Main Trends in the Region’s Public Finances
Despite the recent crisis, progress in public finance in the last decade has been remarkable. Public spending has been more efficient, especially in terms of poverty reduction and income redistribution. This has been possible thanks to increases in tax revenue and a reduction in the level of public debt. Not only has the public debt fallen since the 1990s, from levels of almost 80% of GDP to levels close to 30% in recent years, but its composition has also changed, with a greater proportion of domestic debt (Figure 3.1a). In addition, public investment and social expenditure have increased in almost the entire region.
The generation of primary surpluses during the last boom phase helped reduce public debt levels as a share of GDP. economic growth, discretionary adjustments and to a lesser extent the appreciation of currencies and a fall in interest rates also contributed to reducing debt levels. The period 2003-08 was characterised by a strong widespread reduction of public debt, with governments applying both discretionary and rules-based policies to that end.1 this allowed countries to face the crisis under better conditions, and it is also a factor explaining the dynamism of Latin American economies seen in 2010 and into 2011.
Moreover, the increased public deficit that followed the international financial crisis that began in 2008 did not lead to an increase in public debt as a percentage of GDP, in contrast to what happened in most OECD economies. In fact, this deficit was financed primarily with existing financial assets. Although the crisis resulted in deterioration of the public sector balance sheet, the outlook is for a quick recovery of tax revenue, at least in much of South America.
Latin America & Caribbean (19 countries): Increase in Fiscal Space, 1990-2009
As a result of greater tax revenue, since 1990 public spending has increased in most Latin American countries, augmenting by almost six percentage points of GDP on average in the region (Figure 3.1B). Capital expenditure has increased considerably from a low of 2% of regional GDP in 1990 to almost 5% in 2009. In regard to current expenditure, there has been a notable drop in interest payments on public debt as a percentage of the total; the regional average has dropped from 15% to 7%, reflecting the overall reduction in debt and changes in its cost and maturity profile. These changes have resulted in a decrease in budget rigidities and therefore the expansion of fiscal space.
Given regional infrastructure gaps, public investment is an important indicator of the quality of public spending. On this dimension, the Plurinational State of Bolivia, Chile, Ecuador, Panama and Peru have significantly recovered their levels of capital expenditure, compared to 1990. National public investment systems in these countries have acquired a leading role to evaluate the quality and relevance of this investment spending. By contrast, Colombia, Costa Rica, Haiti, the Dominican Republic, Mexico and Uruguay have seen investment spending decrease or slower growth in this type of expenditure; although development plans in these countries include ambitious targets for the expansion of public infrastructure in the coming years that could reverse this trend.
Levels of public social spending in the region continue to vary (Figure 3.2). This in part reflects the diversity of models for the provision of public goods and services, especially in pensions and health care. But it also reflects the low level of coverage in some countries of essential public goods. However, the region has made significant progress in this area in aggregate terms, with an average increase of more than 5 percentage points of GDP according to ECLAC estimates.However, the region has made significant progress in this area in aggregate terms, with an average increase of more than 5 percentage points of GDP according to ECLAC estimates.2
Although spending at the sub-national level in terms of GDP is lower than in OECD economies (9.5% vs. 18.6% of GDP, respectively), own revenues are proportionally lower (Figure 3.3), generating significant vertical imbalances. In many countries, the states, provinces, regions and municipalities are heavily dependent on central government transfers. There are significant regional differences in terms of per capita income, which reveal deep horizontal imbalances. As financial compensatory mechanisms are limited in Latin America, in contrast to many OECD economies, these regional disparities are not mitigated.
Latin America, Caribbean & OECD Average: Structure of Social Spending by Sector, 2008
Latin America, Caribbean & OECD: Tax Revenue by Level of Government & Tax Category, 2008
Latin America and the Caribbean face significant fiscal challenges: the tax burden is generally low, the structure is biased towards non-progressive taxes and the non-payment of taxes is significant.3 in comparison with OECD economies, in most countries in the region the low tax burden limits the scope for action on the expenditure side (Figure 3.4). in this regard, there is no single formula for all countries;4for example, in Guatemala, Peru and the Dominican Republic, the lower tax burden is a constraint on increasing public spending, while economies such as Argentina and Brazil could aim for a higher quality of spending in terms of both allocation and effectiveness.
Tax & Non-Tax Public Revenue & Social Spending In Latin America & OECD, 2008
This lower tax burden in Latin America and the Caribbean in comparison to OECD economies is not only explained by the region’s lower level of development. It is evident that countries with a higher GDP per capita tend to have a larger public sector and a greater tax burden. However, several studies that take “level of development” into consideration show that the revenue potential of countries in the region is considerably higher than their actual collection.5 this is explained by a number of factors: the importance of productive activities that involve raw materials, which result in non-tax revenues that can make it less important to increase tax revenues; the level of informality in the labour market, tax evasion; and different designs for health and pension reform the latter significantly impact on the collection of personal income tax and the social security contributions of workers and employers).
Tax Statistics in Latin America
A comparison of the tax systems of Latin American countries with those of OECD economies shows that there are significant differences in terms of level and structure. While the tax burden was 34.8% of GDP for OECD economies in 2008, the corresponding figure for selected countries in Latin America was only 20.6%. Additionally, in comparison to the OECD, Latin America has a low rate of direct tax collection, offset by higher revenue from indirect taxes. Given the high correlation between a government’s policy space and the level and structure of its tax revenue, knowing the reasons behind this difference may help in the design of fiscal policy reforms.
In order to provide better statistics for international comparison, the centre for tax Policy and administration and the Development centre of the organisation for economic co-operation and Development (OECD), the economic commission for Latin America and the Caribbean (ECLAC) and the inter-American centre of tax administrations (CIAT), in consultation with the Inter-American Development Bank (IDB), are carrying out a joint project to produce tax statistics in Latin America that can be compared among countries in the region and the OECD.
The objective of this project is to provide comparative data on tax revenue by type of tax and sub-levels of government for a sample of Latin American and Caribbean countries (Argentina, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, el Salvador, Guatemala, Mexico, Peru, Uruguay and the Bolivarian republic of Venezuela) from 1990 to the present. This group of countries represents a high percentage of the region’s GDP and population (around 90% in both cases). The data obtained (from data published by Latin American governments and in some cases by participating organisations) have been edited and reclassified based on the methodology defined in the OECD publication Revenue Statistics. This has enabled the comparison of tax systems among Latin American countries for the first time, as well as a comparison between these tax systems and those of the OECD.
The main task in designing the new database was to collect tax information, classifying each item of public revenue under the new analytical framework by determining the nature of each tax and its resulting classification. Special emphasis was placed on the analysis of legislation and the regulatory frameworks of the tax systems of the countries involved in order to determine whether a specific category of income is from taxes or not, and if so, its classification based on the corresponding tax base. Detailed discussions between all organisations involved have taken place in order to reach agreement on a common methodology. In addition, special efforts were made to collect data at sub-national levels of government or from social security systems, in light of the limited coverage of certain institutional units.
This effort has resulted in a high-quality, highly detailed and internationally comparable database. The forthcoming publication: Revenue Statistics in Latin America represents the first result of a broader OECD initiative (the so-called OECD Lac initiative) to promote policy dialogue and peer review in the region, initially supported by Spain, Mexico and Chile. The continuity of this initiative in the coming years, including the possible expansion of the database to more countries in Latin America, the eventual creation of a parallel database on public spending and networks for dialogue between policy makers, would contribute to improving public debate on fiscal policy in the region.
Less than a third of tax revenue in Latin America comes from direct taxes, while the largest part arises from consumption taxes and other indirect taxes. The average tax burden in Latin American countries is virtually half of that found in OECD economies. This difference is mainly explained by lower revenue in terms of GDP from direct taxes (on income and property). On average, the direct tax burden of the countries of Latin America as a share of GDP is 9 points below that of developed countries. In fact, the direct tax burden in Latin America (relative to GDP) is lower than that of most African countries (Figure 3.5).
International Comparison Of Level & Structure Of Tax Burden
In Latin America the largest share of income tax revenue comes from corporate income. By contrast, in OECD economies taxes on personal income provide the largest share. While corporate tax revenue in the region as a share of GDP is close to the OECD average (3.4% compared to 3.9% of GDP, respectively), the region lags far behind in the case of personal income tax. Latin American countries collect on average only 1.5% of GDP from personal income taxes (even in Uruguay, the country with the highest personal income tax for which data are available, revenue from personal income tax is equivalent to only 2.2% of GDP.) In comparison, in OECD economies, revenue from personal income tax as a share of GDP is over 9%.
The income-tax base is very limited due to the combination of high income inequality, high labour informality, tax expenditures and tax evasion. Most revenue from personal income tax comes from salaried employees. This is mainly a consequence of the greater possibilities for tax fraud and avoidance among the self-employed and the preferential treatment given to capital income in most countries. this situation, also found in OECD economies, is offset in developed economies by, on the one hand, their greater capacity for control over a larger number of taxpayers (given the lower informality), and on the other, because their higher level of per capita (or family) income results in a higher percentage of the population subject to income taxes.
In Latin America, with the exception of Mexico, the income of most individuals falls below the threshold for taxable personal income.6In broad terms, a family with labour earnings starts to be a net payer of personal income tax when its income reaches more than two times the average income for the country. By contrast, in the OECD, this threshold is placed at around half the national average income. For this reason, only a minority of households in Latin America (between 10% and 30% of households with wage earnings) provide all the revenue from personal income taxes.7 in addition, the vast majority of countries give preferential treatment to capital income, reducing the tax base and increasing the complexity of tax systems, thus affecting horizontal equity.8
Income tax non-compliance rates are very high, making it essential to monitor payment of income tax. these rates vary between approximately 40% and 65%, representing an average loss of 4 to 5 percentage points of GDP for these countries.9 Tax evasion affects both horizontal equity (as taxpayers with equal capacity to pay end up paying different tax amounts) and vertical equity (as taxpayers with greater capacity to pay end up paying proportionately less than those with less capacity to pay). an increase in tax rates without adequate control may however result in an increase in hidden activities if there is a shift of firms and workers from the formal to informal sector, further hindering the ability of governments to generate resources. to combat tax evasion, which is of an increasingly international character, it is necessary to promote transparency and international co-operation based on dialogue on tax legislation.
Social contributions are low in many Latin American countries due to the aforementioned labour informality and to the implementation of private pension systems. Faced with the prospect of increased public spending because of an ageing population and inequality arising from the multiplicity of systems, the region has generally opted for reforming “pay-as-you-go” pension systems, introducing mandatory individual capitalisation accounts managed by the private sector. there are institutional differences among the countries of the region that impact on collection levels: replacement systems (the Plurinational State of Bolivia, Chile, el Salvador, Mexico and the Dominican Republic), where the old public system is closed to new registrations; parallel systems (Colombia and Peru), where workers must choose between one system and the other; and mixed systems (Costa Rica and Uruguay), where the pension comes from both systems. in all cases, new members make their personal contributions to their pension fund, not to the public sector (in some countries, corporate contributions have also been eliminated). However, in contrast with expectations, the introduction of these accounts has not resulted in increased participation in the systems, especially among low and middle-income groups most affected by unemployment and informality.10
Tax bases and collection are also limited by the extension of various tax expenditures, of which there is insufficient information and evaluation. According to official estimates, tax expenditures vary widely among countries in Latin America. Some countries show figures of around 2% of GDP (Argentina and Peru), others between 3% and 5% (Brazil, Chile, Colombia and Ecuador), while in Mexico and Guatemala the figure reaches 5.4% and 8.6% of GDP, respectively.11 These variations and levels are similar to those observed in OECD economies. While originally tax expenditures were aimed at encouraging investment (domestic and external), over time objectives became more diversified, and exemptions were extended to new taxes.12 While in Brazil, Guatemala and Mexico there is a strong concentration of tax expenditures on income taxes, in Argentina, Ecuador and Colombia Vat exemptions are larger. there is a growing consensus in the region on the need to identify and estimate tax expenditures in a manner that allows for comparison among countries (with sufficient breakdown by type of tax, sector of activity, region of destination, level of government and income group). this will make it possible to evaluate their effectiveness and integrate them into the budget cycle.13
Increases in tax revenue during the last decades have come from strengthening tax collection on goods and services (especially value added tax, Vat) and from corporate taxes (Figure 3.6). Vat was adopted very early by most economies in the region to replace the cascading sales-tax; this was the most important tax reform in the 1980s and early 1990s. Since 2000 this has been complemented with increased revenues from income taxes, thanks to booming commodity prices, which significantly benefitted taxation associated with the exploitation of natural resources in certain countries of the region, and to the introduction of simplified regimes for small taxpayers and property taxes based on imputed income. this trend contrasts with the decrease in specific consumption taxes because of trade liberalisation and the reduction of the range of goods and services subject to selected taxes. additionally, during this period extraordinary tax schemes have emerged, such as bank withdrawals and deposits and financial transactions.14
Latin America: Tax Structure, 1990-2009
The recent boom in international commodity prices has driven certain types of tax revenue upwards, especially those associated with oil (Colombia, Ecuador, Mexico and the Bolivarian republic of Venezuela), minerals (Chile and Peru) and food (Argentina and Peru). this increase in tax revenue is the result not only of these rising prices in raw materials, but also the implementation of new tax instruments. In the case of agricultural products, Argentina has financed a significant portion of its spending with the resources generated from export duties. new instruments were introduced to raise more funds from non-renewable resources, such as a direct tax on hydrocarbons and derivatives and a windfall profits tax (Plurinational State of Bolivia), a specific tax on mining (Chile), a reform of the Hydrocarbon Law (Ecuador) and increased royalties and income taxes on the oil sector (Bolivarian republic of Venezuela).
There are significant differences among countries in Latin America and the Caribbean in levels of taxation. One group of countries (mainly those in the Southern cone) has tax collection levels close to the average found in OECD economies, while a second group of countries (mainly in Central America and the Caribbean) has much lower levels. the tax burden as a percentage of GDP ranges from 9.2% in Haiti to about 35.4% in Brazil. Focusing on tax revenue potential in terms of GDP per capita, Mexico stands out with a tax burden that is less than half of what the country’s level of development would suggest. Other countries whose tax burden falls below this standard are Ecuador, Guatemala, Panama and the Bolivarian republic of Venezuela. With the exception of Guatemala, the other three countries have significant non-tax revenues (from oil or the Panama Canal) to partially offset low levels of tax collection.15
By contrast, there are fewer differences among countries in Latin America and the Caribbean in terms of the structure of the tax burden. Focusing on direct taxation, if social security contributions are excluded, Mexico is the only country in the region where more than 60% of tax revenue comes from income tax, while its Vat collection is the second lowest (relative to GDP) in the region. Mexico is followed by those countries where the revenue generated from taxes on income and on capital is between 40% and 50% of the total tax revenue collected, such as Chile, Colombia, Panama, Peru and the Bolivarian republic of Venezuela. these economies specialise in the exploitation of natural resources, and their high level of income tax revenue is related to the taxation of companies engaged in such activities. at the other extreme are Haiti and Paraguay with direct taxes below 20%; they are among the poorest countries in the region, which limits their tax base.
Major differences in the territorial distribution of wealth and economic activity lead to significant differences in tax revenue. In recent years, sub-national levels of government, like central governments, have improved their public finances, reaching surpluses and reducing debt levels. this improvement, however, is strongly tied to a rise in intergovernmental transfers based on the growth of economic activity and higher prices for natural resources. From a structural perspective, a potential area of development for sub-national governments to raise revenue would be through the collection of property taxes. on average, they account for about 0.4% of GDP in the region, a fifth of what is collected by developed countries. In particular, taxes on real estate could be strengthened by reducing exemptions, eliminating tax breaks, and improving tax administration through the use of new technologies to improve cadastral records, update property values and improve tax collection itself.16