Tax reform

In 2013, when A Partnership for National Unity (APNU) and the Alliance For Change (AFC) were using their parliamentary majority to stymie the People’s Progressive Party/Civic (PPP/C) agenda for development, the Inter-American Development Bank published a report, “More than Revenue: Taxation as a Development Tool”. The two parties soon entered into a formal coalition that allowed them to govern between 2015 and 2020, but sadly, Tax reform was not on their agenda, just as electoral reform is not on it now. We present the major recommendations in this crucial but neglected area. The report is very frank and presents “taxation in Latin America and the Caribbean as a missed opportunity.
In Latin America, it is largely viewed as a means of generating income to keep the Government in business. It lauds the region for progress made in increasing total revenue, but notes that most countries in the region still lag well behind other countries with similar levels of development. More importantly, Latin American policymakers have not taken advantage of the potential of taxation to contribute to other important development goals.
The weakness of the personal income tax structure has squandered the opportunity to attack the region’s serious income inequality and the failure to use taxes to improve environmental quality and general well-being. In addition, Governments have repeatedly missed the chance to influence consumption and production patterns by using taxes to effect relative price changes.
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. 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. Opportunities to evade taxes that vary greatly across income groups compound this perverse structure, shrinking effective tax bases and resulting in low levels of revenue.
Although the tax situations in the region vary widely, the report proposes that the pro-development tax reforms required by countries in Latin America and the Caribbean must respect five basic principles:
First, the reforms must include taxes that favour the poor. The first priority is to improve the progressivity of existing tax systems with an income tax that has fewer exemptions, real redistributive capacity, and that preserves the income of poorer households. Second, the reforms must establish tax systems that are simpler with broader tax bases. Most of the region’s tax systems are overly complex due to a plethora of exemptions. The outcome is usually taxes that severely distort the allocation of resources and result in narrow and fragile tax bases.
Shifting to simple tax systems with broad bases that create an environment conducive to innovation and business startups is one of the surest ways to promote higher productivity growth and a sustainable improvement in the region’s well-being and equity. Third, tax administrations must be strengthened so that all citizens and businesses meet their tax obligations. Reducing the high rate of tax evasion and creating institutions that guarantee that all economic agents and citizens contribute their share to the collective effort is an essential element of social legitimation, and, as such, a requirement for the sustainability of any tax system designed to support development. Lower tax rates help immensely in this regard.
Fourth, institutional agreements and consensuses must be reached to ensure that local governments have the resources needed to act as agents of development. For decentralised spending to be sustainable, the own-source resources of local governments must be strengthened. Much of the great potential of local revenue is still wasted, especially property taxes.
Fifth, pro-development tax reforms should build tax systems that look to the future. Latin America and the Caribbean enjoys an extraordinary endowment of natural resources. However, environmental taxes or the current design of taxes on commodities do not reflect this situation. To adapt the future to reality, tax systems must create incentives for the more efficient use of finite natural resources and take into account the needs of future generations of Latin Americans.”