Public Revenue Generation: Taxation in Latin America

Management of the public debt is one dimension of fiscal policy making; taxes are another. As
already noted, tax takes a lower share of GDP in Latin America than in OECD countries. It does not
follow, however, that tax revenue in Latin America is “too low” or indeed “too high”. Countries in
the two groups start from different historic bases and face different constraints and opportunities.
This is evident even in the substantial variation between Latin American countries themselves,
where tax revenues range from over 30 per cent of GDP in Brazil, to little more than 14 per cent
in El Salvador.

These lower levels of fiscal resources are among the factors that explain the poor redistributive
performance of the fiscal system in Latin American economies. Latin Americans themselves, however,
are as concerned as OECD nationals about inequality and the welfare state. Expressed preferences
for or against redistribution are on average the same in the two groups, though opinion is generally
more polarised in Latin America than in the OECD.

The tax-collection gap in Latin America does not have a single cause. Personal income taxes, which
provide more than a quarter of tax revenues in OECD countries, are a good example. Contrast GDP
per head of over USD 30 000 in Finland with Colombia’s figure of less than USD 6 000 and it is at
once clear that low levels of personal income limit the scope for income taxes. In many countries,
the vast majority of working people – approximately 90 per cent in Brazil, Chile, Colombia and Costa
Rica, for example – have incomes below the minimum threshold at which personal income taxes
must be paid. Also important is the skewed distribution of income in Latin American countries, which
means that for a given average income, fewer working people in an economy are in the income
brackets where they are liable to pay tax.

Reliable cross-country evidence on the extent of tax evasion is scarce. But simple – yet plausible –
simulations suggest that even eliminating evasion completely would do little to close the tax-collection
gap between OECD and Latin American countries. Indeed, bringing informal workers and employers
into the tax net might create a net fiscal loss, since many would be eligible for benefits and incentives
of various kinds and administrative costs for tax authorities would rise. Nevertheless, measures
to limit evasion – in addition to those legal means of avoiding tax – can play an important role in
increasing fiscal legitimacy.