Comprehensive Tax Reform : The Colombian Experience

Parthasarathi Shome

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 1995
• eBook ISBN: 9781557754646

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Contents

Preface

Introduction

Parthasarathi Shome

A Latin American Perspective

History of Colombian Tax Reform

Objectives and Main Measures of Tax Reforms

II. Value-Added Tax Issues

Parthasarathi Shome

Structural Aspects

Potential Versus Actual Revenue Collections

Calculation Using Input-Output Matrix

Calculations Made on the Basis of Declarations

Revenue Loss from Crediting VAT on Capital Goods

III. Income Tax Issues

Erik Haindl, David Dunn, and Osvaldo Schenone

Tax Reform and Investment

Assessing the User Cost of Capital

Savings-Investment Gap

Effect of 1986 Tax Reform on the Investment Rate

Specific Impacts on the Investment Rate

Potential Versus Actual Revenue Collections

A Summary of Studies Initiated by the DIN

An Alternative Approach

Improving the Procedures

Inflation Adjustment

The Nature of the Problem

Inflation Adjustment in Colombia

Revenue Effects

IV. Customs Tariff Reform

Osvaldo Schenone

Introduction

Developments Preceding the 1991 Reform

August 1991 Tariff Reform

Early Implementation of the Tariff Reform

Tariffs Before and After Decree No. 2095

Surcharges Before and After Decree No. 2096

Impact on Effective Protection

Cost and Financing of Faster Trade Liberalization

Aggregate Procedure

Tariff Item Procedure

A Complementary Policy

An Alternative Complementary Policy

Treatment of Exemptions to Tariffs, Surcharges, and the VAT

Summing Up

V. Conclusions and Future Directions for Reform

Arnold C. Harberger

Customs Tariff Reform

The Income Tax on Juridical Persons

Integration with the Tax on Natural Persons

Dealing with Evasion

The Value-Added Tax

Exempted Sectors

Exemption of Selected Imports

Elimination of Special VAT Rates

The Future of the General Rate of the VAT

Indexing the Tax System for Business Firms

Tax Incentives

Conclusion

Appendices

I. Summary of Tax System as of June 30, 1994

II. Potential VAT Collections from the Input-Output Matrix and Taxpayer Declarations

III. User Cost of Capital

IV. Disaggregated Investment and Savings Model

V. Adjustments Needed to Obtain Potential Income Tax Base

VI. Customs Tariffs: Computing the Change in Fiscal Receipts

Bibliography

Tables

Section

I. 1. Total Tax Revenue

II. 2. Comparison of Gross VAT and VAT Credited on the Basis of the Input-Output Matrix with VAT Calculated from Taxpayer Declarations, 1988

3. VAT Treatment of Capital Goods Before and After Passage of Law No. 6, 1992

III. 4. Summary of Direct Tax Rates

5. User Cost of Capital

6. Gap in the Savings-Investment Market

7. Market Risk Premium

8. Increase in Investment Rates, 1983–89

9. Impact on the Investment Rate

10. Estimates of Income Tax Evasion by the Center for Fiscal Studies

11. Formula Used by the Center for Fiscal Studies to Estimate Income Tax Evasion

12. Calculation of Potential Taxable Income and Income Tax Evasion

13. Breakdown of the Inflation Adjustment of the 100 Largest Taxpayers, 1993

14. Corporate Income Tax: Adjustment for Inflation, Statutory Deduction, and Net Effect, 1993

IV. 15. Average Tariffs and Tariff Surcharges

16. Effective Protection by Use or Economic Purpose of Goods, Before and After Issuance of Decree No. 2095

17. Estimations of the Fiscal Cost of Accelerated Opening by the National Planning Department (PLAN) and Ministry of Finance (FIN)

18. Effective Rates of Customs Taxes

19. Collections, Exemptions, and Imports at All Customhouses, January-June 1991

Appendices

II. 20. Potential VAT Collections Prior to Passage of Law No. 49

21. Potential VAT Collections After Passage of Law No. 49

22. Potential VAT Collections: An Alternative Structure

23. Collections Calculated on the Basis of VAT Declarations Prior to Passage of Law No. 49

24. VAT Credit for Capital Goods of Large Taxpayers in Bogotá

III. 25. User Cost of Capital

26. Rate of Return on Shares

27. Rate of Return on Debt

28. Rates of Taxes and Margins

29. Present Value of Depreciation (Z)

30. Parameters for Computing the User Cost of Capital

IV. 31. Private Savings Equation, 1970–89

32. Private Investment Equation, 1970–89

33. Estimated Impact of Change in Variables on the Investment Rate

34. Estimated Impact on Variables of Reduction in Tax Gap, 1986–89

V. 35. Calculation of Adjusted Income for Income Tax

36. Calculation of Depreciation Allowances for Income Tax

37. Estimation of Annual Change in Collections of Tariffs and Surcharges in 1992, Based on Alternative Demand Elasticity Values (in 1990 Prices)

38. Estimation of Annual Change in Collections of Tariffs and Surcharges in 1992, Based on Alternative Demand Elasticity Values and a Uniform Surcharge of 8 Percent (in 1990 Prices)

39. Tax Reimbursement Certificates (CERTs)Issued

40. Legal Provisions Concerning Import Exemptions

Charts

Section

III. 1. Investment and Savings

IV. 2. Distribution of Tariffs Before and After Issuance of Decree No. 2095

3. Distribution of Taxation, With and Without Surcharges, After Issuance of Decree No. 2095

4. Distribution of Taxation Using Current and Uniform Surcharges

The following symbols have been used throughout this paper:

… to indicate that data are not available;

— to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;

– between years or months (e.g., 1991–92 or January-June) to indicate the years or months covered, including the beginning and ending years or months;

/ between years (e.g., 1991/92) to indicate a crop or fiscal (financial)year.

“Billion” means a thousand million.

Minor discrepancies between constituent figures and totals are due to rounding.

The term “country,” as used in this paper, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and provided internationally on a separate and independent basis.

History of Colombian Tax Reform

Tax reform in Colombia has resulted from many special commissions set up to examine broad or particular aspects of the tax system. The prospect of working with Colombia’s highly qualified tax professionals, as well as the authorities’ open welcome for a cross-fertilization of ideas, generated much interest in international tax experts, and many commission reports were submitted to the Government.² Thus, Colombia has been involved in a continuous tax reform effort over the decades, with each reform comprising an improvement of the existing tax structure. The reforms have involved both domestic taxes and taxes on international trade and have resulted, over the 1980–92 period, in a steady and significant increase equivalent to over 4 percent of GDP in the tax revenue of the central administration, which is the focus of this study (Table 1).

Table 1. Total Tax Revenue

(In percent of GDP; period average)

Sources: Bank of the Republic; Ministry of Finance; National Planning Department; and IMF staff estimates.

¹ Preliminary figures for 1994.

² Includes central administration, social security, and national decentralized agencies.

³ Includes central government and local nonfinancial public sector.

Colombia was one of the first Latin American countries to develop a consumption tax based on value added. Following its introduction in a rudimentary form in 1965, the reforms of 1968, 1971, 1974, 1983, 1986, and 1990 brought about various changes in the tax. However, one important feature of the consumption-type value-added tax (VAT) was missing: complete credit for taxes paid on purchases of capital goods. This feature was effectively introduced only in 1992, and even then as a credit against the income tax rather than against the VAT paid on sales.

With respect to income taxes, Colombia experienced two important reforms within the past ten years, in 1986 and 1990. Both reforms were designed to prevent double taxation of enterprises and individuals and to remove obstacles to investment. Interestingly, according to McLure (1988), Colombia had been also the first nation in the Western Hemisphere to impose an income tax, dating from 1821. A schedular income tax was in effect for over a century, until it was changed to a global income tax in 1927.

The tax reform in recent years has also included customs tariff reform, which reduced the level of tariff rates from an average of 61 percent to 30 percent by 1986. However, a flat, across-the-board surcharge of 10 percent was introduced in 1985 and increased to 18 percent in 1987. These reforms coexisted with several quantitative restrictions on selected imports, and with selective export promotion schemes of varying effectiveness, which the authorities had been implementing since the late 1960s. By 1990, the need for a full-fledged trade liberalization was widely recognized; a program to that effect was implemented, whose pace was accelerated in 1991.

Potential Versus Actual Revenue Collections

In light of the performance of the VAT in Colombia, the authorities became increasingly preoccupied with evasion of the VAT and its magnitude.⁷ A study was consequently attempted that calculated potential VAT revenue using an available input-output matrix. The study then compared the result with the actual collection figure available from the tax administration.

Calculation Using Input-Output Matrix

Using the 1988 input-output matrix (the latest that was available). it was possible to conduct an exercise on that year’s potential VAT collections. The results of this exercise appear in Appendix II (see Table 20). Data on gross output and intermediate consumption in each sector were used. Bearing in mind that, prior to the passage of Law No. 49 in 1991, only a few parts of each sector were subject to the VAT and that differential rates were applied in various categories within each sector, the actual rates were calculated for each sector and its intermediate inputs. Gross payable VAT and the VAT creditable by sector were thus obtained. A similar process was used to determine the VAT assessable on imports and the VAT creditable against exports. The results of this exercise indicate that actual collections amounted to about two thirds of the potential.

Law No. 49 of 1991 expanded the potential VAT base further. The 1988 structure of the input-output matrix was thus again used to calculate the expanded base. The exercise, as shown in Table 21, Appendix II, introduced all the amendments represented by Law No. 49, effectively shifting agricultural products, fertilizers, and pharmaceuticals from zero-rated to exempted status, raising the general rate to 12 percent, and including some new personal services in the base.⁸ Potential collections increased by almost 30 percent, with about one third of this increase pertaining to fertilizers and pharmaceuticals (including the effect of shifting these goods to the exempted category). Actual collections would then depend on the treatment in practice of these changes in the law.

A third exercise was carried out to examine potential VAT revenue on the assumption of an even greater hypothetical expansion of the VAT base than that brought about by Law No. 49. This exercise is presented inTable 22, Appendix II. The modifications introduced to the 1988 base in this case included (1) applying a general rate of 12 percent to all sectors, thus dismantling the differential rate structure;⁹ (2) including all exempted products (such as mining, fertilizers, and pharmaceuticals) in the tax base, except for agricultural products; (3) giving credit for machinery and equipment, both domestic and imported; and (4) including in the tax base ser-vices that were still outside the base.¹⁰ Treatment of the financial sector was left as in Law No. 49.¹¹

The exercise indicated potential collections of over 10 percent above the potential amount yielded by the VAT structure reflecting Law No. 49 and of over 40 percent above the potential revenue from the structure in effect prior to Law No. 49. It bears noting that, according to this initial exercise, the cost of making all machinery and equipment eligible for credit would amount to less than 5 percent of potential collections.¹²

The effect of shifting mining from the exempted to the taxable list did not turn out to be significant, as a large portion of this sector’s output is exported. The effect of broadening the base to include professional services was not insignificant, but in practice this increase would depend mainly on tax administration, as it would surely be very difficult to collect the full potential from this source. Revenue from beverages under these conditions would decrease, reflecting the application of the uniform—and lower—rate of 12 percent.¹³ However, more revenue would be collected on newly taxed consumer items—for example, electricity, water, and construction.

The aim of considering this alternative was to examine the revenue impact of a VAT package that would further simplify its structure, broaden its base, and reduce the distortions that remained in the system after the introduction of Law No. 49. It can be concluded that these modifications would also result in a significant positive impact on potential revenue.

Calculations Made on the Basis of Declarations

As noted above, actual VAT revenue collected in 1988 was roughly two thirds of the potential (or theoretical) collections. What is the explanation for the revenue gap? The theoretical input-output matrix used in the calculations has a gross output base that is much larger than the base reflected in the VAT declarations of 1988, pointing to the impact of tax evasion and other leakages. Consequently, this section compares the calculations for collection made on the basis of information from VAT declarations (see Table 23, Appendix II) with the calculation of potential based on the input-output matrix.

Potential gross VAT, net of exports (see Tables 20 and 23, Appendix II), was derived from the 1988 input-output matrix in accordance with the prevailing VAT law. However, the actual declarations showed that taxpayers declared only 70 percent of gross income as subject to the VAT. Applying this correction factor, an amount of Col$432.2 billion for calculated gross VAT was arrived at (Table 23, Appendix II).

The potential creditable VAT for intermediate consumption was also known from the previous exercise (Table 20, Appendix II). However, the declarations indicated that taxpayers declared 62 percent of gross VAT as creditable VAT. Using this correction factor, an amount of Col$384 billion for VAT for calculated intermediate consu...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Preface
• I. Introduction
• II. Value-Added Tax Issues
• III. Income Tax Issues
• IV. Customs Tariff Reform
• V. Conclusions and Future Directions for Reform
• Appendices
• Bibliography
• Tables
• Footnotes