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The tax reform extends the 0.4 percent financial transactions tax, which directly opens and promotes the underground cash economy, experts say. (Photo: Carolina Muñoz Moreno/Prensa/Alcaldía de Bucaramanga)
Wednesday, October 15, 2014

Colombia Taxes: Negative Impact

Colombia's increased taxes will negatively impact investors and increase the informal economy, experts say.

Inter-American Dialogue

Colombia's government in early October submitted a tax reform plan to the country's Congress that includes, among other measures, an increased tax on corporate profits and an extension of a bank transaction tax, but revised a controversial proposal to increase the wealth tax after criticism from business leaders. The measure is an effort to boost government revenues to meet budget spending goals and fill President Juan Manuel Santos' campaign pledge to invest in areas including education amid lower projected oil revenues. What are the implications of Colombia's new tax reform proposal? Will the new tax reduce investment in Colombia and send domestic capital elsewhere in the world? 

Erich Arispe, director in the sovereigns group of Fitch Ratings: Colombia's tax proposal does not come as a surprise, as it was anticipated that authorities had to replace or extend expiring sources of revenue in order to comply with deficit targets set under the country's Fiscal Rule. The government proposal extends the financial transaction tax, maintains the wealth tax (for net wealth above 1 billion pesos), adds 3 percentage points to the profit tax (CREE) for earnings above 1 billion pesos and withdraws a 2 percentage point VAT refund on credit card transactions. The proposed tax measures do not broaden the country's tax base or reduce the complexity of the Colombian tax system. Moreover, these measures do not increase central government revenues, but instead maintain them close to 17 percent of GDP through 2018 to meet social and investment commitments. Colombia's government revenue base, though, remains low in comparison to Fitch-rated Investment Grade sovereigns and OECD countries. Over the medium term, additional expenditure commitments, especially in the event of a peace agreement with the FARC, infrastructure investment requirements or lower-than-projected oil revenues could increase the need for a more comprehensive tax reform. It is premature to judge whether the government proposal or final congressional bill will have a material impact on the country's attractiveness as an investment destination. In addition to competitive tax rates, Colombia's efforts to continue improving its business environment depend upon the preservation of security gains, eventual reduction in transportation costs through the successful implementation of the 4G infrastructure program, continued reduction of formal labor costs, addressing of bureaucratic hurdles that slow down investment and effectively managing the rise of localized social conflicts.

Jorge Lara Urbaneja, partner at Arciniegas Lara Briceño Plana in Bogotá: According to the government, the tax reform presented to Congress is necessary to cope with the peace initiatives and new government programs, like education and health protection throughout the country. However, looking at the government's present expenditures, only comparable with bureaucratic growth, the tax reform is needed to address the present situation. The tax reform would transfer resources from the private to the public sector. An old formula that has failed whenever and wherever implemented. It extends the highly criticized 0.4 percent financial transactions tax, which directly opens and promotes the underground cash economy, outside the banking system. This is the payment system that supports the business model controlled by the FARC and its criminal partners. The tax reform focuses on taxing the rich by raising income tax rates and establishing a capital tax (under a new fantasy designation) that supposedly just affects high-end companies and individuals; but the proposed levels, in fact, reach low-middle class taxpayers. This new tax structures are presented to be in effect for the next four years; but history proves that temporary taxes in Colombia are forever. The minister of finance has stated that this approach is acceptable because Colombia has strong growth relative to other countries in Latin America. However, Colombia has never had the growth figures of Panama, Chile or Peru. Colombian industry has been decreasing steadily since free-trade agreements came into effect. Furthermore, the IMF just predicted a darker future for the Colombian economy, which may be accelerated by shrinking the productive sector.

Munir Jalil, director and chief economist for the Andean region at Citi Research: The wealth tax and the financial transaction tax are already in place in Colombia, but were scheduled for phase-out in 2015. This created a hole in government revenues for next year of 7 trillion pesos ($3.5 billion). In addition, reduction in oil output and prices this year led to a fall in the sector's expected dividends and taxes by 5.5 trillion pesos. The government initially decided it would extend the two taxes to fill the gap. However, since the amount needed was higher than could be collected with the same rates, it initially proposed increasing the wealth tax. The proposal was not well received by the corporate sector or big entrepreneurs, who said they preferred increases in the VAT or income taxes. In the bill the government sent Congress, the 12.5 trillion pesos the government needs is financed by extending both the financial transaction tax and the wealth tax, but left at the same rates, and the income tax is increased by 3 percent. This will imply a higher tax burden for corporations, which will pay the extra amount that individuals were going to pay in the form of a wealth tax. For multinational companies, the change is positive because they can deduct the amount of income taxes their subsidiaries pay, whereas the wealth tax was not deductible. For the government, this was like picking between poisons as any measure would have negative side effects. In the case of the income tax increase, the effect should be a reduction in the amount of disposable income by companies and hence in dividends. The wealth tax could affect investment, but as the conditions of the tax were not changed, it could be argued that even with this tax in the past, the Colombian economy was able to increase the amount of investment to close to 30 percent of GDP. Having said that, with the current outlook for commodities, especially a bearish view on oil, the question of the effect this tax could have on investment in the country is relevant.

Maria Velez de Berliner, president of Latin Intelligence Corporation: Colombia is at a tipping point created by the intersection of already-high levels of taxation along the production and consumption chain and the hidden taxation of insecurity. New, extended or increased taxes will not compensate for Ecopetrol's violence-induced revenue loss, nor will exports from other industries bring the needed fiscal revenue. Like this proposal, periodic tax reforms since 1982 intended to finance demobilization of guerrilla and criminal groups, stabilize public finances, ensure a progressive relation between income levels and taxes and increase social spending, mainly in education, health, subsidized housing and critical infrastructure. But all failed to achieve these objectives. Consequently, there is no reason to believe this reform would be different. Regardless of its final form, increased taxes will affect investment adversely, creating a self-reinforcing downward spiral of lower investment that results in growing unemployment and reductions in assets and skills utilization. This is being seen in the closing of auto parts and small manufacturing enterprises, the migration of capital in oil and gas to Mexico and of mining to Peru, capital flight into Panama and other 'fiscal paradises' and whole sections of major cities under the control of criminal gangs whose presence deters legal commercial activity. Extortion payments are now an expected, factored-in cost of doing business across the country. Therefore, before the administration burdens Colombian taxpayers with additional taxes, it would be more effective to put Colombia's finances in order by increasing tax collections and stopping 'la mermelada' political expenses, moving these revenues to finance measurable improvements in the quality of public education, including innovation and research and development in the non-extractive industries of the 21st century. Without investments in education, no matter how high taxes go, Colombia will achieve neither fiscal stability nor security, and capital will continue to fly out. An educated, employable labor force is the surest source of public revenue and the antidote to criminality as the economic activity, not of choice, but of necessity.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor

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