Latin America Advisor

A Daily Publication of The Dialogue

Will Colombia’s Controversial Tax Reform Be Voided?

Former Colombian Vice President Germán Vargas is challenging the country’s tax reform in the Constitutional Court. // File Photo: Colombian Government. Former Colombian Vice President Germán Vargas is challenging the country’s tax reform in the Constitutional Court. // File Photo: Colombian Government.

A tax reform that took effect in Colombia at the beginning of this year is facing a challenge in the country’s Constitutional Court. Former Vice President Germán Vargas is challenging the reform, saying procedural errors in the law’s passage last year violate the constitution. The reform raises taxes on some individuals and reduces them for companies, beginning next year. How likely is the reform to be struck down? What would be the consequences for the government, individuals and companies if the Constitutional Court invalidates it? What effects is the tax reform already having on Colombia’s economy?

David Ross, global fund manager at La Financière de l’Echiquier in Paris: “A number of changes went into effect this year that optimists called a tax reform. It wasn’t. It was a modest shift lower in the high corporate income tax rates, offset by a shift upwards in individual tax rates. The effective corporate tax rate of 37 percent went to 33 percent for 2019 and will gradually drop to a permanent rate of 30 percent in 2022. Meanwhile, the top bracket for individuals rose from 33 percent (labor income) or 35 percent (capital) to 39 percent, which has made it unpopular as the electorate sees their taxes increase. While in theory the lower corporate rates should help to structurally reform Colombia’s economy, allowing its companies to be more globally competitive, inducing more domestic and foreign investment, and shifting the economy’s potential GDP growth permanently higher with higher productivity over time, the corporate tax cut is too timid to make much of a difference. Even at the eventual 30 percent, it will be well above the worldwide average of 23 percent, or even the emerging market BRICS average of 27 percent. Capital goes where it is most welcome, and that is still not Colombia. As an example, non-oil/non-mining foreign direct investment in Colombia fell 38 percent over the last two years, and nothing in these tax rates will change that trend. Furthermore, it does appear that there is a strong case for the court repealing the law, and if it is repealed, given its unpopularity, it seems unlikely that the law would be reconsidered, leaving Colombia’s economy in a permanently uncompetitive position.”

Oscar Ardila, head of investor relations and responsible investing at AshmoreAVENIDA: “Designed as a tool to promote investment and economic growth, the tax reform was by no means a perfect device. Aimed at raising 14 trillion pesos in 2019, the controversial reform is expected to generate only 7 trillion pesos. Moreover, there will be a loss in the collection of between 5 trillion pesos (in 2020) and 9 trillion pesos (in 2022) from the VAT reduction of the capital goods imports, and a loss of 8 trillion (in 2020) to 11 trillion (in 2022) from tax cuts to businesses. The tax reform, although imperfect, was needed to facilitate the country’s adjustment to the new macroconditions of a devalued peso and lower oil revenues. Its main provisions included modifications to the consumption, income and wealth taxes, as well as the strengthening of measures to prevent tax evasion. Nonetheless, as with any other negotiation, the passing of the reform required commitments from the government, among them the tightening of the national budget and cuts to subsidy programs. Those commitments may need a more aggressive stance to withstand the lost revenues. Despite the court’s ruling, from a fiscal standpoint, an adjustment to the reform may be needed in the medium term. Considering growth expectations for 2019, the reform is one of the tools that may prove efficient to put Colombia on a growth path once again. Thus, the key macroeconomic question now is not what the consequences of the invalidation of the tax reform law will be, but rather what fiscal path Colombia will follow to continue promoting growth without risking a widening deficit.”

Richard Francis, director of Latin American sovereigns at Fitch Ratings: “The financing law passed in 2018 was heavily watered down from the government’s original proposal and, though it is revenue positive in 2019, it will lead to significant revenue losses beginning in 2020 as corporate tax rate cuts and investment incentives take hold. As such, Fitch did not view the law as an important bill to structurally reduce the fiscal deficit as predicated by the country’s fiscal rule (targeting a 1 percent of GDP fiscal deficit by 2027) and needed to stabilize the debt-to-GDP ratio (which has risen to nearly 44 percent by our calculations from just 30 percent in 2013). The court is expected to rule on the matter on Oct. 14 one way or the other, and it is difficult to predict how the court will rule. If the court rules that the bill is unconstitutional, a key point to watch is if the ruling would be retroactive. That is, would it invalidate the tax measures put in place at the beginning of the year? If the ruling were retroactive, it would mean a significant revenue loss for the government in 2019, which would be difficult to make up so late in the year. The government has highlighted the positive impact of the financing law on investment and growth, stating that the trend growth rate has risen to 4 percent because of the law. Fitch believes the impact is positive but much less than the government’s estimates. So a loss would be only marginally negative for growth, in Fitch’s view. It is important to note that Colombia’s Constitutional Court has frequently ruled on fiscal and economic matters (although this case revolves around procedural errors, not the law itself). This does have an impact on the perception of judicial security by investors.”

César Caballero, manager at Cifras & Conceptos in Bogotá: “The tax reform, or ‘financing law,’ has been the subject of 23 lawsuits. Some seek to eliminate certain articles, and others the entire law. The court already has a positive stance on the former vice president’s suit, and everything seems to indicate that there is a majority tendency to decide in that regard. The government expects some elements that would change its effect, such as allowing its validity for the final months of this year. In essence, what is most likely and predictable is that the law will be declared unconstitutional because of various defects, including: 1.) Collection this year will be smaller, because elements such as amnesty for declaration of assets outside the country has already happened, and there is an over-collection of 10 percent of the goals; 2.) Collection next year will be fiscally positive, since all the new exemptions will be eliminated, and they would generate an additional fiscal gap of between 6 trillion and 8 trillion pesos; and 3.) For entrepreneurs and individuals, we will again have the version of the tax plan that the Santos administration approved. The government will have to decide if it will present the tax reform again in November. In this scenario, it will face many difficulties in Congress.”

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