Strategies for Taxing Economic Elites:The Chilean Experience

Tasha FairfieldT.A.Fairfield@lse.ac.uk

Dept. of International DevelopmentLondon School of Economics

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When can governments increase taxation of economic elites?

How much scope for reform can they create?

Overview

Obstacles to taxing elites investment power & political power

Reform Strategies

Cases from Chile

Research Questions

Obstacles to Reform

Taxing economic elites will be difficult when eitherInvestment Power or Political Power is strong

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Investment Power (Structural Power: Block 1977, Lindblom 1982, Przeworski & Wallerstein 1988)

Market-coordinated investment decisions

Source: Perceived threat of reduced investment

Taxing economic elites will be difficult when eitherInvestment Power or Political Power is strong

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Obstacles to Reform

Investment Power (Structural Power: Block 1977, Lindblom 1982, Przeworski & Wallerstein 1988)

Market-coordinated investment decisions

Source: Perceived threat of reduced investment

Political Power(Instrumental Power: Mills 1956, Miliband 1969)

Deliberate political actions

Sources: Relationships and Resources

Taxing economic elites will be difficult when eitherInvestment Power or Political Power is strong

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Obstacles to Reform

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Obstacles to Reform

Sources of Political Power

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Reform Strategies

Facilitate modest tax increaseson powerful economic elites

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Reform Strategies

Successful cases of market-oriented tax reform

Chile, Argentina & Bolivia

But recurrent revenue needs in 1990s and 2000s

Value-Added Tax Revenue (percent of GDP, average: 1995-1999)

Latin America

Chile Argentina Bolivia EU-15

5.1* 8.0 6.9 6.6 7.2

Sources: Sabaini 2005, SII, DNIAF, SIN, ECTCU 2006

*Includes other consumption taxes as well.

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Chile, Argentina & Bolivia

Income, profits, and wealth are major, under-taxed revenue bases

Differences Between Actual and Predicted Tax Revenue

(percent of GDP, 1990s average)

Latin America Chile Argentina Bolivia

Personal income tax –2.7 –4.0 –4.4 –1.5

Corporate taxes –0.7 –2.4 –1.2 –1.5

Source: Perry et al. 2006, 96. Predictions from regressions based on per capita GDP.

Governments considered increasing direct taxes

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Explaining Tax Policy Outcomes

Chile: marginal increases

Strong business power key reforms off agenda

Argentina: significant increases

Weaker business power more leeway to tax

Bolivia: mixed results

Business power + Popular mobilization

Domestic elites not taxed, but big hydrocarbon royalty increases

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Explaining Tax Policy Outcomes

Chile: marginal increases

Strong business power key reforms off agenda

Sources of Political Power

•Organization

•Partisan Linkages: right parties strong in senate

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Chilean Tax Reforms

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Chilean Tax Reforms

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ChileAnti-evasion reform, 2001

Equity appeals: Vertical: “When you go to buy a kilo of bread, you pay 18% VAT. You

have no trick, no mechanism for paying less. The poor pay all their taxes. And it is just [fair] that the rich pay all their taxes.”

Horizontal: “Tax evasion entails great inequity between those who comply with their tax obligations and those who do not. …from an ethical perspective, no one can oppose an initiative that pursues compliance with the law?”

Applied to income tax base-broadening measures:

–Reform Proposal

–Pres. Lagos

Use of legal tax benefits ~ avoidance ~ evasion ~ morally unacceptable

Fighting evasion, not increasing taxes

“Trojan Horse”

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ChileAnti-evasion reform, 2001

Modest success: The right was in an “absolutely defensive position.”

“The [bill’s] title—evasion—it suggests going after criminals. It’s very difficult to oppose someone who presents that framing”

–Right-party senator (interview)

–Former senate president (interview)

Right abstentions (vs. rejection) in finance committee: “otherwise, President Lagos would have said that the opposition is against combatting tax evasion ”

–Right-party senators (El Mercurio)

Limitations: insufficient to enact reform Significant concessions negotiated with business and right

Voter-party linkages: right draws support from popular sectors through clientelism and charismatic appeals (Luna 2010) minimal electoral impact

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ChileStock-owner tax benefit elimination, 2005

Opportunity: Competition from the Right over inequality

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ChileStock-owner tax benefit elimination, 2005

Opportunity: Competition from the Right over inequality “Inequality, Mr. President, continues. There is a Chile that grows,

but it is for the few, and the great majority have not yet benefited.”

–Pres. Candidate Joaquín Lavín (El Mercurio 5/7/05)

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ChileStock-owner tax benefit elimination, 2005

Opportunity: Competition from the Right over inequality “Inequality, Mr. President, continues. There is a Chile that grows,

but it is for the few, and the great majority have not yet benefited.”

Vertical Equity Appeal: “The infamous article ‘57 bis’ [tax benefit] represents a tremendous

support for inequality. Instead of just talking, why don’t we agree to eliminate ‘57 bis’ in less than 24 hours?”

–Pres. Ricardo Lagos (El Mercurio 5/10/05)

–Pres. Candidate Joaquín Lavín (El Mercurio 5/7/05)

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ChileStock-owner tax benefit elimination, 2005

Opportunity: Competition from the Right over inequality “Inequality, Mr. President, continues. There is a Chile that grows,

but it is for the few, and the great majority have not yet benefited.”

Vertical Equity Appeal: “The infamous article ‘57 bis’ [tax benefit] represents a tremendous

support for inequality. Instead of just talking, why don’t we agree to eliminate ‘57 bis’ in less than 24 hours?”

Success: High salience of inequality during campaign

–Pres. Ricardo Lagos (El Mercurio 5/10/05)

–Pres. Candidate Joaquín Lavín (El Mercurio 5/7/05)

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ChileStock-owner tax benefit elimination, 2005

Opportunity: Competition from the Right over inequality “Inequality, Mr. President, continues. There is a Chile that grows,

but it is for the few, and the great majority have not yet benefited.”

Vertical Equity Appeal: “The infamous article ‘57 bis’ [tax benefit] represents a tremendous

support for inequality. Instead of just talking, why don’t we agree to eliminate ‘57 bis’ in less than 24 hours?”

Success: High salience of inequality during campaign

–Pres. Ricardo Lagos (El Mercurio 5/10/05)

–Pres. Candidate Joaquín Lavín (El Mercurio 5/7/05)

“The opposition accepted things that usually it was not willing to accept so as not to harm the presidential option.”

–UDI Deputy (author’s interview 12/23/05)

Findings and Implications

Argument:•When economic elites have strong political and/or investment power, substantial tax increases are unlikely.

•However, reform strategies can make incremental progressive tax increases feasible.

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Policy Implications:

• Pursue incremental rather than comprehensive reform

• Employ multiple strategies where possible

• Reform design and reform strategies must be tailored to the context at hand

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Chile Tax Reforms