Latin America's Fiscal Performance: Recent Trends

Since 1990, Latin America’s fiscal performance has been encouraging. Fiscal deficits in the region, for
example, have fallen from 11 per cent of public revenues in the 1970s and 1980s, to only 8 per cent
since 2000. Is this change due to good luck or good policies? Evidence for better policies includes
increased expenditures, credible macroeconomic management and greater decentralisation. These
have been accompanied by creative innovations such as new fiscal responsibility rules, conditional
cash transfer schemes and participatory budgeting.

However, fiscal performance is still a long way from closing the gap with OECD benchmarks. Moreover
it remains to be seen how resilient positive trends and institutional innovations will be to any change
in the good fortune brought to the region by buoyant commodity prices, favourable terms of trade,
and cheap and plentiful capital. That test may come soon.

This Outlook assesses that performance gap by comparing and contrasting fiscal performance in Latin
American and OECD countries. Both public revenues and public expenditures in Latin America are
below the OECD average, though there is substantial variation across both groups of countries. Over
the period 1990-2006, total government revenues averaged 23 per cent of GDP in Latin America,
and 42 per cent in OECD countries. Total expenditures over the same period averaged 25 per cent
of GDP in Latin America and 44 per cent in OECD countries. Revenues and expenditures alike have
been rising as a share of GDP in Latin America.

Taxation and expenditure also differ substantially in their structure between Latin American and OECD
countries. Consider just the revenue side of the ledger. Non-tax revenues are far more important to
the public finances in Latin America, averaging fully 8 per cent of GDP. Pure tax revenues only come
to 16 per cent of GDP in the region versus 35 per cent in OECD countries. Of these Latin America
raises 25 per cent from direct taxes, compared with 42 per cent in OECD countries. Within this,
only 4 percentage points is attributable in Latin America to income taxes on individuals, where the
OECD comparator is 27 percentage points.

Contrary to the textbook prescription, Latin American fiscal policy is pro-cyclical: governments
generally spend more during booms and less during slumps. Moreover, a range of important fiscal
variables – including revenues, spending and deficits – are more volatile in Latin America than in
OECD countries. This Outlook shows, however, that this fiscal volatility has been falling in the region
and since 1990 has been closing the gap with the OECD. An index of deficit volatility calculated for
this Outlook shows a fall of a third from 1990-94 to 2000-06, with Latin America standing just 6 per
cent above the level in the OECD in the latter period. Over the same timescale revenue volatility in
Latin America fell by a quarter and expenditure volatility by some 40 per cent.

Local governments in Latin America are flexing their fiscal muscles but relative to their counterparts in
the OECD remain relatively small and heavily dependent on central government transfers. While the
level of local government expenditures was around 41 per cent of central government expenditures
in OECD countries during the period 1990-2006, the corresponding figure for Latin America was
only 23 per cent. The ratio for revenues was similar. In terms of transfers, the gap is slowly closing
but it remains large: inter-governmental transfers as a share of GDP averaged 4.9 per cent in OECD
countries and just 2.7 per cent in Latin America.

Despite this positive overall trend in fiscal performance, Latin America still has plenty to do in terms
of fiscal reform. Revenue generation should diversify away from its reliance on non-tax sources
and indirect taxes. Fiscal volatility, a drag on growth, could fall further. And social transfers do not
yet play their proper role. Achievements and innovations in the fiscal realm need to translate into
sustained policies and lasting institutional reforms.