24/11/2017 -
Edition 730

More than half of the taxes are very distorsive

The national government proposed a new Fiscal Pact. The most discussed issue is the conflict between Buenos Aires province and the rest of the jurisdictions regarding the Fondo del Conurbano –a fund for infrastructure works in the province of Buenos Aires. However, the most strategic point that deserves further analysis is the quality of taxes and a more aggressive reduction of public spending. 

The National Government proposed a new Fiscal Pact with the provinces. In the media, the issue that is constantly highlighted is the possible resolution, in favor of Buenos Aires Province, of the conflict regarding the Conurbano Fund without any harm to the rest of the provinces, since compensations will be provided by the national government. This aspect is the most ostentatious, but not the most important. Without underestimating the importance of reducing conflicts among jurisdictions, the Pact constitutes a very interesting opportunity for a more comprehensive and bold fiscal reform.

A key aspect is the low quality of the argentine tax system. VAT is a neutral tax for production and has advantages such as allowing its draw-back to exporters and investors (no harm to competitiveness) and to the most vulnerable (giving progressivity to the distribution of income). It is also important to highlight the positive impact on income distribution of Profit and Property Taxes. But the rest of the taxes of the system have high distortive impacts because they both discourage production and employment, and they contribute to the regressivity of income distribution.

Based on information published by the Ministry of Finance, tax collection can be disaggregated according to this classification of taxes. For the year 2016 it can be seen that:

  • VAT collects 7% of GDP.
  • Profit and Property Taxes collect another 7% of GDP.
  • The rest of the taxes collect 17% of GDP, these include labor taxes (7%), Sales Tax (4%) and Tax on Bank Credits and Debits (1.6%).

These data show that of the 31% of the GDP that the Nation and the provinces collect in taxes, more than half are done with very distortive taxes. This is the result of not being able to cover the public expenditure with VAT, Profit and Property Taxes, so a bad quality tax structure is used to compensate. The strategic sense of the Fiscal Pact, proposed to by the Nation to the provinces, is the commitment to gradually replace distortive taxes with more neutral and progressive taxes.

Therefore, one of the key aspects of the Pact is the proposal to increase the collection of provincial Profits and Property Taxes and reduce Sales and Stamp taxes. The intention here is to eliminate exemptions from the Profit Tax that do not have the status of a law and/or that apply to certain types of expenses, the unification among all the provinces of real estate valuations, the reduction of the Sales Tax to final sales and its removal on intermediate sales and a cap on the Stamp Tax. The least consistent point is to extend the Bank Credit and Debit’s Tax (one of the most distortive), although there is the possibility of using it as payment on account of Profit Tax.

For the tax system’s progress to be faster and more consistent, the Pact should be bolder in addressing the excesses of public spending. For example, the Pact proposes a change in the pension inflation adjustment rule, something essential but insufficient. Beyond the fact that a pension reform requires broader consensus and deeper study, the Pact could also review pension access requirements that have become outdated and lead to massive duplications of benefits. Furthermore, the Pact should contemplate eliminating the privileges of Buenos Aires Province and Buenos Aires City that receive national funds subsidizing infrastructure and public services, something that rest of the country does not benefit from.

The fact that there are 64 judicial cases in Court due to conflicts between the provinces and the Nation displays a huge political failure. That is why an agreement that allows to overcome controversies and move towards a better quality tax system should be very promising. The likelihood of success would increase if, in addition, more ambitious actions to control the growth of national and provincial public spending were taken.

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