The incidence of social spending and taxes in Peru

Fiscal Policy
Fiscal Policy - Public and Welfare Economics

This article is part of the Online Forum: The Redistributive Impact of Fiscal Policies

      High inequality in Peru is a long-standing and well-known condition. Although there have been considerable advances in the last decades in the reduction of both poverty and inequality, poverty still affects about a third of the population, while inequality levels are quite high by international standards (López-Calva and Lustig 2010; Jaramillo and Saavedra 2010).

In the last few decades Peru has gone from a financially broke state in the late 1980s to an example of fiscally responsible management. After the reconstruction of the tax system in the early nineties, Peru started expanding social expenditures. During the last decade, as the fiscal situation of the country improved, larger scale social protection programs were implemented. Spending by the social sectors also increased, more than doubling social spending in the course of the decade. Only in the second half of the last decade was a cash-transfer program introduced.

In The Incidence of Social Spending and Taxes in Peru we estimate the effects of fiscal policy on poverty and inequality through a tax and benefit incidence analysis. Different income definitions are used in order to observe the effects of different taxes and social expenditure items across the income distribution. In the benchmark scenario contributory pensions are included in the households’ market income and in a sensitivity analysis they are treated as a government transfer.

The main data source used throughout this analysis is the National Household Survey (ENAHO), produced annually by the National Institute of Statistics (INEI), in its version for 2009. The survey has national coverage and collects data on all household members. We use data from other public sources, such as the Finance Ministry’s National Financial Information System (SIAF) and the Education Ministry’s Statistics Unit (ESCALE), to assign the amounts to in-kind health and education benefits. To estimate indirect taxes, we use the detailed consumption data from the household survey as well as data from the National Superintendence of Tax Administration (SUNAT) for scaling-up.

National social spending in Peru in 2009 was 7.25 percent of the GDP. The social benefits considered in our research are those included in the definition of CEQ social spending 1 CEQ social spending is the result of adding social assistance spending, education spending, and health spending. In the benchmark scenario contributory pensions are included in the households’ market income and in a sensitivity analysis they are treated as a government transfer. The national pension system is in deficit and therefore public transfers have been necessary over the last few years in order to fund its liabilities. The national pension system represented less than 1 percent of GDP in 2009.

The main taxable items in Peru are income, consumption and imports. Property taxes are collected at the local level and the tax authority reports them within the ‘other taxes’ category. Most of tax revenue comes from VAT collection and income taxes. Only a third of income tax revenue comes from personal income. The third tax in importance is the excise tax (ISC), with a tax on fuels as its main component. The ‘other taxes’ category includes mainly import tariffs and property taxes.

Table 1 presents indicators that measure the extent to which direct transfers are effective and efficient in reducing poverty. The first column presents estimates of the headcount poverty effectiveness indicator. The Vertical Expenditure Efficiency (VEE) indicator measures the amount of direct transfers that go to the poor. The spillover index (S) indicates how much of the spending that reached the poor was in excess of the strictly necessary amount required for the beneficiaries to reach the poverty line. The Poverty Reduction Efficiency (PRE) indicator is the product of VEE times S. The Poverty Gap Efficiency (PGE) measures the transfers’ effectiveness in reducing the poverty gap. From these indicators one can conclude that direct transfers are more effective in reducing extreme poverty than in reducing total poverty.

Table 1 Coverage and Effectiveness of Direct Transfers
Direct Transfer Poverty Reduction Efficiency

Table 2 presents the results of the incidence analysis corresponding to the benchmark scenario. As expected, direct taxes impact only the income of the richest deciles, reflecting the progressive tax rate structure. Indirect taxes have a significant effect on incomes across the distribution. Counterintuitively, their effects are higher among those with higher incomes, an effect that may be a result of high informality levels, as richer households are more likely to buy from formal establishments, while poorer households are more likely to buy products in informal conditions, such as from street vendors or in informal markets.

Incidence by Market Income Deciles

Note that implicit subsidies (tax exemptions) have greater incidence among deciles around the middle of the distribution. Finally, after direct taxes, direct transfers and indirect taxes, households in the first two deciles are net transfer receivers, while households from the third decile on are net tax payers. The analysis changes significantly when health and education transfers are included. In-kind education and health transfer receivers, as well as public health insurance beneficiaries are concentrated among the poorest deciles. The public health contributory system is the only transfer with a higher impact on the income of richer deciles.

Results indicate that the extent of inequality reduction induced by fiscal policy in Peru is small. Although in-kind transfers have the largest impact, direct transfers are the most effective per dollar spent. This effect is most important among the extreme poor. Results also suggest that the small impact is associated with low social spending rather than with inefficient spending. Most of the social spending components are progressive and overall social spending is progressive as well. However, social benefits tied to the formal labor market (health and pensions) are either relatively progressive or regressive. Taxes, on the other hand, have positive though small effects on inequality. Countering intuition, indirect taxes are progressive due to extensive informality.

One policy implication deriving from these results is that targeted transfers are the most effective way to reduce poverty. In contrast, linking benefits to formal employment relationships tends to exclude the poor. However, targeted transfers are significantly more effective in rural areas. Looking at poverty and inequality effects of taxes and transfers for urban and rural areas, three important results come out:

1. Direct transfers are significantly more effective in reducing inequality and poverty in rural areas than in urban areas.

2. Direct taxes have no effect on poverty in either area.

3. Indirect taxes have an impact on poverty and inequality in urban areas but no effect in rural areas.

One challenge for social policy in Peru is how to effectively introduce targeted cash transfer programs in the urban area. One possibility that should be evaluated, as Peru tries to reform her poorly targeted and corruption prone food programs, is to turn them into cash transfer programs, starting a new register of beneficiaries with a more rigorous targeting mechanism.

1. CEQ social spending is a definition put forth by the CEQ initiative. Led by Nora Lustig and Peter Hakim, the “Commitment to Equity” (CEQ) initiative is a joint project of the Inter-American Dialogue (IAD) and Tulane University’s Center for Inter-American Policy and Research (CIPR) and Department of Economics. CEQ is designed to assess the progressivity of social spending and taxes, their impact on poverty reduction, and their redistributive effects.


López-Calva, Luis, and Nora Lustig, eds. 2010. Declining Inequality in Latin America: A Decade of Progress? Baltimore, Maryland: United Nations Development Programme, Brookings Institution Press.

Ministerio de Economía y Finanzas. 2009. Cuenta General de la República. Lima, Peru: Dirección Nacional de Contabilidad Pública, Ministerio de Economía y Finanzas.

SUNAT. 2012. Nota Tributaria. Lima, Perú: Superintendencia Nacional de Aduanas y Administración Tributaria.

Share this