Fiscal policy in Chile: Hindering sustainable development by favoring myopic growth

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2 Fiscal policy in Chile: Hindering sustainable development by favoring myopic growth Ramón E. López a,b & Eugenio Figueroa B. a a Universidad de Chile ; b University of Maryland Fundación Siglo 21 Santiago, Chile Noviembre 24, 2004

3 Chile s economic development during the period was characterized by: 1. highly unbalanced Economic growth (traditional natural resource and environment degrading industries vs. knowledge and human capital intensive sectors); 2. poverty declined, but inequality remained among the highest in the world (even increased).

4 Central hypothesis of our paper fiscal policy has been in part responsible for the slow progress of the Chilean economy towards diversifying into knowledgeintensive and environmentally cleaner industries and towards social justice. Instead the economy continues to be greatly dependent on primary and dirty industries.

5 Specific hypotheses We show that the tax system in Chile is insufficient, inefficient and inequitable. Insufficient: it does not yield enough revenues Inefficient: it is highly unbalanced causing most of the tax burden to be concentrated in few distorting (pro physical capital and pro natural resource based and dirty industries) taxes while neglecting the use of the least distortion prone tax mechanisms available; it artificially fosters capital intensification Inequitable: it forces middle and low income groups to shoulder most of the tax burden; and allows super rich to pay one of the lowest tax rates among middle income and advanced countries.

6 We show that: Tax policies failed to provide fiscal resources needed for human capital expansion and to finance broader anti poverty and prodistribution programs. Tax policies magnify the physical capital intensity of the economy by artificially sustaining the marginal productivity of capital through large capital tax expenditures. In addition, the dual tax on corporate profits (Primera Categoría and global Complementario) distorts investments decisions by encouraging socially unprofitable investments to be implemented. Giving away vast amounts of natural and environmental resources (in principle belonging to all Chileans) to a few large corporate interests have artificially increased productivity of physical capital over the short run.

7 We show that: The tax system has restricted the scope to increase fiscal revenues via non distortive taxation. Also reducing incentives to increase human capital and, on the other hand, has deteriorated the economy`s long run growth by impeding the growth of total factor productivity due to insufficient human capital.

8 Economic consequences of Chile s tax system o Tax system and tax elusion and evasion Legal tax loopholes confer especial privileges to powerful established economic interests allowing them to evade paying taxes for the large economic rents generated from natural resource exploitation and environmental degradation. The tax system also allows large income tax evasion rates to the wealthiest people of the country.

9 Economic consequences of Chile s tax system o VAT and human capital The tax system imposes a high tax burden on indirect consumption taxes, especially the value added tax (VAT), which means that a high portion of the tax burden is shouldered by middle and low income groups. The high VAT is likely to cause significant deadweight because it causes inefficiencies by reducing the disposable income of the low and middle income classes that face liquidity constraints. This restricts even further their ability to invest in human capital and other assets and middle class households have indebted themselves highly by having to accept credit often provided at usury rates.

10 o The tax system and the natural resources The lack of royalties and the lack of environmental taxes prevent the government from raising tax revenues using instruments that are possibly the least distortion prone of the available tax mechanisms. This attempts against economic efficiency and also constitutes a massive implicit transfer of wealth from the average citizen (the ultimate owner of the country s natural resource patrimony and who pays most of the costs of environmental pollution) to powerful economic groups that have access to the exploitation of vast natural resources and the environment for free.

11 o The tax system and the structure of the economy These policies amount to counter sustainable policies; far from stimulating emerging new activities that may possibly have important spillovers such as high tech ones, these policies instead artificially raise the relative ( comparative ) advantages of traditional industries that often have few positive externalities or spillovers and many negative externalities.

12 Faustian economics: welcoming myopic growth at the expense of long run sustainability These fiscal policies, with such inbuilt distortions and strong incentives to make the economy more capital intensive and inequitable, may foster growth over the short run but they are not consistent with sustained long run economic growth. They may be a case of Faustian economics, where short run output growth is in part achieved at the cost of a stagnating human capital, ever souring social conditions caused by extreme inequality that reduce solidarity, promotes crime and foment discontent, and the continued destruction of the natural capital and the environment.

13 Chile s Corporate Tax System Induces Overinvestment in Physical Capital: Illustration 1. A socially desirable (marginal) investment m = net social rate of return of the project (10%) r = opportunity cost of capital rate (10%) No tax situation: Investment is implemented Situation with dual tax system: Tax rates: 20% First Category ; 40% FC + Global Complem. Private after tax rate of return = 8% Private after tax opportunity cost of capital = 6% Investment is also implemented in this situation Tax system does not discourages investment

14 Chile s Corporate Tax System Induces Overinvestment in Physical Capital: Illustration 2. A socially undesirable (marginal) investment m = net social rate of return of the project (10%) (8%) r = opportunity cost of capital rate (10%) No tax situation: Investment is NOT implemented Situation with dual tax system: Tax rates: 20% First Category ; 40% FC + Global Complem. Private after tax rate of return = 6,4% Private after tax opportunity cost of capital = 6% Investment is NOW NOW implemented due to tax incentive Tax system promotes socially undesirable investments

15 Chile s Corporate Tax System Induces Overinvestment in Physical Capital: Illustration 3. Tax reform (Unified Tax System = FC + GC) m = net social rate of return of the project (10%) r = opportunity cost of capital rate (10%) No tax situation: Investment is implemented Situation with unified tax system: Tax rates: 40% (FC + Global Complem.) on profits & interest income Private after tax rate of return = 6,0% Private after tax opportunity cost of capital = 6% Socially desirable Investment is NOW STILL implemented Unified Tax System is neutral & prevent socially undesirable investments

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17 UNBALANCED GROWTH AND INEQUALITY Regarding growth an inequality, we show that: 1. Chile has had one of the most unbalanced patterns of economic growth in the world; and, 2. Chile s level of inequality is much worse than what earlier studies have purported to show; and, 3. Inequality is likely to have increased over the last two decades.

18 Chile s economic development during the period: Evidence

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34 What is wrong with taxes in Chile? Low tax revenues; Low spending on education, provision of technical skills, health care, and social security; Low investments in human capital among the vast majority of the population; Perpetuation of low skills and poor human capital of the labor force that, in turn, has become a binding constraint to the expansion of skilled intensive activities other than the traditional resource extractive ones. The under development of human capital has contributed to restrict the income growth of the poor and middle income classes.

35 What is wrong with taxes in Chile? The tax system is almost single mindedly directed to provide large incentives to investments in physical capital, particularly for the most traditional resourcedependent and environmentally dirty industries. Physical capital investment has remained attractive in low human capital intensive natural resource based and dirty sectors thanks to the large rents accruing to capital due to the country`s gracious cession of economic rents to the capitalists investing in these sectors.

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55 IMPUESTO A LAS 40% MAX. 35% R E N T A S Impuesto GLOBAL COMPLEMENTARIO Impuesto ADICIONAL % SEGÚN TRAMO INGRESO. CHILENOS DE LAS 15% EXTRANJEROSS E M P 20% R E S A S IMPUESTO ÚNICO A LAS UTILIDADES Impuesto PRIMERA CATEGORÍA

56 NO CAMBIA LAS TASAS IMPOSITIVAS MANTIENE LAS TASAS PENSADAS POR EL LEGISLADOR AUMENTA LA RECAUDACIÓN TRIBUTARIA EN 25% (5% PIB); US$ 10 MIL MILLONES

57 PODRÍA REBAJARSE EL IVA (A 10 12%) SE EXCEPTÚA DEL PAGO A LAS PYMES NO TIENE EFECTOS SOBRE LA INVERSIÓN

58 GRACIAS!!!

59 Reforma tributaria en Chile: cómo, cuál, cuándo, por qué? Prof. Ramón E. López Universidad de Chile University of Maryland

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61 + COSTOS DE TRABAJO + OTROS COSTOS INGRESOS TOTALES COSTOS = UTILIDADES (retorno al capital) DEDUCCIONES = UTILIDADES TRIBUTABLES 15% DEL CAPITAL INVERTIDO DEPRECIACIÓN INTERESES OTROS COSTOS DE CAPITAL ( tasa mínima requerida inversión en Chile) Si utilidades son 15% utilidades tributables son 0 Impuesto Aplicable = 0 Si utilidades son > 15% utilidades tributables son > 0 Impuesto Aplicable = tasa impositiva * (Exceso de Utilidades por sobre 15%)

62 EJEMPLO DE PROYECTO CAPITAL A INVERTIR = $ 100 MILLONES TASA RETORNO ANTES IMPUESTO = $ 18 MILLONES (18%) AFECTO A IMPUESTO SI TASA IMPUESTO ES 20% RETORNO DESPUES DE IMPUESTO = $ 17,4 MILLONES (17,4%) PROYECTO ES VIABLE Y SE IMPLEMENTA SI TASA IMPUESTO SUBE A 40% RETORNO DESPUES DE IMPUESTO = $ 16,8 MILLONES (16,8%) PROYECTO ES VIABLE Y SE IMPLEMENTA CONCLUSIÓN TASA IMPUESTO A UTILIDADES NO AFECTA VIABILIDAD EIMPLEMENTABILIDAD DE LOS PROYECTOS DE INVERSIÓN

63 Crecimiento del PIB y variación de la PTF; a 2011 (% promedio anual) Fuente: Dipres, estimaciones 2009/2011 CCS

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66 Economic consequences of Chile s tax system low tax revenues deprive the government of the financial resources low investment in human capital among the vast majority of the population Tax system is almost single mindedly directed to provide large incentives to investments in physical capital, particularly for the most traditional resourcedependent and environmentally dirty industries.