Latin America Advisor

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Will Colombia’s Tax Reform Get a Green Light in Congress?

Iván Duque.

The government of Colombian President Iván Duque on April 15 formally submitted to Congress its tax reform proposal, which includes scrapping many deductions and increasing levies on individuals and businesses and aims to increase annual tax collection by $6.38 billion, or 2 percent of GDP. The government has forecast a fiscal deficit of about $26 billion this year, or about 8.6 percent of GDP, in part due to increased government spending in the face of the pandemic. What are the most significant parts of Duque’s tax reform proposal? How much opposition does the reform face in Congress, and will lawmakers significantly modify it? How important is the tax reform to maintaining Colombia’s fiscal sustainability, and should the government be taking additional measures in order to close the deficit?

Maria F. Valdés, coordinator of tax issues at Friedrich-Ebert-Stiftung in Colombia: The proposal is the most revenue-ambitious tax reform in recent Colombian history. Most of its revenue, 69 percent, will be used to pay down the national debt, given that government finances have deteriorated enough that the country’s credit rating could be downgraded. The remaining 31 percent of revenue will be used to finance expenditure initiatives, such as an unconditional solidarity cash transfer for the poorest 40 percent of Colombian citizens. Seventy-three percent of the revenue will come from personal income tax, mainly by widening its tax base. If the law passes, Colombians with monthly incomes as low as 2,500,000 pesos ($690) will pay income taxes. Currently, people start paying income tax at twice that amount. The second source of revenue, 31 percent, will come from the VAT, where many products will be taxed at higher rates. The reform also proposes important green taxes, such as a more ambitious tax on carbon emissions and taxes on polluting cars. In Congress, only a few parties actually support it. According to a recent poll, the general population also opposes it, with 82 percent of Colombians saying they would not vote for a presidential candidate in 2022 who supported this reform. Most criticize it for being too radical and, rightly so, for excessively hurting the middle class, a segment where the majority does not earn the legal minimum wage, while not taxing the richest, in a country with one of the highest concentrations of income at the top in the world. However, in Colombia, Congress has never declined any tax proposal, and this time is unlikely to be different. Regardless of its unpopularity, this tax reform will pass with major modifications and reduced revenue potential."

Richard Francis, senior director at Fitch Ratings: “Tax reform is a critical factor for Colombia’s public debt dynamics and will therefore be significant in Fitch’s resolution of the Negative Outlook on Colombia’s ‘BBB-’ sovereign rating. The government’s tax reform proposal targets a permanent increase in revenues worth 1.4 percent of GDP by 2024, net of transfers to sub-national governments and new social spending commitments, but Congress is likely to amend it. The proposal is part of the government’s strategy to stabilize the debt/GDP ratio over the next five years. Other measures include allowing the roll-off of transitory pandemic-related spending (higher-than-expected pandemic spending plans in 2021 partly reflect under-spending in 2020) and improving tax administration. These should yield some fiscal benefits, as will economic recovery, higher oil prices, and potential one-off measures such as asset sales. However, Fitch believes that a permanent increase in tax revenues would be necessary to stabilize and start to reduce the public debt burden. Credible tax reform would also anchor medium-term fiscal expectations, supporting policy credibility and reducing vulnerability to shocks. The proposal’s heavy reliance on personal income tax measures increases uncertainty around the eventual revenue impact, which will depend on compliance, although this could be improved by broadening the tax base and reducing exemptions. The ultimate impact of tax reform will depend on how much Congress amends and potentially dilutes the proposal.”

Mariana Zepeda, Latin America analyst at FrontierView: “This long-waited tax reform is one of Colombia’s most ambitious. Not only does the ‘Ley de Solidaridad Sostenible’ aim to protect Colombia’s hard-fought fiscal credibility, it also expands social spending. While both goals are crucial to tackling Colombia’s fiscal and social challenges, pursuing them will be difficult, particularly in a post-pandemic context. The most controversial aspects of the reform include expanding the income tax base and higher VAT costs, particularly for certain income deciles. As a result, the current tax bill would not only directly affect middle class households, it could also push up costs for producers who lose access to VAT exemptions along the supply chain, likely raising costs for consumers down the line. Protests are already brewing, and according to a recent Polimétrica poll, 82 percent of Colombians would not vote for a presidential candidate who supports the bill. With 2022 elections looming, voting for the bill would come at a high political cost, and even key members of the Centro Democrático have refused to get on board. But the Duque administration has limited options. Duque himself has referred to Colombia’s fiscal situation as a ticking time bomb. Poverty levels are rising, and it is crucial for the country to retain its investment grade rating. Not only would rising debt costs in the wake of the pandemic—during which Colombia’s debt has ballooned—be catastrophic for the country, a downgrade would also hit Colombia’s competitiveness, limiting its access to capital, constraining investment and likely weakening the peso further. But under the current social and political context, it is clear that compromises will be required; what is less clear is whether a revised reform would reach the 1.4-5 percent of GDP tax collection threshold that rating agencies will likely require to stem a credit downgrade.”

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