Implementing the policies we have discussed so far means financing them. Fiscal policy — how revenue is raised and expenditure allocated — constitutes the core of public policy and sets the political equilibrium in a society. In a democracy, voters’ preferences for the amount and type of redistribution shape important aspects of fiscal policy and, in turn, fiscal policy influences their perceptions about the level and quality of services delivered by the public sector.

Never simply secondary or technical concerns, for most countries in Latin America they are particularly important given that their social contracts are extremely weak or in some cases broken.

What then is the role of the region’s middle sectors in shaping the social contract and fiscal policy? Do its members demand more social insurance? Would they be willing to pay more taxes to finance more or better public services? This chapter explores these issues, in particular the attitudes of the middle sectors towards taxation and redistribution. It also looks at the other side of the coin: the effects of fiscal policies on the middle sectors. Are they a net contributor or recipient? Which expenditures and taxes redistribute the most? A detailed tax-benefit incidence analysis for Chile and Mexico sheds some light on these issues.

A better understanding of how perceptions on the role of fiscal policies are formed and the practical effects these policies have on income distribution are vital steps in an informed debate on alternative ways to finance and deliver essential services in the region.

1 Throughout the region this is reflected in tax revenues that are low relative to GDP, the corresponding importance in the public finances of non-tax revenues which are often linked to volatile commodity prices, high levels of tax evasion, and a tax structure biased towards indirect taxes. Most governments find themselves unable to raise the resources needed to deliver the level of public services necessary for development; while at the same time the quality of public services such as education and health is low compared not only with OECD countries but their developing peers. The tensions inherent in this weak social contract have come to the fore since the mid-1980s as countries in the region have increasingly embraced democracy.