Ana Corbacho

Value Added Tax: Let It Be

The idea of levying a tax on value added emerged in the first half of the twentieth century, and has spread throughout the world. Introduced in France in 1954, a value added tax (VAT) had been adopted by 10 countries by the late 1960s, by 48 countries by the late 1980s, and is used by more than 140 countries today. It has been so successful because, in comparison with other revenue sources such as foreign trade taxes, income tax, or social security contributions, VAT offers advantages in terms of revenue, neutrality (equal treatment for all sectors), and ease of administration (simplicity of monitoring and enforcement).

Making the Most of Tax Administration

Without an institution to collect taxes, taxation is nothing more than inert legislation. Even the best tax code has no life without the support of a collection agency. But the role of tax administrations goes beyond revenue collection. A tax administration that aspires to be a development tool should be determined to reduce tax evasion and provide the best possible service to taxpayers—to the point of being considered a necessity in their business and personal progress, rather than that feared institution that goes after their money.

Beware of Informality

The words “taxes” and “informality” often occur together, and for good reason. In its currently most widely accepted definition, “informality” is failure by individuals or businesses to comply with regular tax obligations (and other regulations). Informality can hamper tax collection, but its consequences do not end there. Informal workers who are not covered by social security services lack protection against the risks of illness and economic insecurity in old age, and may not enjoy other benefits that their peers who are employed by formal firms receive. Meanwhile, firms that operate in the informal sector tend to operate on a very small scale, which in practice eliminates the risk of penalties. But operating on such a small scale may mean sacrificing productivity gains and possibly limiting access to productive resources, from credit to technology. Thus informality has costs for the economy and society that go far beyond loss of tax revenue.

Undressing the Myths

The structure of taxation in Latin American and Caribbean countries is usually described as suffering from four major shortcomings: collection is very low, taxes are barely progressive, tax evasion is rampant, and tax administrations are very weak.1 These characteristics create a self-reinforcing vicious circle, whose deep historical roots can be found in the distribution of wealth and effective political rights in the region. 2 One of the rent-seeking mechanisms that the most affluent have imposed on the rest of society is the regressive design of the tax structure. Opportunities to evade taxes that vary greatly across income groups compound this perverse structure, shrinking the effective tax bases and resulting in low levels of revenue. 3

Corporate Income Tax: The Art of Competing for Investment and Increasing Revenue

The recent increase in revenue from corporate income tax (CIT) is one of the most important features of taxation in Latin America. Although the rates of this tax have tended to decline around the world, Latin American companies are paying more income tax than ever. But CIT is far from a horizontally equitable tax, levied equally on all economic sectors, as is desirable in principle. Instead, the effectiveness of CIT is hampered by the proliferation of incentives and lack of good systems of international taxation. To compete for investment, mainly from large companies, and perhaps also because of weakness in the face of the influence of certain pressure groups, governments have granted a large number of incentives, which have eroded the base of CIT. The fiscal cost of these incentives is enormous and often lacks transparency, since in some countries this cost is not even known. Little has been done to develop new forms of international taxation that would help regulate governments’ relations with international companies and strengthen tax administration to attack evasion and avoidance of the tax. With adequate design and administration of CIT, governments can both raise more revenue and successfully compete for investments.

Protecting Goods by Taxing “Bads”

The production of “bads” is nearly as old as man and most certainly predates the market economy: it is believed that some species of large North American mammals were exterminated by nomadic hunters who corralled and killed large herds, depleting the hunt for later generations. “Bads”—or in economic terms, negative externalities—are an undesirable by-product of either the production or consumption of goods.

Growing a Reform Agenda

Taxation is an essential ingredient of public policymaking. Taxes provide a fundamental—arguably the best—source of financing for public expenditure programs. They also link citizens to their governments. If properly designed, tax systems can enhance governance, transparency, and accountability.

The Politics of Taxation

Tax revenues in Latin America are comparatively low. There are many potential explanations for this fact, including the level of development, the level of informality, the structure of the economy, and the age composition of the population. Yet, as chapter 1 shows, tax revenues in Latin America are low even after controlling for these factors.

Local Taxes for Local Development

Subnational governments in Latin America and the Caribbean must take more responsibility for generating their own-source revenue in order to promote local development and meet the growing demand for local infrastructure and services arising from growing urbanization.1 Why is greater fiscal responsibility at the subnational level desirable? First, it grants authorities greater autonomy to choose and implement their policy decisions. Second, it reduces dependence on central government transfers. Third, it increases the efficiency and transparency of spending, since when citizens pay taxes they tend to demand more accountability from their leaders.

Tax Systems for a Smooth Ride

Like a wild rollercoaster, steep ups and downs describe the economic performance of the Latin American and Caribbean region.1 Econom ic booms have been followed by deep and long recessions, sometimes driven by poor domestic policies, other times precipitated by negative exogenous shocks, often times fueled by both. Notwithstanding considerable progress since the notorious lost decade of the 1980s, managing volatile economic cycles remains an important policy challenge for most countries in the region.