed countries or to tax havens.

The tax islands

From the foregoing, we can conclude that the region’s tax system is currently fragmented into multiple isolated islands with different tax treatments, from which their residents do not want to leave, especially when on that island they have achieved some tax benefit compared to the general regime with full taxation[3]. It goes without saying that the best island for defaulters is the island of informality, a true tax haven within the country itself, without the need to formulate complex tax planning.

Undoubtedly, this fragmentation means that the same country does not have the same tax burden for the same turnover, added value, or profitability, as it will depend on the island of which one is a resident (informality, special regimes, the regime general with benefits or without benefits).

This reality has been reached because “politically it is very easy to grant a tax benefit, considering that many friends are won, but it is very difficult to deny or repeal it because this causes many enemies.”

The tax bridges

Instead of continuing to create more islands in this tax archipelago to increase the current tax complexity[4], and unhinge the control of any tax administration, the key would be to start building bridges to the general regime. But this general regime, in turn, should have essential qualities to have a correct functionality.

No matter how many bridges there are, if the destination of a taxpayer is an economically inhospitable, fiscally aggressive place, there will be few who want to cross it voluntarily and they will do anything to stay on their island. The desirable tax system is one that has optimal taxes, that is, a broad base and a moderate tax burden[5] that enables business development.

This is not new, as Ibn Khaldun[6] (1377) argued, claiming that “at the beginning of a dynasty, taxation generates a large amount of income from a small contribution, but at the end of a dynasty, taxation generates a small profit of a great contribution ”[7]. A concept later picked up by Arthur Laffer insofar as he maintained the relationship between tax rates and collection, arguing that after an optimal point, the increase in the rate implied a fall in the collection, which is known as “the Laffer curve”, although It should be called “the Khaldun – Laffer curve”.

Hence, in the face of this trap, it would be appropriate to walk the path towards normality and common sense, and for this, there are tax policy decisions that could be applied in the matter, among others, namely:

  • The general regime must have an optimal tax burden in accordance with the contributory capacity of taxpayers, so that it does not negatively impact the economy and therefore on voluntary compliance, for this it must have a broad base and a moderate tax burden,
  • Under the premise of fiscal responsibility, some islands should cease to exist,
  • To broaden the base, the tax benefits of the Income Tax should not be unlimited, they should have an expiration period[8]. Said extinction should be gradual with a reduction of the benefit by percentage and year. This would apply to both new and old benefits. It would be necessary to carry out a comprehensive review of the benefits granted and a weighting of the term for their return to the full general regime,
  • The bridges from informality to a special regime for small taxpayers and from this to the general regime must be “silver bridges”[9], paraphrasing Sun Tzu (5th century BC)[10],
  • The small taxpayers of a special regime, to the extent that they exceed the limits, and have to pass to the general regime, must have a bridge based on a transition regime with a gradual “in crescendo” reduction of the tax burden until its full integration[11].

Conclusion

The existence of a strengthened general regime implies that it is based on optimal taxes according to the contributory capacity of the taxpayers, that is, it has a broad base and a moderate tax burden, together with tax bridges to integrate taxpayers from informality and special regimes.

[1]Labor informality before the pandemic was 56% in LA and after the pandemic it was estimated at 62%. “Labor informality and coronavirus: a challenging combination”, Claire Bentata, Jordi Prat, Laura Ripani, BID Blog (2020).
[2]In Brazil only 157,614 companies are registered in the General Regime (2020), in Peru only 218,000 (2021), in Income Tax 3 Category.
[3]Also within an island are the taxpayers of the general regime who have obtained a specific benefit as indicated earlier.
[4]The Tax system of Chile, as of January 2020, increased to three new regimes: General Regime (semi-integrated), Pro SME Regimes, and Transparent Pro SME regime. To which are added the Presumptive Income Regime and that of taxpayers not subject to art. 14 IR. To which must be added multiple special regimes for mining, agriculture, small taxpayers, etc.
[5]Eduardo Escartin González, Francisco Velasco Morente and Luis González Abril, “Moderate Taxes according to Ibn Khaldún” (2012), Open Editions Journal, MEDIEVALIS Nro 11/2012. A great academic debate arose on whether the imposition of the “flat tax” was plausible within this concept, due to its lack of progressivity.
[6]Book “Al-Muqaddima” (“The Introduction”) (1377), “Ibn Khaldun: his life and works”, Muhammad Hozien (2010), Muslim Heritage. “The Tax Theory of Ibn Khaldun and its relevance today”, Abdul Azim Islahi (2006), Paper for presentation to the Conference on Ibn Khaldun Organizing institutions: The Islamic Research and Training Institute, a member of the Islamic Development Bank Group, in collaboration with Universidad Nacional de Educación a Distancia (UNED) of Spain, and Islamic Cultural Center of Madrid Venue: Madrid, SPAIN, November 3-5, (2006).
[7]In other words, higher taxes implied lower income, which caused an economic crisis that ended a government. The problem for Ibn Khaldun was that the bureaucrats are unaware of the business world and its spirit. This was the theme of his extensive knowledge, because he also, among other activities, worked in a time as a bureaucrat.
[8]With renewal upon expiration only for essential activities.
[9]They should not be jumps into the  unknown, but also consider certain stimuli.
[10]“The Art of War.” Point out strategies that were used for their effectiveness in various disciplines.
[11]On the other hand, the philosophy of the Tax Incorporation Regime (RIF) of Mexico that all small taxpayers must pass obligatorily to the general regime, is far from reality.

667 total views, 1 views today

Disclaimer. Readers are informed that the views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author's employer, organization, committee or other group the author might be associated with, nor to the Executive Secretariat of CIAT. The author is also responsible for the precision and accuracy of data and sources.

2 comments

  1. Asmae Tber Reply

    an excellent article. Thank you for sharing with us.

  2. Dario González Reply

    Estimado Asmae gracias por tus palabras…también quiero en este post brindar un homenaje al gran Ibn Khaldun una mente brillante que merece ser reconocido por sus lúcidos pensamientos. Muchas de sus ideas fueron adoptadas posteriormente por economistas pero sin el debido reconocimiento al padre de esas ideas, que fue Ibn.

Leave a Reply

Your email address will not be published.

CIAT Subscriptions

Browse through the site without restrictions. Consult and download the contents.

Subscribe to our electronic newsletters:

  • Blog
  • Academic offer (Only in spanish)
  • Newsletter
  • Publications
  • News alert

Activate subscription

CIAT Members

Representatives, Correspondent and Authorized staff (TA)