Pesos or Plastic?

Financial Inclusion, Taxation, and Development in South America

Ken Mitchell, Robert H. Scott, III, Robert H. Scott III

• Publisher: Palgrave Pivot
• Year: 2019
• Print ISBN:
  9783030148751
• eBook ISBN:
  9783030148768
• Topic: Economics
• Subtopic: Financial Accounting
• Index: Economics

Shows financial inclusion contributes to better tax collection by encouraging more formal consumer transactions via the use of bank-provided credit and debit cards
Argues that the higher a country's BPR the greater the economic impact
Includes a case study of Argentina focuses on the intersection of financial inclusion and public revenue or taxation
Finds that changes in formal banking participation rates and increased credit card and debit card use are correlated with increased VAT revenue

© The Author(s) 2019

Ken Mitchell and Robert H. Scott, IIIPesos or Plastic?https://doi.org/10.1007/978-3-030-14876-8_1

Begin Abstract

1. Financial Inclusion and the Middle of the Pyramid, a New Public Revenue Strategy for the Twenty-First Century

Ken Mitchell¹ and Robert H. ScottIII²

(1)

Department of Political Science and Sociology, Monmouth University, West Long Branch, NJ, USA

(2)

Department of Economics, Finance and Real Estate, Monmouth University, West Long Branch, NJ, USA

Ken Mitchell (Corresponding author)

Email: [email protected]

Robert H. ScottIII

Email: [email protected]

Abstract

This chapter begins with a recognition that developing economies collect less in tax revenue than developed economies, and this presents obstacles to economic and political modernization. Low tax revenue is a chronic problem in Latin America, where regional tax-to-GDP lags behind the OECD average—in 2016, the gap stood at 22.7–34.3% (OECD 2018). Low tax revenue stunts industrialization, causes de-industrialization, worsens commodity dependency, undermines public infrastructure, retards educational and health systems, encourages high poverty, inequality and crime, and ensures periodic economic crises. Recent decades saw a shift in public finances to dependency on Value Added Tax (VAT) revenue: in 2016, VAT accounted for 29.3% of Latin American tax revenue, the region’s largest revenue stream, more than personal income, corporate, trade or property taxes (OECD 2018). This chapter explores why this shift occurred, constraints on VAT collection linked to sizable informal or shadow (“non-taxed”) economies, and how government policies in the area of financial inclusion together with consumer behavioral shifts can improve VAT evasion rates in the future.

Keywords

TaxationEconomic developmentSouth AmericaFinancial inclusionMicrocreditConditional cash transfers

End Abstract

Introduction

Margaret Levi starts Of Rule and Revenue, her seminal work on the political economy of taxation, by linking the modern state’s evolution to its capacity to tax and stresses “[a]t the foundation of increases in a state’s provision of goods and services is its revenue production systems” (Levi 1988: 1). No developed tax system, no developed state (Kaldor 1963; Migdal 1988; Tilly 1990; Steinmo 1993; Brautigam et al. 2008; Bahl and Bird 2008; Fuest and Zodrow 2013; Besley and Persson 2013). Goods and services imply more than the standard public healthcare, education and infrastructure, and includes enforcement of property rights and other essential regulatory activities modern states perform in order to chart a Northian path to economic and political development (see Huntington 1968; North and Thomas 1973; North 1990; Bates 2001; Besley and Persson 2009; Acemoglu and Robinson 2012). Underdeveloped states collect insufficient tax revenue and the result fosters the conditions for protracted economic and political stagnation and cyclical financial crises, due to the fact that such states must either abdicate from essential tasks, print too much domestic currency, or borrow unsustainable sums from abroad.¹

Diagnosing ills, especially those developing states encounter, is easy enough, but conventional solutions to the problem eluded above (i.e., insufficient tax revenue) have a poor track record. Neoliberals call for fewer “public goods and services” and lower overall rates of taxation designed to boost economic growth in the private marketplace—more economic growth, more taxation. But this approach runs into two problems. First, unregulated markets rarely deliver as promised and too often, the product is a large informal market, less secure property rights, and substitution of public for private monopolies. Informal markets are, by and large, a product of ineffective or nonexistent regulation tied to low state capacity—for example, the average size of the shadow economy as a percentage of the total economy from 1991 to 2015 in the USA (8.34%) and Germany (11.97%) fell well below Brazil (37.63%) and Argentina (24.14%) (Medina and Schneider 2017).² Informal markets skirt taxes, thus reducing tax revenue, and become the bane of economic development , contrary to neoliberal advocates (de Soto 1989). Second, political constraints intercede. Free people as well as newly economically mobile people (Lipset 1959; Huntington 1968) demand more not fewer state goods and services, a reality witnessed in developed and developing countries. On the other hand, statists assume away the existence of a weak state unable to collect tax and jump to supplying more goods and services, and either borrow or print currency to stimulate the economy. Neither neoliberal nor statist approaches furnish a sustainable solution to the pivotal issue: how to collect enough and consistent tax revenue for the modern state’s requisite institutional development ? Or, as Besley and Persson (2013) sum up the challenge of development, “[h]ow does a government go from raising around 10% of GDP in taxes to raising around 40%?” This book presents an alternative approach to both questions that adheres to the existing political, economic and institutional constraints found in three South American countries (Argentina , Brazil and Chile ).

Financial crises have become commonplace in South America . In the last few decades, inflation , high unemployment, currency devaluations, debt accumulation, low aggregate demand and so on have plagued the region intermittently.³ In 2018, the regional landscape included Venezuela’s 80,000% annual inflation rate (highest in the world) and 15% annual GDP decline, Argentina’s 48% annual inflation rate (4th highest in the world), 50% currency devaluation, 26% government bond interest rate (highest in the world) plus $57 billion in emergency IMF aid (an historical high), and Brazil ’s 9.4% government bond interest rate (third highest in the world), rising poverty after a 7% GDP contraction (2015–2017) and a near sovereign default at the start of May. While each financial crisis is unique, several factors are often present. The final trigger of most financial crises in South America is that government debt increases to unsustainable levels causing financial markets to doubt whether debt obligations can be serviced. Financial market doubts put pressure on domestic currencies (Peso, Real, or Bolivar), and currency devaluation with national debts largely in US dollars makes a default, or an emergency IMF bailout, all but inevitable.

Government debt is largely the result of two important related factors: first, the government trying to stimulate the economy through fiscal policy (i.e., increasing government spending to compensate for lower consumer spending). When a government has spent too far beyond their means, it has often led to double-digit (or more) inflation . Rising inflation creates economic uncertainty and a loss of faith in a president, a ruling party or a central banker, thus adding more instability. Second, as a consequence (or perhaps cause) of an economic slowdown, tax revenue shrinks, which puts more pressure on the government to deficit spend. These two factors are not mutually exclusive. In fact, as an economy slows tax revenues decline, which entices the government into more deficit spending (or draconian austerity policies that cut spending at the worst time exacerbating the problems). Sometimes a government’s interventions can stabilize a shrinking economy. But, as we contend in this chapter (and book), it is the loss of tax revenue that puts the greatest pressure on a government to spend excessively (or cut spending) and create a downward debt spiral that is difficult to reverse. Had South America matched the OECD tax-to-GDP average in the 1980s, 1990s and 2000s, much economic and political suffering and turmoil would have been avoided. In South America, the problem of low tax revenue is particularly pernicious, which is why it shows up as a common theme across crises.

Two opposing economic realities amplify the problem of government debt accumulation in South America : (a) countries have become dependent on Value-Added Tax (VAT ) revenue, and (b) countries all feature large informal (shadow) economies where it is difficult to collect VAT revenue. As inflation starts to rise or macroeconomic conditions deteriorate, a sizeable percentage of consumers and producers are incentivized to shift seamlessly between formal and informal markets. Consumers seek out lower prices in street markets. Producers, especially small and medium-sized enterprises (SMEs), undertake the rational cost/benefit decision to operate informally rather than formally. Movement into the informal economy presents an urgent problem for tax collection. As VAT has grown to provide a greater portion of tax revenue since the 1980s, any disruption in formal consumer spending is bound to have a corresponding effect on overall tax revenue. Here is where the end game of a debt spiral results, as an economic downturn morphs into a full-blown economic crisis. Consumption and VAT revenues fall inevitably as an economy contracts; yet, this decline is compounded by a significant percentage of remaining consumption moving from formal to informal markets.⁴

The above scenario roughly depicts regional circumstances in the 1980s and 1990s. However, an important anomaly occurred thereafter as VAT revenue grew and r...

Table of contents

• Cover
• Front Matter
• 1. Financial Inclusion and the Middle of the Pyramid, a New Public Revenue Strategy for the Twenty-First Century
• 2. Public Revenue, Financial Inclusion and Value-Added Tax in Argentina
• 3. Financial Inclusion and Value-Added Taxes in Argentina, Brazil and Chile
• Back Matter