One surefire way to increase the competitiveness of a country’s exports in global markets is to make its tax system amenable to businesses—and especially to manufacturers of products and providers of services in which the country has a competitive advantage.
Unfortunately, designing the ‘perfect’ tax structure isn’t easy, even on the national level. Policymakers must devise a system that raises enough tax revenues to finance public expenditures without sacrificing the nation’s competitiveness.
The difficulties are compounded when the nation is a member of a regional trade block, since then policymakers are faced with the need to harmonize their tax systems with those of the other nations. Not surprisingly, conflicts of interest often materialize between national constituents and members of the regional trade block.
Tax experts from the IDB, the University of Buenos Aires and Brazil’s Institute for Applied Economic Research (IPEA) discussed in a recent workshop at IDB headquarters the tax reform and integration issues currently facing the Mercosur countries of Brazil, Argentina, Paraguay and Uruguay. They urged the countries to consider the trade and integration effects of proposed tax policy reforms, such as the impact on investments and on transaction processing speeds.
Vito Tanzi, a senior expert on the Special Initiative for Integration and Trade at the IDB, pointed out the merits of keeping taxes stable over time. “There’s an old saying that ‘Old taxes are good taxes.’ The reason is that when investors get involved in a country, they make certain assumptions based on the tax structure at the time of their investment. Changing the tax structure invalidates those assumptions.”
The tax experts agreed that in general, countries should aim for imposing broad-based taxes at low rates, rather than narrow-based taxes at higher rates.
“Unfortunately, most politicians want to do exactly the opposite,” Tanzi said. “The big problem is that there’s a conflict between [tax] efficiency and what I call ‘equity in theory,’ meaning public perceptions about equity rather than real equity, in practice.”
A common perception in many countries is that businesses and upper-income people are the only ones who should pay taxes—or that they should at least pay the most taxes—since they can presumably ‘afford it.’ But since the entire population—not just top-rate taxpayers—consumes such public goods and services as highways and education systems, so-called ‘equitable’ tax policies are anything but, according to Tanzi.
The problem is that politicians looking for votes are sometimes more concerned with public perceptions than reality, so they favor short-term tax incentives and exemptions. For example, candidates may promise tax exemptions to lower-income groups to get elected; and governments may grant exemptions to trade unions and non-competitive industries for fear of worker unrest and sometimes end up overtaxing private companies to make up the difference. Tax exemptions can distort the markets and foster corruption, and overtaxing the private sector deters investment.
Alberto Barreix, a trade and integration economist at the IDB, raised concerns about the effect on the Mercosur countries of substituting solid sector and regional development policies with tax incentives. “Among the [undesirable] effects of such a substitution are increased mobility of capital and highly skilled labor and fiscal wars, where countries and regions use tax policy to compete with each other for investment and savings retention.”
“One way to mitigate those effects is to incorporate tax coordination policies into Mercosur and other trade agreements,” Barreix said. “That can be done on both a bilateral and multilateral basis.” Barreix co-authored with IDB trade and integration economist Luiz Villela a study exploring that premise, titled “Taxation in the Mercosur Countries and Coordination Possibilities,” earlier this year.
According to Barreix and Villela, the tax systems of the Mercosur countries appear to be fairly similar on the surface. In all four countries, the majority of public revenues come from taxes on goods and services, direct taxation levels are low, and the amount of the overall tax burden derived from social security is relatively high.
Nevertheless, a closer look reveals some marked differences in the tax systems of the four countries. “These differences mean,” Villela said, “that in order for tax policy coordination to be effective, the countries must address a number of priority issues:
1) Serious competitiveness problems regarding the value-added taxes need to be corrected and excise taxes should be implemented that deter smuggling and include ranges;
2) Savings and portfolio issues that pit the smaller countries against the larger countries;
3) Incentives for investment at both the regional and sector levels;
4) Development of regional tax administration treaties and policies, as well as mechanisms for cooperation among national tax authorities;
5) Development of regional dispute resolution authorities (i.e. a tax court) and safeguards for reducing investor uncertainty;
6) Communications among national customs agencies.”
Hugo Gonzalez Cano, a professor at the University of Buenos Aires and consultant to the IDB, and Ricardo Vasano, an economist at Brazil’s Institute of Applied Economic Research (IPEA), presented case studies on tax reform in Argentina and Brazil, respectively, at the workshop.