If we want more economic growth in Latin America, we need more and better taxes

Fiscal Policy
Fiscal Policy - Public and Welfare Economics

A woman sells newspapers and cigarettes at a cart in downtown San Salvador January 31, 2014.

REUTERS/Henry Romero

This article is part of the World Economic Forum on Latin America 2017 and  was previously published in the World Economic Forum Blog, on March 29, 2017.

Tax collection in Latin America and the Caribbean reached 22.8% of GDP in 2015, according to the recently released database Revenue Statistics in Latin America and the Caribbean. Following strong growth over the past decade, thanks to the economic boom and various reforms, taxes on goods and services accounted for almost half of tax revenues in the region. By contrast, corporate income tax revenue declined and the contribution from personal income taxes and social security contributions remains limited.

On average, resources available to governments remain well below the levels observed in high-income economies. In fact, tax revenues in OECD economies amount to 34.3% of GDP. In other words, Latin American governments can spend on key public services such as education, health, pensions, citizen security, infrastructure and on other key development policies 11.4 percentage points of GDP less than the most developed economies. Taxes are, as the InterAmerican Development Bank put it, more than revenues, as they finance key policies for growth and equity. And, after two decades of convergence to OECD levels, the catch-up has resumed but at a slower pace than during the commodity boom.

It is true that tax revenue heterogeneity remains a hallmark in the region, but the fiscal muscle remains weak in the majority of countries. Taxation levels range from OECD-levels (over 32%) in Cuba, Argentina and Brazil, to less than 15% in the Dominican Republic and Guatemala, closer to levels seen in sub-Saharan Africa. But overall, the fiscal capacity in Latin America remains weak, and the tax system does not contribute enough to inclusive growth.

Policy action is needed

Public revenues in many Latin American and Caribbean countries have been affected by the fall in commodity prices. In 2015 this decline was even larger than during the financial crisis. In commodity-exporter countries, revenues (both from taxes and non-taxes on foods, minerals or energy, such as royalties and revenues of public enterprises) fell to around 3% of GDP in 2016, from almost 9% of GDP in 2011.

Without reforms, Latin American governments cannot expect higher resources in the years to come, given the modest economic scenario for the region and the persistence of weak projections for most commodities. This is happening at a time when the economies in the region would benefit from the resources to promote more and better education and infrastructure, incentives for their firms to innovate and invest, and the consolidation of key social programmes for their citizens.

Thus, the implementation of structural tax reforms, as in Chile, Colombia and Mexico, where tax revenues are expected to increase 2 percentage points of GDP or more, and the debate in many others, as in Argentina, Costa Rica and the Dominican Republic, is good news. Given the heterogeneity in Latin America, in some countries these reforms should aim at re-designing the tax composition, to make the system more efficient and equitable. In most countries, reforms should focus on raising tax collection to finance development.

Taxes over GDP in Latin America and the Caribbean and OECD (percentage of GDP)

Panel A. Total tax revenue in LAC, 2000-2015

Panel B. Tax revenues in LAC countries and OECD, 2015

OECD/ECLAC/CIAT/IDB (2017), Revenue Statistics in Latin America and the Caribbean

Beyond taxes

But tax reforms have to go hand-in-hand with policies to improve tax management. Latin American governments need not only to raise the quality of the public services they provide with public resources, but also to fight decidedly against corruption and waste. Between 2010 and 2015, Latin Americans with little or no confidence in the government jumped from 55% to about 65%, according to the latest Latin American Economic Outlook. And almost 60% of the citizens in the region stated in 2015 that they were not satisfied with the functioning of democracy. This could have implications for the political system itself, as today only 40% of Latin Americans express confidence in the transparency of election results, much lower than the already modest OECD average of 62%.

Latin American economies need more sufficient and solid sources of revenues, as part of a larger pact for better governance and institutions. This is a key component of the inclusive growth agenda. Citizens and firms deserve more efficient, transparent and innovative governments. The case is clear for a virtuous circle from tax and fiscal reform. The upcoming electoral wave in Latin America, with more than a dozen presidential elections scheduled from now until 2018, represents more than an opportunity. It heralds a time for action, for debating and for implementing sounder fiscal policies. Let’s hope it happens.

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