Features of fiscal pressure in Latin America and the Caribbean 1

Introduction

Standardisation initiatives are essential in a globalised and heterogeneous world, since they enable a wealth of comparisons and analytical possibilities. In the fiscal arena, the Organisation for Economic Co‑operation and Development (OECD) has been a pioneer in defining the way in which tax revenues are classified and measured, not only by OECD member countries² but also by other nations around the world.

At the heart of the OECD’s work on tax revenues is the classification that defines taxes as “compulsory, unrequited payments to the general government sector”. This definition has three distinct elements, each with a sound rationale. That taxes are

“compulsory” payments is generally accepted. Equally, if tax statistics are to reflect the state’s efforts to collect revenue from its citizens, it is difficult to characterise a payment as a tax unless it is paid “to the government”. Finally, in OECD’s view, as there is a wide range of circumstances where governments provide services in return for a fee, such circumstances should be distinguished from those where payment is “unrequited” and simply required as an incident of one’s personal or corporate residence.

There have been several other attempts at defining and standardising how we account for a government’s fiscal revenues. Under all these frameworks, international comparisons have consistently emphasised the low levels of tax revenues in Latin America, and to a lesser extent the Caribbean, relative to more developed countries. As is often the case, however, the reality is more complex. Governments everywhere raise revenues differently in their structures and dimensions. In the case of Latin American and Caribbean (LAC) countries, additional insights into the nature of the interaction between governments and their citizens can be gleaned from a broader comparison of fiscal revenues. For example, it is widely known that LAC countries derive significant revenues from permitting the exploitation of natural resources. Moreover, private and public arrangements to finance social security co‑exist in Latin America to a much greater extent than in OECD countries, a circumstance that is not completely addressed in international definitions and comparisons.

In this regard, it may be useful to take into account those two additional sources of revenue or “revenue equivalent” besides the tax revenues traditionally considered.

In this special feature we incorporate the sum of these sources into the theoretical construct known as the Equivalent Fiscal Pressure (EFP). For that purpose, it is important to establish the basic concepts that comprise the EFP (Barreix et al, 2013a). The first is the traditional revenue from taxes, consisting of all sorts of direct and indirect taxes levied on residents at all levels of government. The second comprises the social security contributions made to all mandatory pension and healthcare systems, both private and public. The third part of our construct consists of all the non‑tax revenues derived from the exploitation of renewable and non‑renewable natural resources – that is, fees, royalties, dividends paid and net profits that (totally or partially) state‑owned public enterprises engaged in the exploitation of natural resources transfer to national treasuries.

I. TAX REVENUE TRENDS 1990-2013/TENDENCIAS TRIBUTARIAS 1990-2013

REVENUE STATISTICS IN LATIN AMERICA AND THE CARIBBEAN 1990-2013 © OECD/ECLAC/CIAT/IDB 2015

ESTADÍSTICAS TRIBUTARIAS EN AMéRICA LATINA Y EL CARIBE 1990-2013 © OCDE/CEPAL/CIAT/BID 2015 35

EFP = general government tax revenues + all mandatory social security contributions + non‑tax revenue from the exploitation of natural renewable and non‑renewable resources

This fiscal‑revenue indicator may offer a more comprehensive picture for LAC countries, both from the perspective of the revenues available to the state and from the viewpoint of the effort demanded of citizens. Figure S1.1 shows that components 2 and 3 of the EFP are not only significant but also widespread in the region.

Figure S1.1. Equivalent Fiscal Pressure (1990-2013)

Share of GDP (both left and right axes)

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

12 15 18 21 24

0 5 10 15 20 25 30 35 40

1990 2013 1990 2013 1990 2013 1990 2013 1990 2013 1990 2013 1990 2013 1990 2013 1990 2013 1993 2013 1990 2013 1990 2012 Argentina Bolivia Brazil Caribbean CA*,

Panama &

Chile Colombia Mexico Paraguay Peru Uruguay Venezuela Percentage of GDP Percentage of GDP

Tax Revenue Public Social Security Contributions

Private Social Security Contributions Non-Tax Revenue from Natural Resources EFP Average for LAC (top and right axes)

Note: Values for the Caribbean, *CA (Central America), Panama and the Dominican Republic are unweighted averages.

Sources: Tables 1 and 4 and IDB‑CIAT Database 2014.³

12 http://dx.doi.org/10.1787/888933189676

Figure S1.1 distinguishes between the three components of the EFP: tax revenues, mandatory public and private social security contributions, and revenues from renewable and non‑renewable natural resources. It also highlights the effects that the 12 structural social security reforms, occurring in the LAC countries between 1981 and 2008, had on the landscape of fiscal revenues, as well as the significant proportion of revenues derived from natural resources in 10 countries of the region.

It should be noted that despite the considerable fiscal effort of LAC countries during the past two decades, there persists a substantial revenue gap between the region and more developed countries. This is clear from a calculation of the differences in absolute collection. For that purpose, the weighted average of the OECD and LAC countries’ per capita collection was calculated in 2011 US dollars at purchasing power parity (PPP), to reflect the relative levels of spending capacity.

The differences are noteworthy, as Figure S1.2 shows. The weighted average per capita collection (at PPP) for the OECD in the period 2011–13 was three times that of LAC, and almost seven‑fold that of Central America, Panama and the Dominican Republic (CA‑PA‑DR). The gap is narrower if the comparison is with the aggregate of MERCOSUR, Chile and Mexico, which have the region’s largest per capita income. They achieved a per capita collection close to a third of the OECD average. This substantial revenue gap highlights the significant revenue differential to finance public services, and the critical need to improve tax policy and administration in LAC countries.

I. TAX REVENUE TRENDS 1990-2013/TENDENCIAS TRIBUTARIAS 1990-2013 I. TAX REVENUE TRENDS 1990-2013/TENDENCIAS TRIBUTARIAS 1990-2013

REVENUE STATISTICS IN LATIN AMERICA AND THE CARIBBEAN 1990-2013 © OECD/ECLAC/CIAT/IDB 2015 ESTADÍSTICAS TRIBUTARIAS EN AMéRICA LATINA Y EL CARIBE 1990-2013 © OCDE/CEPAL/CIAT/BID 2015

Figure S1.2. Equivalent Fiscal Pressure, per capita and as % of GDP^a

PPP, constant 2011 international USD

664 879

2 143 2 410

5 559

9 507

1 859 2 498

4 029 4 626

8 134

12 360

11.8 12.7

19.9 22.1

27.8 30.6

17.5

23.2

27.6 30.3

32.2 30.5

0 5 10 15 20 25 30 35

0 2 000 4 000 6 000 8 000 10 000 12 000 14 000

90-92 11-13 90-92 11-13 90-92 11-13 90-92 11-13 90-92 11-13 90-92 11-13

CA, PA, DR CAN b/ LAC b/ Mercosur + Chi + Mex b/ Portugal OECD c/

EFP ( % of GDP) Per capita fiscal pressure

(PPP, constant 2011 international USD)

Pc EFP 90-92 Pc EFP 11-13 EFP 90-92 (right axis) EFP 11-13 (right axis)

Notes:

a/ Average and per capita fiscal pressure weighted by PPP‑GDP, in constant 2011 USD . b/ LAC and subregions do not include Argentina and Ecuador. Mercosur includes Brazil, Paraguay, and Uruguay. c/ OECD excludes Chile, Slovak Republic, Slovenia, Estonia, Israel, Mexico and Czech Republic.

Sources: IDB‑CIAT (2014), World Bank (2014).

12 http://dx.doi.org/10.1787/888933189686

The following sections provide a more in‑depth explanation of the alternative fiscal revenue equation for LAC countries.

The social security revolution in Latin America

In the early 1980s, the so‑called “lost decade”, Latin America experienced a series of reforms to its social security systems that, arguably, have come to shape the way in which fiscal revenues can be accounted for in LAC. The main feature of the pioneering Chilean reform was the introduction in 1981 of privately managed individual capitalisation accounts. This was the first experiment of its kind, allowing the free market to finance public pensions while slowly phasing out the traditional pay‑as‑you‑go system. At the time, supporters of the reform championed it on the assumption that individual responsibility would promote national savings and labour formality, contribute to the development of capital markets and the subsequent returns on capital, and insulate pension funds against political prying (Uthoff, 2001; Gill, Packard and Yermo, 2005;

Bosch, Melguizo and Pagés, 2013).

Following Chile’s example, several other countries embarked on a quest to overhaul their national public pension systems through structural reforms. These shifts, while diverse and complex in their own ways, have been broadly grouped into three categories:

“The replacement model” (Chile, 1981; Bolivia, 1997, reversed in 2010; El Salvador, 1998; and Mexico, 1997), whereby the public pension programme is completely replaced by a fully funded, mostly privately managed pension system financed through individual capitalisation accounts.

“The parallel model” (Peru, 1993; Colombia, 1994), which ends the state’s monopoly by introducing a new private alternative. In this model, the public and the private pension programmes coexist and compete, and employees can choose between them when they enter the labour market.

“The mixed model” (Argentina, 1994, reversed in 2008; Uruguay, 1996; Costa Rica, 2001; Dominican Republic, 2003; Panama 2005–2007), in which the provision of a basic universal service is complemented by compulsory contributions to individual

I. TAX REVENUE TRENDS 1990-2013/TENDENCIAS TRIBUTARIAS 1990-2013

REVENUE STATISTICS IN LATIN AMERICA AND THE CARIBBEAN 1990-2013 © OECD/ECLAC/CIAT/IDB 2015

ESTADÍSTICAS TRIBUTARIAS EN AMéRICA LATINA Y EL CARIBE 1990-2013 © OCDE/CEPAL/CIAT/BID 2015 37 capitalisation accounts run by privately managed pension funds. Under this model, the non‑contributory and the contributory schemes meet in a single programme (Mesa‑Lago, 2000; Bonilla and Conte‑Grand, 1998; Rofman, Apella and Vezza, 2013).

The most recent wave of structural reforms, dubbed the “re‑reforms” (Mesa‑Lago, 2009), sought to instill stability and adapt pension systems to the particular socio‑

economic context of each country. For instance, Argentina (2008) decided to end the private pillar by which citizens saved for retirement, and returned to a pay‑as‑you‑go system. It also extended coverage to those previously excluded from the system. Bolivia (2007) nationalised its pensions system once again and established three branches: a contributory branch for the elderly, the disabled and survivors; a semi‑contributory branch to serve as a solidarity fund; and a non‑contributory pillar to finance the “Dignidad” bond.

On a different note, in 2008 Chile introduced a supplementary, non‑contributory pillar to the private pillar already in place. In 2009, both El Salvador and Peru introduced minimum pension guarantees for low‑income citizens who did not reach the established threshold of contributions. This latter group of countries filled the gaps but did not change the nature of the private system.

As discussed above, the focus of the OECD Revenue Statistics is to measure the value of tax revenues paid to government and establish the sources of these payments.

However, from the individual’s perspective, whether the payment is made to the public or private sector is of less consequence in the short term to the employer or the employee.

Both types of payment equally affect the overall cost of labour. The size of the fiscal burden – that is, the fiscal effort demanded of contributors – will be affected, given the compulsory nature of social security contributions, which clearly resemble a tax in the eyes of the taxpayer – whether actually defined as a tax or not. A critical issue, then, is to understand the state’s fiscal responsibilities and liabilities arising from these reforms.

In this regard, the last two models described above involve active participation by the state. In the replacement model the state’s participation was curbed, but it still played an important role as a regulator and guarantor of the private system. In most cases the state financed the transition, which entails a substantial fiscal cost that is still being paid by most countries that underwent reforms. Additionally, several studies have shown that pensions paid through traditional public systems tend to be regressive which raises questions regarding the solidarity component claimed by public social security programmes (Barreix, Bès and Roca, 2009; Barreix, Roca and Villela, 2006; Lustig, 2013).

Furthermore, the system of social security contributions comprises several public programmes, especially health insurance, which makes it a complex and indivisible system as a whole. Data also indicate that, contrary to intuition (see Figure S1.3), social security contributions paid to the public sector did not decline sharply in countries where replacement models were enforced. In fact, public social contributions increased in Mexico, where the public pillar was closed to new entrants and where a large share of contributors to the public scheme were required to switch to the newly created private pension fund. But even in countries that did experience a decline in public contributions (Argentina, Uruguay and El Salvador), the fall was not dramatic despite the increase in contributions to the private pillars. This might be explained by the intrinsic link between pensions schemes and healthcare systems (sickness, maternity, excluding paid benefits, and occupational hazards), wherein the main goal of the reforms was to increase coverage and thereby reassert solidarity⁴ within the system. In this regard, virtually all Latin American countries reformed their healthcare systems (Mesa‑Lago, 2013). These health reforms, however, did not greatly affect the role of private providers in this type of insurance market, at least, not in the same way that structural pension reforms substantially changed the landscape of public finances in the region.

I. TAX REVENUE TRENDS 1990-2013/TENDENCIAS TRIBUTARIAS 1990-2013 I. TAX REVENUE TRENDS 1990-2013/TENDENCIAS TRIBUTARIAS 1990-2013

REVENUE STATISTICS IN LATIN AMERICA AND THE CARIBBEAN 1990-2013 © OECD/ECLAC/CIAT/IDB 2015 ESTADÍSTICAS TRIBUTARIAS EN AMéRICA LATINA Y EL CARIBE 1990-2013 © OCDE/CEPAL/CIAT/BID 2015

Figure S1.3. Public and private social security contributions

Percentage of GDP

-20 2 4 6 8

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Argentina