New options and old challenges in the design of a tax agenda for Latin American countries**

The COVID-19 pandemic has brought with it a crisis and a fall in the level of activity unprecedented in the world. The global economic outlook is surrounded by great uncertainty, a product of the dynamics of the pandemic, which adds to the urgencies caused by climate change.

In Latin America, the effects of the pandemic have been more intense than in the rest of the world, in health, social and economic terms. In addition to the fact that prior to COVID, the region as a whole already showed low levels of economic growth, limited fiscal policy space and growing social conflicts. In addition to the important level of inequality and the combination of inefficient public spending and structures tax inadequate, the pandemic arrived in the region at a time of high social conflict, since the end of 2019, related to the perception of large sectors of the population subject to large and well-known inequalities and an inferior quality in the public service coverage.

The attention to the health emergency had a strong impact on the public accounts of the region, which by the end of 2020 exhibited large fiscal deficits. Among the uncertainty resulting from this crisis and its impact, a couple of certainties stand out: the immediate future will require increased and better public intervention; there is a high consensus on the need for greater post-pandemic state intervention and the greater effectiveness, at this time, of fiscal policy over other economic policies. A second certainty is that this will require an increase in public financing and, in the near future, an increase in the tax burden, which should promote greater growth and equity.

Consequently, the current context and the prospect of the near future with greater funding needs have brought back to the public policy debate in general, and to taxation in particular, the need to take advantage of those tax bases not only underused, but in cases, they have grown during the pandemic. In addition, consideration should be given to the impact that the necessary process of decarbonization of economies would have on the extractive sectors, an important source of fiscal resources for many governments (central and subnational) in the region. Within this framework, modern tax systems take on a leading role as a fundamental basis for public financing for the future.

In recent months, most governments and international agencies have been exploring new initiatives to tax previously underutilized tax bases, which sometimes have grown and taken center stage during the pandemic. In addition, the emergence of the digital economy, the health emergency and the worsening environmental situation in the world call for addressing these tax bases in order to “level the playing field” and correct the negative externalities and other market failures.

In this context, recent reform proposals mainly include:

  • strengthening the property taxation (assets, wealth, inheritance);
  • taxing the digital activities, which have grown during the pandemic, mainly through increasing VAT on digital consumption and accompanying the international debate on the effective taxation of income generated in these sectors;
  • improving selective taxation as a tool to discourage various socially harmful consumptions (sugary drinks, alcohol, tobacco, pollution by fossil fuels, plastic waste, etc.).

Various recent works have analyzed and estimated the tax collection potential of this set of potential innovative tax reforms, with diverse sources and methodologies (Jiménez and Moran, 2021)[1]. Although the fiscal reality of the region indicates that the strengthening of these taxation modalities would not be sufficient to cover the funding gap required to meet the requirements of public intervention post-pandemic, the expectation in terms of collection should not be an impediment, given that the development of a tax reform solvent, equitable, sustainable, and balanced between the various components of the tax structure should be understood as a necessary condition (but not sufficient), in terms of adequacy and equity, to justify a new agenda of tax reform that will contribute to support the distributional and environmental objectives. It is essential to combine the implementation of reforms that update tax systems in terms of property taxation, digital activity and selective consumption taxation along with addressing the remaining challenges to be able to finance the fiscal gap widened by the pandemic. The new post-pandemic tax agenda, then, should also assume reform guidelines that could already be identified years ago for most countries in the region.

The Value Added Tax (VAT) still shows room for increasing its productivity, either through an increase in the general rate (in the region, it is still quite low) or through the reduction or elimination of differential treatments such as exemptions and reduced rates. Although this option is usually resisted by the usual regressive character of the tax, the distributive effects of such treatments are not always desired and should be reviewed. It may be preferable to generalize VAT by accompanying this measure with compensation for the most vulnerable households, through targeted transfer programmes.

In Income Tax (IT), strengthening the tax on individuals is the main challenge for all Latin American countries. This requires effectively reaching all the income flowing to the subject taxed, whether it comes from work, business, financial or mixed activity. As an intermediate step, various countries have already made progress in consolidating the dual scheme, with progressive rates for labor income and proportional rates for capital income. Knowing the difficulty of countries to tax the wealthiest individuals, the consideration of higher rates or aliquots, whether temporary or permanent, has to be evaluated.

This should be linked to the income tax that applies to legal entities, where the main problem does not seem to be so linked to current rates-in line with international averages – but to the series of existing tax incentives and benefits. The rationalization of these differential treatments (both in the income tax and in relation to other taxes) could provide genuine additional resources to public financing, in addition to favoring a more efficient and equitable collection.

With regard to the control of tax evasion, at the domestic level, it is necessary to continue and advance with the technical and operational strengthening of the tax administrations, especially with regard to the segmentation of taxpayers in order to deploy differentiated strategies of supervision and control. In addition, innovative tools such as the implementation of electronic invoicing should be deepened and incorporated due to their potential benefits in terms of tax collection management. At the international level, although progress has been made thanks to various international cooperation initiatives, the problems of diversion of corporate profits to low-tax or zero-tax jurisdictions and the harmful tax competition that accompanies this process still have a significant impact on the countries of the region. International tax cooperation has recently re-emerged, with a momentum unprecedented in the recent history of international taxation, with proposals such as the creation of a minimum tax on business income. These actions acquire particular importance in the context of strengthening direct taxation, to the extent of improving the collection and information exchange necessary to determine income and wealth, which would support the strengthening of the income and wealth taxation.

Financing the fiscal effort needed to support the exit from the pandemic will, however, require recourse to a variety of tax instruments In this context, the role of taxing the most favored sectors, and the harmful and polluting consumption sectors would not only be a tax collection measure, but would also make an important contribution in distributive terms, strengthen legitimacy and social acceptance and political support for other adjustments to the tax systems that would be necessary to cover the large existing fiscal gap, in response to the new challenges posed by the traditional balance between the principles of equity, efficiency, sustainability and sufficiency, which is currently under threat. It should not be lost sight of the fact that the slowness with which the exit from the pandemic is being processed is combined with the emergence of social mobilizations demanding improvements in the quality of public services, the expansion of the coverage levels of the policies applied and the equitable financing of these policies.

In these conflicts, two tensions stand out that will have a direct impact on the relationship between the state and society: the pressures and demands of broad sectors of the population for greater public intervention and better provision of public goods and services, and the resistance of taxpayers to increases in the tax burden. That is why it is particularly important in this instance to evaluate the economic, social and environmental impact of the reforms, so as to properly calibrate the sequence of reforms and their political economy, prioritizing political consensus and social legitimacy, both of the latest trends and of the pending challenges.

There is room for the inclusion of innovative measures in tax matters that allow achieving objectives beyond those of a strict fiscal nature. However, the serious fiscal situation makes it essential to insist on addressing pre-existing challenges through the strengthening of instruments such as VAT and the Income Tax. In turn, it will be necessary to deepen efforts to resolve the two main weaknesses of the region’s tax systems, that is, rationalizing the existing set of tax expenditures and reducing the elevated levels of tax evasion.

The necessary tax reforms do not appear to be an easy or quick task. To ensure that their effects are beneficial and permanent, the changes to be introduced must be part of a complex process of political negotiation between different actors in a framework of consensus on the fundamental objectives that will govern the state financing in the coming years. Once the tax design and negotiation stage with the interested parties has been completed, the time will come for the implementation of the agreed modifications, for which a gradual and progressive strategy can be adopted in order to achieve greater social legitimacy of the required reforms and allow taxpayers to adapt to the new tax conditions.

We should bear in mind that the weakness of the welfare systems in the region, the recurrent emergency reforms and the inability to reach comprehensive, lasting and inclusive agreements, including the large informal sectors, have in the past been among the central constraints to sustainable, efficient and equitable public provision. To the extent that there is high informality and large pockets of evasion, the necessary social and fiscal agreement ends up becoming an incomplete contract, so it is important to expand the public services coverage, strengthening the fiscal citizenship.

**This article summarizes the main arguments of the recent publication “The challenges of a new post-pandemic tax agenda in Latin America: Persistent weaknesses, health emergency, social discontent and climate emergencies”, Revista Proyección Económica, Consejo Profesional de Ciencias Económicas, October 2021.
https://issuu.com/consejocaba/docs/proyeccion_octubre_2021. The valuable comments of Gabriel Vilches to preliminary versions of this article are appreciated.
Most ideas and arguments presented throughout this article have been the product of countless talks and reflections with Juan Carlos Gómez Sabaini (1938-2021), whom we will always thank for his intellectual generosity and his close friendship.

[1] https://issuu.com/consejocaba/docs/proyeccion_octubre_2021

Disclaimer. Readers are informed that the views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author's employer, organization, committee or other group the author might be associated with, nor to the Executive Secretariat of CIAT. The author is also responsible for the precision and accuracy of data and sources.

Leave a Reply

Your email address will not be published.

CIAT Subscriptions

Browse through the site without restrictions. Consult and download the contents.

Subscribe to our electronic newsletters:

  • Blog
  • Academic offer (Only in spanish)
  • Newsletter
  • Publications
  • News alert

Activate subscription

CIAT Members

Representatives, Correspondent and Authorized staff (TA)