Crítico Diagnóstico Tributario de OCDE 2010 (inglés)

Strengthening tax revenues for targeted social spending

Expenditure on education and social programmes is increasing

Despite good growth performance in recent times, inequality remains very high in Chile by international comparison (Figure 2.8). Poverty, in turn, has decreased substantially no matter what particular level for the poverty line is chosen and whether it is defined in absolute or in relative terms. Nevertheless, many people continue to hover around the poverty line (Larrañaga, 2009). In addition to its policies to enhance growth performance Chile uses well-targeted social policies to make progress to reduce poverty, which however remain limited in size in comparison with most OECD countries (Figure 2.9), although like in some OECD countries publicly mandated social spending is higher than it appears in Figure 2.9. Pension benefits accruing from the private compulsory system accounted for about 1.5% of GDP in 2007 and spending on healthcare by private insurers accounted for another 1% of GDP, although not all of this corresponds to compulsory health insurance. In addition, private spending on education below the tertiary level, which is mostly public in most OECD countries, accounted for close to 1% of GDP in 2006. Chile has recently substantially increased spending targeted at poorer households. This includes: school subsidies for poor children; in-work benefits for young low-wage workers; easier access to the Solidarity Fund of the unemployment benefit system, which is partly funded from the general budget; a substantial expansion of subsidised places in nurseries and kindergartens and higher tax-paid minimum pensions along with top-up payments for those individuals who are not or insufficiently covered by the private pension system (around 70% of the labour force). These initiatives should help reduce poverty further, improve emp l oy me nt ch ances f o r yo ung low-wag e wo rkers and p rov ide bet t er opportunities for poor children to develop their abilities to their full potential.
Tax revenues in Chile are relatively low in relation to GDP and overall the tax system is slightly regressive (Engel et al., 1998; Cantallopts et al., 2007). This is due to a relatively low yielding progressive income tax and a high share of indirect taxes in overall revenues (Figure 2.10), a combination which is not atypical for middle-income countries. It should be noted, though, that tax revenues, like public spending, are somewhat underestimated to the extent that the main pensions system and parts of the health care system are private and contributions are not recorded as public revenues. In 2007 they accounted for more than 6% of GDP. This section makes suggestions to limit or abolish some of the less efficient and more regressive tax expenditures. Proceeds can be used to target the commensurate
subsidies better at lower income households, to finance higher social spending or to lower tax rates, thus making the tax system more efficient.
Given that the tax system plays no role in Chile’s redistributive efforts, spending on education and social programmes will remain important to reduce poverty and attenuate inequality Approved social reforms, including the pensions reform, are expected to be financed by future revenues and to a lesser extent by assets accumulated in sovereign wealth funds, including the Fondo de Reserva de Pensiones, which was set up to pre-finance a part of future pension benefits. Decreasing outlays for the public pension system, which is being phased out, are also going to contribute. On the other hand, the long-term development in revenues could be weaker than projected if recent copper price increases were not sustained or if the longer term impact of the crisis on potential output was stronger than currently expected. First, Chile should ensure that spending is effective and efficient. But government tax revenues may need to be expanded in the medium term in order to finance higher spending on social programmes and important public goods, such as education, while keeping public finances sustainable. Broadening the tax base by abolishing some of the less efficient and regressive tax exemptions and working to increase the yield of the income tax system would contribute to this goal. As Chile is making important progress in reducing informality, including by improving the efficiency of its tax administration, it will become possible to strengthen tax revenues over time without risking an increase in the informal sector.
Chile has a commendable reporting system for tax expenditures. The nature and size of tax expenditures is reported every year in the budget report. Their costs in terms of foregone tax revenues are estimated to amount to around 5% of GDP (Ministry of Finance, 2009). The cost of tax expenditures is not comparable across countries given that estimates depend on the definition of what would be the benchmark. Judging from self-reported foregone tax revenues of the biggest tax expenditures in selected OECD countries, however, Chile’s tax expenditures should be comparable in size to those of other countries (OECD, forthcoming). Limiting or abolishing tax expenditures that are thought to be unnecessary is often difficult, because in many cases they favour well-organised interest groups. Chile could therefore consider complementing its reporting system with an independent evaluation of the effectiveness and efficiency of tax expenditures in reaching their stated goals compared with alternative instruments. This could give the government reassurance when the tax expenditures are well designed. When they are not, the evaluation would provide the government with arguments to limit or abolish them. It would also be desirable to publish the distributive features of tax expenditures more regularly. An analysis in the budget report of 2006 shows that tax expenditures benefit mainly the wealthiest parts of the population, owing largely to the fact that few Chileans actually pay income taxes. As an example, 85% of the tax deferrals in the personal income tax system, including the one for retained corporate earnings, benefit the wealthiest 5% of the population and 66.6% benefit the wealthiest 1% (Ministry of Finance, 2006).

Limiting less efficient tax exemptions could help finance higher spending…

The government might want to review remaining exemptions and preferential tax treatments. With a uniform rate at 19% and few exemptions, VAT in Chile has a rather broad base compared with OECD countries, which explains its relatively high contribution to overall revenues (see Figure 2.10). However, a few exemptions and tax credits remain, amounting to around 0.8% of GDP of foregone tax revenues. The government has recently capped the VAT credit for housing construction for more expensive buildings so as to reduce the foregone tax revenue and make the tax credit less regressive. The tax exemptions for health and education services could be reviewed, as well. They have a regressive impact as both are mainly consumed by higher-income households, while poorer households consume free public education and health services. Limiting these exemptions or abolishing them altogether could help finance recent increases in education and social spending or alternatively help to reduce the VAT rate to make the tax system more efficient and somewhat less regressive.
Chile could reconsider the tax treatment of private pension savings to further strengthen subsidies for medium- and low-income earners to save, while capping tax benefits for higher-income earners. The private pension system in Chile has contributed to the deepening of the financial market. At the same time it is characterised by low coverage, as around 55% of the working age population were not covered in 2005, and low density of contributions, as many more contribute for less than half of their working lives. Chile has made commendable progress by increasing tax-financed minimum and top-up pensions for this group and introducing subsidies for young low-wage workers and mothers. However, income tax allowances to promote pension contributions mainly benefit higher- income groups given that a majority of Chilean workers have earnings below the exemption threshold and do not pay income taxes. Mandatory contributions also benefit from tax subsidies, although the need to provide savings incentives for higher-income individuals is likely to be limited when coverage is compulsory. Some of the public revenues now foregone due to tax incentives for higher-income individuals might be better spent on subsidies for low-income individuals to save. The main challenge that Chile’s private pension system needs to confront is low coverage and density of contributions of low-income workers who struggle to save sufficiently for old age. Subsidies should be well targeted at this group.
Contributions to the private pension system and the accrued return on accumulated funds are tax-free in Chile, while the benefits are treated as taxable income upon withdrawal. This regime is often referred to as exempt-exempt-tax (EET, see OECD 2006, Antolin et al., 2004; OECD, 2004b). It is a common treatment of voluntary private pension savings in OECD countries. In Chile, it is applied both to mandatory contributions and to volu ntary top-up co ntrib u tions u p to a ceil ing, in cludin g employer-spons ored programmes. It is considered a favourable tax treatment compared with the so-called comprehensive income tax regime that treats all sources of income equally (Antolin et al.,
2004, de Serres and Yoo, 2004). In such a regime, saving contributions and accrued returns would be subject to income tax, while benefits would remain tax-free (tax-tax-exempt, TTE). Compared to this the treatment of pensions in Chile is a tax deferral. The main rationale for the EET-regime is that it does not distort the decision between current and future consumption. In practice, however, tax regimes rarely achieve neutrality, not least because other savings instruments are rarely subject to an EET-regime. Estimates of the net cost of different tax treatments for pension savings in OECD countries suggest that the EET regime is a particularly expensive model to favour pension savings (Antolin et al., 2004; de Serres and Yoo, 2004). Countries who tax contributions or accrued returns to some extent incur lower foregone revenues compared to the benchmark TTE. In Chile the treatment of pension savings is one of the costliest tax expenditures according to government calculations.
In principle, Chile could treat compulsory private pension savings like any other savings instrument, as compulsory savings need not be supported with tax incentives at least for those individuals who are able to save sufficiently without subsidies. However, the government may still wish to apply a favourable tax regime to pensions, especially for the part that goes beyond the compulsory level to encourage higher pension savings. Evidence suggests, however, that a favourable tax treatment of pension savings is more likely to distort the composition of savings, while doing little to increase overall savings, especially when tax incentives benefit mainly higher-income earners (OECD 2006, Antolin et al., 2004: OECD, 2004b). In Chile the low coverage of self-employed workers of 3.3% in 2007 is testimony to this, as these workers are eligible for the favourable tax regime, but their contributions were voluntary until recently.
Making private pension savings compulsory for additional programmes and groups is probably more effective to increase the coverage of the pension regime and the density of contributions. For example, in the longer term Chile could consider whether it is feasible to make occupational pension programmes mandatory, as they are in a number of OECD countries (Antolin et al., 2004). The government has made pension savings mandatory for the self-employed who declare income taxes, which will be gradually phased in over 2012-18. This is a welcome initiative. Making pension contributions mandatory for the self- employed will require enhanced control efforts, because even those who pay income taxes now could start under-declaring their income. Extending the reach of mandatory pensions would allow the government to lower fiscal incentives to contribute to the system, freeing resources to support pensions of low-income households.
Subsidies for pension savings could be better targeted, by concentrating them more on workers with middle and low incomes. The government has already taken measures to improve access to subsidies for some contributors who pay little or no income tax, as workers who contribute voluntarily can now opt for a direct subsidy instead of tax breaks. It could consider strengthening subsidies for medium- and low-income earners further and capping the tax relief for pension contributions by providing a flat non-wastable tax credit or a subsidy instead of a tax allowance. This way the subsidy would be available for middle- and low-income earners with earnings below the tax exemption threshold, who are most likely to need support to be able to save sufficiently for old age. At the same time, the tax incentive would no longer increase with marginal tax rates and thus income. Limiting the subsidy for higher-income workers is justified, because they are likely to be able to save even without support. Higher pension savings subsidies for low- and middle-income earners who declare taxes can also be a powerful incentive to move into the formal sector.
To limit the cost of fiscal savings incentives further, the government could even consider applying a low flat tax rate to accrued earnings. This can reduce the net fiscal
costs of savings incentives substantially, even when applied at a relatively low rate (Antolin et al., 2004). It would be important to calibrate such a tax carefully, however, so as not to endanger the adequacy of future pension income. Providing tax credits for pension contributions and taxing accrued returns at a low rate can still be calibrated so that the net present value of tax payments is lower than for other saving instruments. This could remain true even if the income tax were continued to be applied to benefits at the full rate, given that pension income is likely to be lower than previous earnings. However, if the government is concerned about double taxation it could apply some tax relief to benefits. What is important in the end is to reduce the fiscal cost of savings incentives, while targeting them at those who need them most.
The rental income derived from much of the country’s real estate is tax exempt and there would be merit in reviewing this measure. Rents derived from properties that are smaller than 140 square meters and have been built in line with the provisions of Law Decree No. 2 of 1959 (Decreto con Fuerza de Ley No. 2, DFL 2) are tax exempt. This was originally designed to encourage the building of affordable housing. According to estimations of the internal revenue service, only 20% of residential housing do not benefit from this measure. The rationale and the effectiveness of this tax expenditure could be reviewed not least because the VAT tax credit for housing construction serves the same goal. In addition there are well-targeted demand-oriented housing subsidy programmes (OECD, 2007). The government should evaluate the effectiveness and efficiency of the instruments it uses to promote affordable housing, including their interaction. It might well be preferable to retain only the most effective instrument.

… and Chile could work towards increasing its income tax revenues

The contribution of the personal income tax to overall tax revenues in Chile is low in international comparison. This is due to a relatively high exemption threshold, low rates for most tax payers (Box 2.2) and the difficulty to tax high-income earners at the rates foreseen in the personal income tax schedule. Retained earnings are taxed at the corporate tax rate of 17%. Corporate tax earnings have recently increased substantially, because private mining companies have started to pay taxes, after benefitting from accelerated depreciation allowances on their original investments. The personal income tax rate, which is significantly higher than 17% for higher incomes, is applied only once earnings are distributed. This creates an incentive for high-income individuals to keep most of their income as r e ta ined earni ngs o f cor p o r ations. The e x istence of m or e tha n
30 000 investment societies (sociedades de inversión) that are exclusively created to manage retained profits is testimony to this (Cantallopts et al., 2007). The fiscal revenues losses associated with deferring personal income taxation for retained corporate earnings is estimated to be around 2% of GDP (Ministry of Finance, 2009).
Th e gove rn ment co ul d c o ns ider cl os in g th e ta x lo oph o les a s s o ci at ed wi th corporations that are created for the sole purpose of deferring taxes or avoiding them altogether, such as sociedades de inversión. It has recently suppressed the possibility for such vehicles to defer payment of corporate income taxes to the moment when profits are withdrawn, a treatment to which some small companies in Chile are eligible. It could consider moving further into this direction by banning sociedades de inversión altogether or by applying the personal income tax rate to savings retained in such vehicles. As a complementary measure, the government could also consider bringing the corporate income tax rate and the top personal income tax rates closer together to reduce incentives

The Chilean tax system

Personal and corporate income taxes are fully integrated and together account for about one third of tax revenues. The corporate tax rate (impuesto de primera categoría, IPC) is flat at 17%. The earnings tax for dependent workers (impuesto de segunda categoría, ISC) and the general income tax (impuesto global complementario, IGC) are subject to the same
progressive tax schedule. They are filed on an individual basis.
Retained profits are taxed at the corporate profit rate. Once they are distributed, the corporate tax is creditable against the IGC which then becomes due at the individual level. Individuals or legal entities that are not residents in Chile pay a 35% additional tax on dividends, withdrawals and/or remittances of profits (against which paid corporate taxes can be claimed as a tax credit).
There is a presumptive tax system for unincorporated businesses in selected sectors (agriculture, small mining and transport) subject to turnover thresholds. Special tax regimes are also in place for small enterprises based on simplified accounting and for small taxpayers (street vendors, miners and craftsmen, etc.) based on turnover.
The Value Added Tax (VAT) with a uniform rate of 19% is the main indirect tax accounting for more than 40% of total tax revenues. Education and health care services, public transport services, real estate rents and life insurance are tax exempt. There are no registration thresholds. Other indirect taxes include excise taxes on tobacco, alcohol and fuel.
Chile introduced a small royalty on operating profits (after normal depreciation) of mining companies in 2005. The tax rate increases with sales above 12 000 equivalent tonnes of copper (metallic and non-metallic minerals) and can reach up to 5% for sales above 50 000 equivalent tonnes of copper.
Municipal taxes account for 1.5% of GDP and comprise a property tax, municipal licenses and a vehicle registration tax.

for aggressive tax planning. Lowering top personal income rates could be justified politically if the tax base could be broadened at the same time by eliminating regressive tax exemptions. However, to strengthen tax revenues through such a measure this would also need to involve increasing the corporate income tax rate at least a bit.
Increasing the corporate tax rate involves more difficult decisions, but as long as the increase is not too high, ensuing problems should be limited. The corporate tax rate in Chile is among the lowest in the OECD and depreciation allowances are very generous. Depreciation allowances are worth more the higher the capital income tax rate. The government could evaluate whether low corporate tax rates and high depreciation allowances are needed at the same time. In fact, there is evidence that at least for large firms that are not credit-constrained the corporate tax rate does not influence investment decision in Chile (Bustos et al., 2003), mainly because of the high depreciation allowance and interest rate deductibility. On the other hand, there is some – although not entirely conclusive evidence – that the reduction of the corporate tax rate on retained profits in 1984 has helped spur the ensuing investment boom, possibly by helping credit-constrained firms to finance this investment (Hsieh and Parker,
2006) in a context of weakly developed financial markets. However, it should be noted that the tax rate was lowered from 40% to 10% at the time and financial markets have developed since then. A moderate increase in the corporate tax rate should do little harm to firms’ ability to finance profitable investments, especially if the government continues its efforts to improve the access of small and medium enterprises to capital markets. It is also important to consider that depreciation allowances that go beyond economic depreciation are likely to distort the allocation of resources in favour of particularly capital-intensive sectors, such as mining in Chile, with potential damage to employment.
Increasing income tax revenues need not imply lower work incentives for many. Recent OECD work suggests that while income taxes are preferable over consumption taxes in terms of their effects on distribution, a revenue-neutral shift from income to consumption taxes may have slightly positive effects on growth (Johansson et al., 2009). This is because consumption taxes often have a broader base than income taxes, because they apply to all forms of income, and because they are proportional, while income taxes are progressive which is found to be less beneficial for growth. However, this empirical result is obtained for OECD countries with comparatively high and progressive marginal income tax rates that cover large parts of the population. In Chile increasing income tax revenues by bringing the personal and the corporate income tax rate closer together might have some negative effect on the incentives of high income individuals to work and save as they might effectively pay a higher income tax than before. However, this effect could be kept relatively low as long as higher personal income tax rates were lowered sufficiently. Moreover, some of the higher income tax revenues along with proceeds from abolishing the remaining VAT exemptions could be used to lower the VAT rate, which would produce countervailing effects. This is because VAT lowers the purchasing power of real after-tax wages, weakening work incentives in much the same way as the income tax. Since marginal consumption tax rates are high in Chile compared to marginal income tax rates for most individuals, this could raise the efficiency of the tax system.
Chile could also consider applying a very low income tax rate to an income bracket that is below the exemption threshold so that more people with lower income pay income taxes. Today, the exemption threshold is very high in international comparison (Figure 2.11). Simulations suggest that if Chile were to apply a 3% tax rate to individuals who are currently not taxed it could raise its income tax revenues by almost 2% of GDP, although this is an accounting exercise that does not take into account people’s reactions (OECD, 2009b). It is also important to note that while it may be possible to lower the tax exemption threshold, it would not be advisable to abolish it altogether as assumed in this simulation exercise. Lowering the tax exemption threshold, however, would not be politically feasible unless it came in a package with important improvements for low-income earners, such as stronger unemployment benefits or lower indirect taxes after a broadening of its base. If indirect taxes could be lowered sufficiently, however, this could well result in a lower tax wedge for these low-income earners, as the impact of a low income tax rate on their tax wedge could well be lower than the impact of a VAT rate of 19%.
To strengthen tax revenues property tax would also be a good candidate. Taxes on immovable property are relatively growth-friendly, because they do not affect decisions to supply labour, produce, invest and innovate to the same extent as other taxes. Also, these taxes are more difficult to evade because real estate and land are highly visible and immovable. Property taxes with regular updating of valuation can also contribute to the progressivity of the tax system (Johansson et al., 2009). This should be the case in Chile where the exemption threshold for housing real estate corresponds approximately to the median value of homes owned by the lowest income quintile. The median value of residential property rises sharply for higher income deciles (Torche and Spilerman, 2004). While the revenues of the real estate tax go to municipalities, higher property tax revenues could still free resources for the central government, as municipalities are dependent on central government transfers. Alternatively, the central government could increase its surcharge on the municipal tax.

Recommendations to strengthen the fiscal framework

● Consider possibilities to further strengthen the fiscal rule.

● Consider strengthening the insurance element of the unemployment benefit system, by easing access to the Fondo Solidario further and allowing to some extent for higher benefits. Severance pay could be lowered in return, for example by keeping it flat rather than letting rights increase with job tenure.

● Complement reports about the size of tax expenditures with evaluations of their effectiveness and efficiency.
● Consider abolishing or limiting remaining VAT exemptions.

● Consider strengthening subsidies for pension savings supporting low- and medium- income earners further, while capping tax benefits for high income earners.
● Close tax loopholes associated with corporations created for the sole purpose of deferring the payment of personal income taxes.
● Consider increasing the property tax rate, if needed.

Extractado de «OECD Economic Surveys,
CHILE», Volume 2010/1 January 2010.

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