High taxes and evasion hurting economic growth

The IDB pointed out that Latin America and the Caribbean have low tax collection by international standards.

WASHINGTON, United States, March 4, 2010 – The region’s governments are being advised to simplifyy their tax systems to reduce the amount of money they’re currently losing as a result of complexity and tax evasion.

The advice has come from the Inter-American Development Bank (IDB) following research which is contained in the soon to be released IDB book ‘The Age of Productivity: Transforming Economies from the Bottom Up’. The book offers a comprehensive analysis of productivity in the region, its impact on economic growth and recommendations for policymakers on how to address the causes of low and stagnant productivity.

“Complex tax systems and widespread evasion are distorting investment decisions by companies in Latin America and the Caribbean, reducing the efficiency of markets and preventing governments from investing in infrastructure, education and other key public goods,” the study said. “This hinders the productive possibilities of the region’s economies.”

The IDB pointed out that Latin America and the Caribbean have low tax collection by international standards, with collection concentrated on large corporations, although tax rates as percentage of profits are high, reaching an average of 48 percent compared with 41 percent in high-income countries.

The Bank said those high taxes can reduce the firms’ incentives to invest in technology and other productivity-enhancing strategies because taxes reduce the potential profits generated by those investments. As a result, productivity is reduced in the formal sector, hurting the overall long-term economic growth, the study concludes.

It suggests that by shifting to smarter tax programmes, governments can increase their revenue intake to finance much-needed social and investment programmess without hurting productivity and growth. 

The study urges governments in the region to simplify their tax regimes, reducing the hurdles and the time required to comply with them. In addition, countries in the region should establish gradual increases in tax rates among the different regimes to reduce the barriers for micro and small companies to invest and expand their businesses.

It noted that in order to reduce the level of informality and increase the tax base, several countries in the region have adopted special tax regimes for micro and small companies. These regimes also seek to reduce labour contributions by employers and expand labour benefits for low-income workers and reduce costs for the government in administering taxes on small companies so they can devote resources in fighting evasion among large corporations, it added.

However, despite their good intentions, these regimes can have harmful effects on productivity and, therefore, may erode long-term economic growth, the study said. It contended that the main problem with these regimes is that they can deter growth of small companies because they lose the special tax treatment if they grow beyond a certain point.

“These regimes create incentives for firms not to grow beyond a certain point,”--Carmen Pagés

“If they invest and grow, they will not be entitled for such a special treatment and their taxes will increase dramatically. The additional taxes they will have to pay will, many times, not pay for the investments they make. So they simply don’t invest,” said Carmen Pagés, coordinator of the study. 

As for the issue of tax evasion, the study says that it’s not surprising that it is widespread in Latin America since tax rates and transaction costs are high. It says tax evasion among both small and large companies is rampant, with the great majority of small and micro companies paying no taxes and formal companies underreporting as a much as 40 percent of sales in some countries, such as Brazil and Panama.