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Colombia’s Tax System: Trade-off between tax revenue and growth?

By: Kathyrn Kellyne Chong, Navya Bajaj

Research Head: Shreya Kasibhatla

Editor: Akshat Daga, Anish Kishor

Illustration by KJ Shakti

Abstract

Despite being the best-performing Latin American economy in 2019 with 3.36% Gross Domestic Product (GDP) growth, Colombia has deterred investments and businesses due to its complex taxation system with high corporate taxes. Besides exploring the current tax system and reforms, this article analyses the recent plan to further increase taxes and projected impacts on Colombia’s economy.

1. Economic climate in Colombia The fourth largest economy by GDP in South America and known for producing the finest emeralds, Colombia has a prudent macroeconomic and fiscal management (The World Bank, 2019). Its economy is dealing with blows from fall in global oil prices and Coronavirus pandemic. Due to the government’s efforts, introducing several growth and welfare programmes, poverty has substantially reduced and productivity subsequently increased (OECD Economic Surveys, 2017). However, income inequality remains high, while social mobility stays low. Sustained GDP growth is attributable to strong macroeconomic and social policies. Despite downturns, Colombia’s projected 2020 GDP is US$380 billion (Trading Economics, n.d.).

*GDP OF COLOMBIA OVER THE YEARS*

Inflation reached the central bank’s targeted range in early 2018 and is expected to remain within the range with its prudent monetary policy and anchored inflation expectations. (The World Bank, 2019). *Tax revenue as percentage of GDP from 2012 to 2017*


*Government expenditure as percentage of GDP from 2014 to 2024*

Comparing the two charts above, government expenditure is consistently higher than tax revenue. Since government expenditure is projected to remain at above 20% of GDP, tax revenue must increase to alleviate pressure on the government’s expenditure and increasing debt (Table 1).

*Table 1: Increasing government debt (% of GDP) *

As of 2017, Colombia’s Gini coefficient was 49.70, which decreased from a maximum of 58.70 in 2000 (Graph 1), suggesting its move towards greater income distribution (Indexmundi, n.d.).

*COLOMBIA’S GINI COEFFICIENT OVER THE YEARS*

The coronavirus pandemic and oil price shock have caused the peso to plunge to record low, pressurising external and fiscal revenues.


2. Colombian Tax System

Though the Gini coefficient has improved, over 85% of the population still feel inequality is high despite declining poverty rates. High inequality is mainly due to unemployment, and market segmentation into formal and informal labour force has furthered income discrepancies. The tax system has shifted from a regressive to more progressive one. Richer households pay a relatively higher effective tax rate. The government aims to overcome inequality by cutting down formal labour costs (Moller, 2012). According to the World Bank, this alternative minimum income tax could potentially reduce the Gini coefficient by about 2 points.

Columbia’s current value-added tax (VAT) is 19%, corporate tax is 33% (20% if in a free trade zone) and capital gain taxation is 10% (LLOYDS BANK, 2020). The financial transactions tax is 0.4%. The labour and capital income tax are in tables below (Executives, 2019):

Colombia collects relatively modest revenues from personal income taxes (PIT) at 1.1% of GDP, compared to 1.8% of GDP in Latin America and 9.0% of GDP in the OECD. Moreover, ‘Familias en Accion’ conditional cash transfer program, a cost-effective way to reach the poor and reduce inequality, has 7.8 million beneficiaries and takes up 0.3 % of GDP. The ‘pay as you go’ pension system costs 3.3 % of GDP annually with 1.4 million beneficiaries. By taxing and spending progressively, Colombia could potentially reduce inequality to levels similar to Chile or Costa Rica, even without raising taxation (though doing so could reduce inequality even further) (Moller, 2012). 3. The 2019 Tax Reform President Iván Duque proposed a tax reform bill, enacted in December 2019, to boost economic growth and increase productivity. Concerns arise that the draft submitted by the national government does not respond to Colombia’s needs.This reform aims to reduce current high corporate tax burden. One change is the SIMPLE Taxation system for small companies to settle tax obligations, which reduces business costs. Corporate income tax rate is reduced from 33% to 30% and income from some activities would be subject to 10% corporate tax rate. Taxpayers are allowed to treat taxes paid as deductible expenses and can use the turnover taxes to offset corporate tax obligations. Hopefully, corporate tax reductions would create more jobs and growth for companies. Taxes will be increased for higher-income earners. Those with average monthly income of more than US$40 million, US$50 million and US$105 million will have an income tax rate of 35%, 37% and 39% respectively. By combining labour, pension and capital income, the tax system for PIT has also been simplified. Improvements in electronic invoicing mechanisms and tax administration procedures would fight tax evasion (OECD, n.d.). General VAT rate will be reduced from 19% to 18% in 2019 and 17% in 2022. The 5% VAT rate on certain products and services would be eliminated. Many current exclusions and exemptions will be removed, and a VAT refund program would be added to aid low-income families. These tax reforms have helped create a Colombian Holding Company regime to incentivize multinational groups to establish headquarters and carry out investments in Colombia. A new component in this bill is tax standardisation. Fiduciary rights held in Colombia integrate insurance with material savings aspects and private foundations, foreign trusts and investment funds from abroad and subject them to taxes. 4. Success of tax reform While other Latin American economies grow at 1% GDP, Colombia had 3.36% GDP growth last year from 2.27% in 2018 (Plecher, 2019). This suggests some success attributable to its 2019 tax reform with business tax incentives implemented which boosted job opportunities and thus greater consumption. 5. Shortcomings of tax reform The elimination of presumptive income tax over the next three years would be problematic for the government because this tax has encouraged the productive use of goods and has reduced tax evasion. Furthermore, the existing complex system with a narrow base would only yield modest revenue. The preferential tax regime introduces additional taxes to protect tax revenue. Despite relatively modest revenue from PIT, the heavy corporate tax burden weakens the business climate in Colombia. The Compliance & Policy gap in VAT leads to inefficient collection of taxes. 6. Government’s Recent Plan to Increase Taxes Despite an increase in GDP last year, Colombia plans to increase PIT to fund public service improvements, prompted by protests in Chile where millions demanded better pensions, free university education and better healthcare. Another reason might be Colombia’s migration influx from Venezuela which boosted consumption but cost 0.4% of GDP in health and education expenditure. Reliance on oil and coal industries and falling agricultural exports due to poor infrastructure and rural violence might also be reasons for plans to increase taxes to boost tax revenue and thus government expenditures. 7. Conclusion *COLOMBIA’S TAX REVENUE (1999-2020)*

Increased VAT and PIT will impact tax revenues minimally. Its negative impact on business activities would be offset by substantive growth in business investments entailed by lower corporate taxes (IMF, 2019). The tax reform which attracted mixed reactions has shown some improvements. After it was introduced, tax revenue increased by almost 50% in January 2020 from December 2019 (CEIC, n.d.), likely because of a larger tax base and higher PIT. Hopefully, Colombia would see greater business investments and income equality with its lower corporate tax and steady growth.


References:

1. CEIC (n.d.). Columbia Tax Revenue. CEIC. Retrieved from: https://www.ceicdata.com/en/indicator/colombia/tax-revenue

2. IMF (April 2019). IMF Country Report No. 19/107: Colombia Selected Issues. Retrieved from: https://www.imf.org/en/Publications/CR/Issues/2019/04/29/Colombia-Selected- Issues-46829

3. OECD (n.d.). OECD Policy Brief on Financing Law in Colombia. OECD. Retrieved from: http://www.oecd.org/economy/surveys/OECD_policy_brief_on_financing_law_in_Co lombia.pdf

4. Plecher, H. (October 22, 2019). Colombia: Growth rate of the real gross domestic product (GDP) from 2014 to 2024. Retrieved from: https://www.statista.com/statistics/369076/gross-domestic-product-gdp-growth-rate- in-colombia/

5. Stott, M. (March 2, 2020). ‘The only way is higher taxation’: Colombia heeds the message of mass protests. Financial Times. Retrieved from: https://www.ft.com/content/adae4610-58d1-11ea-a528-dd0f971febbc

6. Executives, T. o. (2019, July). Colombia Income Tax. Retrieved from KPMG: https://tradingeconomics.com/colombia/gdp

7. (2020). Retrieved from LLOYDS BANK: https://www.lloydsbanktrade.com/en/market-potential/colombia/taxes

8. (2020, March Wednesday). Retrieved from The Economist: https://www.economist.com/finance-and-economics/2020/03/18/economies-can- rebound-quickly-from-massive-gdp-slumps-but-not-always

9. (2019, October). Retrieved from The World Bank: https://www.worldbank.org/en/country/colombia/overview 10. (2017). Retrieved from OECD Economic Surveys: http://www.oecd.org/economy/surveys/Colombia-2017-OECD-economic-survey- overview.pdf

11. Moller, L. C. (2012, December 17). Retrieved from https://www.worldbank.org/en/news/opinion/2012/12/17/why-colombia-needs-a- more-progressive-tax-system (n.d.).

Retrieved from Trading Economics: https://tradingeconomics.com/colombia/gdp (n.d.).

Retrieved from: Indexmundi: https://www.indexmundi.com/facts/colombia/indicator/SI.POV.GINI

12. (n.d.). Retrieved from https://taxinsights.ey.com/archive/archive-news/colombian- government-proposes-structural-tax-reform.aspx


13. Colombia: New Tax Law in Effect. (n.d.). Retrieved from https://www.ortevo.de/insight/colombia-new-tax-law-in-effect/?lang=en

14. Gonçalves, P., & Gonçalves, P. (2020, February 4). Colombia's new tax bill comes into effect. Retrieved from https://www.internationalinvestment.net/news/4000717/colombia-tax-comes-effect


15. INSIGHT: Tax Reform in Colombia-Key Points for Foreign Investors. (n.d.). Retrieved from https://news.bloombergtax.com/daily-tax-report-international/insight- tax-reform-in-colombia-key-points-for-foreign-investors


16. Quijano, D. D. (2019, January 9). Everything You Need To Know About The Proposed Tax Changes In Colombia - Tax - Colombia. Retrieved from https://www.mondaq.com/Tax/769868/Everything-You-Need-To-Know-About-The- Proposed-Tax-Changes-In-Colombia

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