Tax Systems and Tax Reforms. Some ideas on the topic (i)

We consider that a tax system is a set of taxes in force in a country at a given time.

When talking about a tax system, one must always consider the reality in which it applies. For this reason, on the one hand there is a space limit, because it applies to a specific country; and on the other, a time limit because it governs at a specific period, that is, it follows time.

The word system implies harmony between taxes and between the fiscal and extra-fiscal objectives of the state.

By its own definition, system implies that there are different elements, that there is a link between them, a specific order or form, pre-established and common objectives.  For this reason, most doctrines claim that reaching the tax system is the ideal, but what we have are tax regimes, which in many countries are characterized by unpredictability, permanent change and tax reforms for the sole purpose of tax collection.

Some of the principles that an ideal tax system should respect are:

  • Justice and equity in all taxes (horizontal and vertical equity).

  • Stability, predictability and legal certainty.

  • Neutrality, i.e. promoting the economy, not affecting the decisions of economic operators.

  • Sufficiency in the performance of public functions and services.

  • Comprehensible, simple and easy to apply.

  • Certainty, that is, clear and precise rules.

  • Economical, in the relationship between collection and system administration costs.

Each of these principles has a greater preponderance in the tax reforms faced by countries, and many of them have changed over the years.

Tax reform, by definition, consists in changing the structure of one or more taxes or the tax system, in order to improve their functioning for achieving their objectives.  Every time a tax reform is proposed there must be certain elements or steps to be followed, which are recommended for its success and implementation.

Firstly, the tax reform proposal must have a description of the proposed ideal tax system, that is, what the reform is intended to do and where it is intended to go.  It is essential to make a very good diagnosis of the current system.

In this regard, in a paper entitled: Tax Policy, What to tax, How to tax, what objectives should the tax system pursue?, written by Santiago Díaz de Sarralde Miguez[1], a diagnosis is made of the fiscal situation in Latin America and the Caribbean; it concludes that there is relatively low fiscal pressure: 22.8% of GDP, 11.5% less than the OECD (2015). However, there are large differences between countries in levels of taxation (ranging from 12.4 per cent in Guatemala to 13.7 per cent in the Dominican Republic; up to 32.0 per cent in Brazil, 32.1 per cent in Argentina and 38.6 per cent in Cuba). In addition, the region has a strong reliance on indirect taxation (nearly 50% of the total) and of the corporate income taxation than the OECD. On the other hand, there is a lower share of personal income taxation (8.8% of the total, 24% in the OECD) and Social Security contributions (16.4% as against 26.2%).

The study highlights the high inequality in the income distribution, and the limited redistributive powers of the fiscal policy (in the OECD, the Gini inequality index is 0.47 – it is reduced by 36%; whereas, in LAC a 6% -starting with a Gini Index of 0.5-).

It also warns of the high informality (41% versus 17% of OECD) and high evasion, especially on the income tax of legal entities.

According to the latest study published by ECLAC, the evasion in the region is 6.7% of GDP.  All this has a high impact on the erosion of the tax bases and the shifting of profits to avoid taxation.  In addition, the high tax expenditures (around 30% of potential revenue) are highlighted. The document synthetically says that we must start from the economy and then to see the public spending.

In this way, public revenues and taxes will have to be determined. The paper affirms the fundamental role of the personal income tax as a mechanism to reduce inequality.

I understand that as long as the tax system is analyzed, the whole public spending of the country should be analyzed together and also what is known as tax expenditures, which is the amount of income that the state ceases to receive, by granting a tax treatment that departs from the general norm established in the tax legislation, with the objective of benefiting certain activities, zones or taxpayers (examples exemptions, deductions from the tax base, reduced tax rates).

It is very important to estimate tax expenditures in order to bring transparency to the tax policy, to measure the potential of the tax system and the performance of the administration.

As for the tax expenditure, in public spending it becomes essential to check permanently its efficiency and propose the necessary corrections; this being a key to transparency.

I am convinced that one of the ways to be more efficient in these aspects is to make them transparent, as this is the best ally to fight against one of the main evils, which is corruption.

I highlight a recent work entitled: “The Fight Against Corruption in the state” [2], which says that no country is immune to corruption. The abuse of public office for personal gain undermines the trust of the population in the government and the institutions, undermines the effectiveness and equity of public policies, and embezzles the money of the taxpayers originally intended for schools, roads and hospitals.

There, more than 180 countries were analyzed, and the study concludes interestingly that that the most corrupt countries collect less taxes, since people pay bribes to avoid them, for example, through tax loopholes conceived in exchange for bribes. Moreover, when taxpayers believe the state is corrupt, tax evasion becomes more likely.

The study states that, globally, less corrupt governments collect 4% more of GDP in tax revenues than countries at the same level of development that have the highest levels of corruption.

I fully share this analysis by pointing out that tackling corruption is a challenge that requires perseverance in many areas, but that it certainly has enormous dividends beyond, obviously in the tax field.  As stated in the study, the political will is key, along with a continued strengthening of institutions to promote integrity, greater transparency, accountability and international cooperation.

next -> Tax Systems and Tax Reforms. Some ideas on the topic (ii)


[1]     Working documents CIAT 3 – October 2017.

[2]     Vitor Gaspar, Paolo Mauro and Paulo Medas

 

 

 

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