On 14 December 2021 the IMF published a Country Focus on the role of taxation in the Latin America and Caribbean (LAC) region. The analysis is based on the IMF’s latest Regional Economic Outlook for the region.

The IMF notes that the public debt ratios in the Latin America and Caribbean region increased by around 10 percentage points of GDP in 2020, giving rise to more pressure to either reduce government expenditure or increase taxes. This challenge is made more difficult by the need to support individuals and businesses in the pandemic. The report notes that tax reforms in the region could support growth and fiscal sustainability while helping to reduce the income inequality in the region.

In most countries of the LAC region there is a large gap between actual and potential tax collection, partly due to the level of development but too large even after allowing for the size of the informal economy and limited enforcement capacity.

The main source of tax revenue in the region is value added tax (VAT), from which the tax collected is in line with the level of development in the region, except in Mexico which could still improve its VAT collection.

The corporate income tax collected in the LAC region is above what would be expected taking into account income levels. This reliance on corporate income tax for revenue has a negative effect on economic growth as it discourages investment in the region.

The share of personal income tax revenue in total tax collection is low in the region. The personal income tax, if designed correctly, would not have the same negative impact on growth as corporate income tax and could help to improve equality in the region. It would therefore be a positive move for the countries in the LAC region to use personal income taxes to a greater extent, with credits to encourage individuals to participate in the labour force. This would also permit the countries to reduce their reliance on corporate income taxes.

The IMF concludes that the countries of the region need to correct the design faults in their tax systems to reverse the erosion of the tax base and to improve income equality. The personal income tax systems in the region are not collecting enough tax revenue, owing to low rates of tax, high income thresholds, and too many deductions from taxable income. These faults decrease the tax base and reduce tax collection, as well as increasing income inequality. Just by eliminating the tax deductions from the personal income tax the amount of tax collected could be doubled, as the effective tax rate of the top 10% of income earners would be increased. Appropriate earned-income tax credits could be introduced to encourage participation in the labour force and reduce the size of the informal sector.

The corporate income tax could be reformed by adjusting tax rates to help attract investment and discourage profit shifting, while reducing the number of deductions. The current international tax reforms and global minimum tax are an opportunity for reconsidering the corporate income tax.

The VAT systems could be strengthened by eliminating some reduced rates and exemptions, while protecting vulnerable groups by targeted transfers. The digital economy should be subject to the VAT in the same way as other sectors.