Tax Reform, Take Two
Executive Summary
Several months of opposition and discussion to President Bachelet’s proposed tax reform has resulted in a compromise deal between government and opposition.
The main issue had to do with the taxation of income from capital. Chile today has a system of full integration between personal and corporate taxes.This current system has advantages and disadvantages. The main advantage is that it provides a powerful stimulus to investment.The main problem is that it easily gamed.
In an effort to close these loopholes, the government initially suggested that owners of firms be taxed on an accrual basis.This formula would have reduced elbow room for tax evaders, but on the other hand, it would be hard to implement. Also, many economists conjectured this would have a harmful effect on firms’ savings and investment.
The tax agreement keeps this formula as an optional one, but adds another alternative from which firm owners can choose. . The second formula increases corporate tax to 27%, owners are only taxed on a distributed basis and owners can claim as a credit 65% of what the firm should pay. This alternative is easier to implement and provides an incentive for firms to use retained earnings as a way to finance investment.
On the negative side, with so many alternatives, the new system will be complex and hard to administer. This complexity may end up generating as many loopholes. Also, the top rate on capital earnings will be 44.45% and the top rate on labor income 35%. No textbook recommends this.
The agreement reached in Congress was well received by the markets not only because of the perceived improvement to its content, but also because of the political significance. But, the agreement left some political casualties in its wake.
Now read on...
Register to sample a report