President Correa proposes a new tax reform in Ecuador

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blog-Presidente Correa propone nueva Reforma Tributaria en EcuadorThe government of President Correa has presented the draft “Organic Law on Social Spending Redistribution” to the National Assembly of Ecuador. The bill was submitted in accordance with Article 140 of the Political Constitution, which provides for a thirty-day expedite procedure for bills considered as economic emergency. The Assembly has until November 24 to make a final decision on the project. The Legislative Assembly approved the bill in first debate and the Economic and Tax Regime Commission of the Assembly has until next Wednesday 14 to submit the report for the second debate. Under the new legislation the government proposes to fund an increase of the Human Development Grant from $35 to $50, and other social expenditures.

There are two main groups of proposed measures: those that amend the taxes applied to the financial sector and those that simplify the tax system.

Measures affecting the financial sector include taxation of financial services (not intermediation) with VAT at the general tax rate, increase from 0.084% to 0.25% of the tax on assets held abroad by entities of the financial system (0.35% if it is in a tax haven), and restricting the option for reducing up to 10% of the income tax payment when the profits are re-invested in credits to the productive sector, so that it will apply only to housing loans granted by regulated cooperatives and mutual entities.

The measures that simplify the tax system and facilitate control include strengthening the obligation to provide financial information to the tax administration (fines are increased, a time limit of ten days is set, no secrecy is admitted for tax purposes), the subjection of the Popular Economy sector to the obligation to disclose information about their depositors (requested through the superintendents), the increase of the income tax advance payment to 3% of  the previous period’s taxable income (It was previously equivalent to 0.2% of the total net worth, 0.2% of total costs and expenses deductible from income tax, 0.4% of total assets and 0.4% of income subject to income tax) and that the tax on currency outflow (5%) be considered as tax credit once the corresponding return is submitted.

The proposed reform has several interesting features for the discussion of tax policy in our countries:

First, standing out from the standpoint of the legislative procedure, is the application of the constitutional provision which allows for the expedite processing of the bill in case of economic emergency. Many countries in the region would benefit from the application of a similar rule in cases of special need.

Second, the bill seeks to generate tax revenues for a specific purpose, not for the government’s general fund.  The purpose is to finance the increase of the “Human Development Grant” from $35 to $50, and pensions for low-income groups (jointly granted to 1.9 million people). The allocation of new revenues to a specific purpose is an increasingly observed feature in tax bills in the region. It is partly the result of democratic regimes with high citizen participation. It has been necessary to “pre-allocate” resources, because citizens and parliaments are not willing to authorize new taxes without knowing how resources will be used. What happens then to the old fiscal principle that objects the allocation of taxes for specific purposes in order to give flexibility to macroeconomic authorities and force those responsible for the expenditure to periodically justify their needs? The Ecuadorian proposal adopts an intermediate position: it allocates resources for a specific purpose, but allows their use in other activities with a similar purpose. This forces those in charge of the expenditure to justify why they, and not their close colleagues, should receive the new revenues. It certainly sacrifices the discretional aspect of aggregated management of the expenditure, which will have to be regulated through fiscal responsibility rules or circumstantial provisions.

Third, the bill proposes the redistribution of the income received by a specific sector, instead of applying provisions of a universal nature. It notes that the income and profits of the financial sector have increased at very high rates in recent years, and considers that they should make a greater contribution for the benefit of the poorest groups. The financial sector responded immediately: why is the redistributive effort concentrated in this sector, when there are others with a higher revenue-yielding capacity? Why discriminate against a specific sector? The issue is of relevance for all our countries. Before discussing whether or not to discriminate (positively or negatively) certain sectors, it must be borne in mind that most of the actions proposed in this specific bill seek to eliminate special benefits given to the financial sector – such as applying the general VAT rate to the services it renders, excluding intermediation- or facilitate collection – through withholdings, credits and reporting obligations.

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