Minimum or alternative taxes to the income tax

The arguments in favour of replacing the income tax with an alternative minimum tax are based on the weakness of tax design and administration, the tax formalization of small and medium-sized enterprises (SMEs) and the direct and indirect costs of tax collection and taxpayer compliance. Many countries resort to the adoption of taxes that act as a lower bound for the income tax, based on the value of a company’s assets or its total gross sales or gross income.

Stotsky (1995) points out that a minimum tax aims to prevent businesses or individuals that earn an income from regularly avoiding paying the corresponding income tax. This argument explains why developing countries are more likely to implement simplified taxes with low collection costs, such as minimum or presumptive taxes, as a remedy to the insufficient tax administration capacity in the region.

Gómez Sabaíni and Jiménez (2011b) explore the application of minimum taxes in the region in depth (table 14). Argentina applies a minimum tax on the value of gross assets, which is an alternative measure to business earnings under the assumption of capital mobility but still protects revenues in an inflationary environment. Costa Rica opted for taxing companies’ fixed assets. Colombia, Ecuador, Panama and Uruguay all use net equity or assets, albeit with tax rate levels. Guatemala applies the solidarity tax, which assesses a 1% tax on 25% of either net assets or gross income, whichever is greater.

From 2008 through October 2013 (it was repealed in the recent tax reform), Mexico had a minimum tax (Impuesto Empresarial de Tasa Única, or IETU), which assessed a flat rate (17.5%) on the residual profit or return on factors of production.

As an alternative to the income tax for small businesses, a minimum tax, when correctly applied, can successfully expand the tax base to increase both the number of taxpayers and the volume of tax payments, thereby reducing the cost of tax compliance for businesses (mainly SMEs) and promoting a reduction in tax avoidance and evasion. However, experience shows that when countries apply presumptive tax rates that force small taxpayers to opt for calculating the tax owed by the taxpayer based on real profits, it generates incentives for companies to move into the informal sector, producing the opposite of the intended effect.

TABLE 14

MINIMUM INCOME TAX FOR BUSINESSES IN LATIN AMERICA, 2012

Country Tax (rate and base)

Argentina 1.0% on gross assets

Bolivia (Plurinational State of) No

Brazil No Chile No

Colombia 3% on net wealth

Costa Rica No

Ecuador^a 0.15% on net wealth

El Salvador 1.0% on gross income

Guatemala 1% over the 25% of the net assets or 25% of the gross income, whichever is greater (Solidarity tax).

Honduras 1.0% on assets

Mexico No (IETU was in force between 2008 and 2013)

Nicaragua 1.0% on gross income

Panama^b CAIR (Alternate Calculation of Income Tax): 25% of the greater between the net taxable income and the 4.67% of taxable gross income (1.4% of gross income).

Paraguay No

Peru ^c 0.4% on net assets

Dominican Republic 1.0% on assets

Uruguay 1.5-3.5% on net wealth

Venezuela (Bolivarian Republic of) No

Source: Author’s elaboration based on Gutiérrez et al. (2010); “Global Corporate Tax Handbook 2010”, and updated country legislation.

a The tax base consists of immovable property but the tax is not intended as a property tax but as an additional tax on the profit of the companies

b This tax is in the form of a license to do business and the maximum amount of tax is 20,000 Balboas per year.

c While TTNA does not constitute a binding minimum tax, it does for the current fiscal year as its surpluses are likely to return as a tax credit.

When these taxes operate above the tax calculated on profits, they can discourage productive investment since they tax inventories, productive assets, machinery and other fixed assets. This can result in disinvestment in firms with losses, regardless of the tax mechanism (lump sum, percentage of assets, gross income, etc.), because taxing above net income turns the income tax into a capital tax. In sum, these taxes become a substitute for net income taxes, with all the associated consequences —both negative and positive.

Sadka and Tanzi (1993) argue that when the minimum tax is combined with a presumptive income tax, it can increase efficiency by inducing businesses to pursue a socially efficient use of capital.

At the same time, Graetz and Sunley (1988) hold that a minimum tax can equalize the marginal tax rates of the different economic sectors, since it unfavourably affects firms with an advantage in activities that are subject to a preferential tax regime.

However, even when a lump-sum tax is used, some activities will be untaxable, which creates tax efficiency costs. Furthermore, the introduction of this type of tax, especially as a replacement for the income tax, can be a strong blow to horizontal and vertical equity.

Finally, proponents of these unconventional taxes generally draw on arguments of urgency or crisis, and their implementation is usually conditioned on their being phased out in the medium term. In the case of financial transaction taxes, tax productivity decreases when they are in force for long periods, because the tax base tends to shrink due to financial disintermediation or the development of evasion mechanisms.

According to Shome (2011), the implementation of non-tax regulatory reforms is preferable, and if the two measures are used simultaneously, then the tax should be temporary, global and low.

In the case of minimum taxes or alternative income taxes, the duration of this type of tax is usually temporary and highly variable in legal terms in the tax structure over the years. Considering that the application of minimum taxes is the flip side of deficiencies in tax administration and legal shortcomings in the definition of taxes such as the income tax (Baer, 2006), governments should address the solution to these structural problems in the medium term.

In conclusion, any tax system must provide an integrated set of instruments that can consistently guarantee revenue sufficiency relative to the level of public spending and the premises of horizontal and vertical equity established by society. The tax system must therefore be able to adapt to fluctuations in the activity level (flexibility) and —with minimal distortion of private incentives in the face of State involvement— to generate revenues in a way that is simple for taxpayers and incurs low tax administration costs.

III. The economic and social consequences