Taxes and their possible functions

Social acceptance of the tax system and due compliance with the tax obligations are essential. On the other hand, these adequately designed instruments, within the fiscal policy and in interaction with others, are also potentially relevant for promoting economic stability, generating working, investment and productive innovation incentives. They are also appropriate for responding to negative externalities such as pollution and other social harms, improving the distribution of income, forging democratic bonds, among other uses. In sum, they promote the integral and inclusive development of the countries which is so necessary for the Region.

The current complicated situation in Latin America

In recent times, Latin America has been evidencing a very complicated and complex economic and social situation, with high political instability and institutional weakness, due to structural economic problems, high levels of poverty and the strong concentration of revenues, the highest in the world. The Economic Commission for Latin America and the Caribbean (ECLAC)[1] has identified obstacles that prevent social development; among others, embedded poverty (30.2% of the population  and 10.2% in extreme poverty in 2017), chronic inequality (which was reduced, with a certain slowdown in the past years), gaps in education, health and access to basic services, lack of investment at the social level and other emerging issues such as climate change, violence, new technologies, etc.

The 2030 Agenda for Sustainable Development (United Nations, 2018) provides a transforming vision toward economic, social and environmental sustainability and a historical opportunity for the eradication of extreme poverty, reduction of inequality in all its dimensions, inclusive economic growth with decent jobs for all, sustainable cities and climate change, among othersand to which the adequate design and implementation of the taxes will undoubtedly contribute.

The features of the Latin American tax systems and their possible improvements

The Prologue of the work published by the Institute of Fiscal Studies (“Tax Systems in Latin America”)[2], prepared by Ignacio Corral Guadaño, director of the School of Public Finance of Spain, reads as follows:

The last Chapter of the book concludes as follows:

• With the heterogeneity existing in the Region, the average tax pressure is low -although Brazil, Argentina and Uruguay show relative high levels -, if compared with other regions (OECD, European Union) or with the needs for financing social expenditure and the infrastructure. It is likewise volatile, as a result of a productive structure based, mainly in some countries, on the exploitation of natural resources and the commodities. In the Region, the average tax pressure is 23% of the GDP with an increasing trend through time, although slowing down in these past years, while in the OECD it is around 34%[3].
• Regressive tax systems, due to the strong relevance of indirect tax collection, particularly VAT.
• It is observed that direct taxes have acquired greater relevance through the years. Worth noting is the collection of corporate taxes, and although being pending matters, the individual income tax and the net worth tax.
• Although specific excise taxes have lost relevance, they continue to be important sources of collection, as well as the tax on financial transactions.
• There is still much to be done with respect to environmental taxation, although one should point out achievements in international taxation and electronic invoicing.
• The Tax Administrations (TAs) play a crucial role ensuring that the tax policy may end up being what they are able to apply. With advances and improvements in management, there is still a long way to go in order to simplify, facilitate and reduce the compliance cost. Digitalization, professionalization and administrative cooperation constitute the path.

The OECD encourages[4] the use of tax policy for developing economic agendas that may promote inclusive growth, in the sense that benefits may be shared in a more equitable manner. It is recommended that in the design and implementation of taxes, consideration be given to its role in inclusive economic growth. The options for designing tax policy should consider:

• Expansion of the tax bases and elimination of tax expenditures that are not in tune with the redistribution objectives.

• Improvement of the progressiveness of the tax system beyond the individual income tax and bearing in mind the global progressiveness of the tax systems and the respective benefits.

• Adoption of the necessary measures in relation to behaviors and opportunities, including incentives that may lead individuals to develop, accumulate in an optimal manner and use human capital and knowledge.

• Improvement of the tax policy and strengthening of the TAs to reduce the size of the informal economy.

Lastly, it is worth adding that the following are crucial for achieving an effective inclusive growth:

• Given their economic relevance in the Region, special consideration should be given to small and medium taxpayers, as well as achieving a sensitive balance between facilitation of formality and discouraging fiscal dwarfism.

• Electronic invoicing and documentation is an important aspect in its double facet. On the one hand, to facilitate compliance and reduce the cost of compliance (achieving greater competitiveness) but, on the other, serving as an almost immediate control tool.

• The new paradigm of international taxation introduces the need to review and strengthen the design of the tax systems. In particular, direct taxes as well as to promote the role of the TAs in this complex field, as stated in the BEPS project, especially with respect to the progress of digitalization of the economy. Thus, in addition to facilitating and controlling integral and timely compliance, the TAs should also ensure that taxes be paid in the jurisdiction wherein value is generated, for which purpose international administrative cooperation is essential.

Final statements

There are no universal recipes. Some developed countries have worked better with high taxes, while others did so with lower rates. The amount of collection is not the only relevant aspect, but also of the type of taxes, how they are spent and in broad terms, the model of society wherein they are applied. Accordingly, when making recommendations one should not only consider the level of tax pressure or the tax rates in an isolated manner.

In these last decades, the tax burden has increased in the region, approaching the OECD’s mean. Nevertheless, the redistributive effects which taxation produces in those countries have not yet been evidenced in the Region. In addition, the problem is that there has been a greater increase in expenses. In many countries there is room for increasing taxes; in some VAT and individual income tax in the majority, although without disregarding the fact that excessively high rates discourage savings.

Lastly, one of the great challenges is to reduce the evasion levels, which according to ECLAC estimates reached 6,3% of GDP in 2017.

[1] “Los ocho obstáculos al desarrollo sostenible de América Latina”, 3/10/19: https://news.un.org/es/story/2019/10/1463292
[2] The digital book may be consulted at: https://www.ief.es/docs/destacados/publicaciones/libros/op/2017_SistemasTributariosAL.pdf
[3]Tax Statistics in Latin America and the Caribbean, prepared by OECD, CIAT, IDB, ECLAC (2019). The countries with less tax pressure are Guatemala (12,6% of GDP), Dominican Republic (13,7%) and Peru (16,1%). At the other extreme there is Cuba (41,7% of GDP), followed by Brazil (32,2% of GDP) and Argentina (31,3%). The experts consider Cuba as a separate case, given the particular characteristics of its economy, which differs from those of the rest of the region.
[4] “The governments should use the tax systems to promote the inclusive growth agenda”, 20/07/16.

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