Income tax reform in Colombia and Venezuela: A comparative history

0305-75OW92 $5.00 + 0.00 @J 1992 Pergamon Press plc

World Development, Vol. 20, No. 3, pp. 351-367,1992. Printed in Great Britain.

Income

Reform in Colombia

CHARLES

E. McLURE,

JR.

The Hoover Institution, Stanford, California Summary. -This paper compares the history of income tax reform in Colombia and Venezuela since the late 1950s. Brief histories of income tax reform in each country describe both what was proposed in major studies and what was enacted. The present Colombian income tax is seen to be much better than the Venezuelan system. Colombia has also made more use of local tax experts than Venezuela. The final section speculates that the ready availability of oil revenues explains why Venezuela does not have a better income tax and more local analysis of tax policy.

1989 the government proposed both reform of the income tax and introduction of a value-added tax, but as of June 1991 no action had been taken. By comparison, in 1974 Colombia undertook a massive reform of its income tax, based largely on the recommendations of the Musgrave Mission.4 Then in 1986, fol!owing several rounds of reform and “counterreform,” Colombia again moved to introduce further fundamental reforms, especially in its income tax. These were based on the analysis of local experts, rather than foreign advisors. Finally, at the end of 1988 Colombia adopted a comprehensive system of inflation adjustment in the measurement of income, based on the 1987-88 study. Administrative improvements were an extremely important aspect of the reforms carried out during 198688.5 Colombia now has one of the best income taxes of any developing country.6 In short, Colombia has greatly improved its tax system over the past 30 years, while Venezuela has made relatively little progress in this area. This paper compares these two countries’ experience with income tax reform since the late 1950s. Sections 2 and 3 highlight the history of income tax reform.’ Colombia’s system is described first, to provide a benchmark against which to appraise Venezuela’s, Section 4 brings together some of the major differences revealed by the individual histories, and Section 5 comments on differences in experience.

1. INTRODUCTION In 19.58 Professor Carl Shoup led a distinguished group of experts to, examine the tax system of Venezuela and make recommendations for its reform.’ During the early 1980s a Fiscal Reform Commission, composed of Venezuelans, but drawing on technical expertise of foreign advisors from the International Monetary Fund (IMF), again examined the nation’s tax system and recommended reforms.2 Colombia has a history of tax reform studies during the same period that is superificially similar. Professors Milton Taylor and Richard Musgrave led teams of foreign advisors to Colombia in the early 1960s and in 196869, respectively, and this author directed a study of the taxation of income from business and capital in 1987-88.3 The reports of both the Shoup and Musgrave Missions have become classics in the field of taxation in developing countries. The similarity of tax reform experience in these neighboring countries essentially ends with the existence of several studies in each. In Venezuela the reforms enacted as a result of the Shoup Mission extend little beyond elimination of a low-rate turnover tax, the taxation of dividends, and the replacement of the complicated system of schedular income taxes with a semi-global income tax. Virtually all the other proposals of the Shoup Mission were ignored or adopted in distorted form. Thus in the early 1980s the Fiscal Reform Commission found many of the same defects identified by the Shoup Mission - and some new ones. These defects have remained largely untouched. In November

*The author acknowledges the helpful comments Richard Bird and Carl Shoup made on an earlier draft.

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2. INCOME

TAX REFORM

DEVELOPMENT

IN COLOMBIAs

It is useful to distinguish two major waves of income tax reform in Colombia the first beginning with the Taylor-Musgrave Missions and culminating in the 1974 reforms and the second spanning the 1986 and 1988 reforms, during which the study of the taxation of income from business and capital was completed and acted upon.” During the first, primary emphasis was on distributional equity, with substantially less attention to questions of economic efficiency and of simplicity and administration.“’ The reforms of the 1980s by comparison, were motivated largely by concerns with economic neutrality, simplification, and administrative issues, with distributional equity taking second place.”

(a) The Taylor-Musgrave-1974

reform era

At the time of the Taylor Mission in the early 1960s and the Musgrave Mission in 1968-69, Colombia employed a global individual income tax levied at graduated rates; its schedular tax had been replaced in 1927. Several minor surtaxes were earmarked for the financing of particular expenditures. Taxes were levied under separate graduated rate schedules for corporations, limited liability companies (limitadas, a form of business organization used by many of the nation’s largest firms). and partnerships. There were also taxes on net wealth and excess profits. Corporate dividends were taxed when received by shareholders. and the owners of limitadas and partnerships were taxed on their part of profits, whether distributed or not. There were numerous tax incentives for investments in particular activities, and interest on the debt of governmental units and state-owned enterprises was system of exempt. There was a complicated itemized deductions for individual taxpayers, based both on income level and the number of dependents. There was no adjustment for inflation, either for amounts fixed in nominal (monetary) terms or in the measurement of income from business and capital. As in all developing countries, it was difficult to tax certain groups, such as independent professionals and owners of small businesses. Both the Taylor and Musgrave Missions found the net wealth tax to be a useful complement to the income tax, especially because it provjided an additional “tax handle” that increased progressivity. The two missions disagreed about the excess profits tax, the Taylor Mission finding that it should be retained while the Musgrave Mission

argued that it should be abolished. The tax was eliminated in 1974. Both missions recommended the repeal of earmarked surtaxes, and this advice was followed. Both missions provided detailed examinations of the taxation of business firms and their owners, including the case for integrating business and individual taxes. The more influential Musgrave Report recommended that corporations and limitadas be taxed identically, but that integration would not be appropriate. Implementation of the Musgrave proposals has occurred gradually over a period of almost 20 years. The use of graduated rates was discontinued in the 1974 reforms, but the taxation of corporations and Iimitadas was not unified until 1986. In the 1986 reform, dividends were removed from the taxable income of shareholders as a kind of approach to integration “rough and ready” thought to be more appropriate to the situation of Colombia than the conceptually more attractive approaches employed in many developed countries (dividend deduction, split rate, and shareholder credit or imputation). The Taylor Mission was generally favorably inclined to the use of carefully designed and targeted investment incentives, but critical of the particular incentives being used in Colombia. Though less enthusiastic about incentives, the Musgrave Mission also thought that they could be useful under the right circumstances. When most of the existing incentives expired during the early 197Os, they were not renewed. Both missions advocated elimination of tax exemptions for income from a wide range of activities. In 1974 these proposals were enacted for most forms of capital income. Constitutional limits on the “emergency powers” under which the President promulgated the reforms prevented elimination of exemptions for labor income. The 1986 reforms repealed many of these. The Taylor and Musgrave Missions found the itemized deductions overly complex and, in some cases, questionable on conceptual grounds. The Taylor Mission proposed that most be eliminated or greatly limited; the Musgrave Mission proposed replacing those that remained with a system of deductions that vanished as income rose. This was one of the few Musgrave proposals that was implemented before the massive 1974 reforms. Experience soon revealed that the vanishing deductions were extremely complicated, and the 1974 reforms replaced them with a simpler system of tax credits. One means of dealing with agriculture - a sector that is notoriously hard to tax - identified by the Taylor Mission and endorsed by the Musgrave Mission was the use of a presumptive

INCOME

TAX

income tax based on net wealth. Though a 1973 law providing such a tax on agriculture was never implemented for political reasons, in 1974 this approach was extended to all taxpayers. Because wealth (notably real estate, the primary identifiable component of wealth) is more visible than income flows, the presumptive income tax has provided an important “backstop” for the regular income tax, protecting the revenue yield and progressivity of the system. The Taylor and Musgrave Missions considered inflation adjustment for both nominal amounts and the measurement of income, but rejected it, not only because it is complex, but because it would reduce resistance to the pursuit of inflationary policies. Both advocated accelerated depreciation as a means of compensating for inflation and encouraging investment. Despite this advice, in the 1974 reforms Colombia moved reluctantly and tentatively into the area of inflation adjustment.12 It initially limited adjustment for nominal amounts to 8% per year, raised the limit to the smaller of 14% or 60% of actual inflation, and finally allowed full adjustment. It also provided for the exclusion of part of the monetary correction on mortgage bonds of constant purchasing power. Following the policy advice of the Taylor and Musgrave Missions, Colombia also adopted a system of accelerated depreciation. Both the Taylor and Musgrave Missions proposed raising the top marginal tax rate on individual income from its then current rate of 51% (52% at the time of the Musgrave Mission) to 62% and .55%, respectively. The Taylor Mission made important recommendations for improving tax administration, especially withholding on wages and salaries and on interest and dividends, advance payment of estimated tax, and self assessment. These recommendations were adopted in 1967, before the Musgrave Mission.

(b) The 198689

era

Several aspects of the 1986 Colombian reforms are worth notice. First, they were “homegrown”; that is, they responded to concerns identified locally, and were not based on studies by foreign advisors. But they were not free from foreign influence. They were clearly cut from the same cloth as the tax reforms occurring elsewhere at that time, notably the United States and the United Kingdom among developed nations and Chile, Indonesia and Jamaica among developing ones. They emphasized economic neutrality (including the advantages of lower rates),

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simplicity, and administrative issues relative to distributional equity. Second, they were not enacted in response to an economic crisis, as has so often been the case in less developed countries (LDCs), including Colombia. l3 They were intended to achieve the goals listed above, not to raise revenue; indeed, they were intended to be revenue neutral. Finally, unlike most previous reform efforts, the reforms of 1986-89 focused as much on administrative procedures as on substantive or structural tax policy. These issues are discussed separately. (i) Structural reforms In order to simplify the system, the 1986 reforms eliminated personal credits for dependents, most itemized deductions and credits, and the provision that allows the taxpayer (commonly the husband) to “cede” a limited amount of income to a spouse in order to soften the effects of the graduated rate structure. With these changes it was possible to make withholding on wages and salaries more accurate and eliminate tax returns for many employees with only limited amounts of net wealth and nonlabor income.i4 The 1986 reforms were motivated in part by concern for “decapitalization” of the Colombian economy - as indicated by debt-equity ratios that were rising over time.15 The response included the elimination of the individual tax on dividends and the phasing out of deductions for the inflationary component of interest expense. Taxation of the inflationary component of all interest income was also eliminated, bringing to its logical conclusion the policy begun in 1974 with the partial exclusion of the “monetary correction” for certain obligations of constant purchasing power. The 1986 reforms did not extend inflation adjustment to depreciation (and similar) allowances or to cost of goods sold from inventories. Rather, the government of Colombia commissioned the 1987-88 study of the taxation of income from business and capital. This study went beyond the narrow question of inflation adjustment to consider related issues in the taxation of income (especially timing of the recognition of income and the deduction of expenses) and net wealth. Moreover, it considered replacement of the income tax with a system of direct taxation based on consumption, rather than income. Such a system would eliminate both timing issues and the need for inflation adjustment in the measurement of income.16 The 1987-88 study proposed two alternative means of inflation adjustment, ad hoc adjustment of particular items in the income statement and an “integrated” system patterned after that

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used in Chile, in which balance sheet items are adjusted. The reforms announced at the end of 1988 adopted a two-stage approach in which ad hoc adjustment will be made until the end of 1991, with a switch to an integrated system in 1992. Contrary to the recommendations depreciation was not decelerated when inflation adjustment was extended to depreciation The 1986 reforms reduced both the corporate tax rate and the top marginal rate applied to income of individuals to 30%. This step shows a remarkable shift in thinking, given the rates of 62% and 55% proposed by the Taylor and Musgrave Missions. The final important structural reform of 1986 89 involves elimination of the net wealth tax, effective in 1991. This reform, which was not proposed in the 1987-88 study, can be expected to reduce substantially progressivity of the Colombian tax system. Though as being consistent with the of a comprehensive unrelated.lx Repeal of the net wealth tax reflects thelBolitical

sophisticated and too complicated for its relatively weak fiscal authorities to administer. During the reforms of 1986-88 it adapted to reality by adopting important administrative reforms, and by simplifying the system in key respects. Colombia had relied heavily on a system of of tax payment (pa2 y salvo). Such were required for a variety of activities, including leaving the country, registering an automobile, real estate, contracting with the government, and importing or exporting. There were several problems with this approach. It absorbed enormous amounts of personnel; at best, it could help assure collection of established but could not assist with auditing or other means of and it was easily subverted through falsification certificates. In 1988 Colombia abolished the system, freeing 1,800 employees of the tax administration for more productive work.” Colombia had required that taxpayers file with their tax returns documentation

mentation suppliers avalanche

transactions. Such docucould, in theory, be used to audit both and taxpayers. In fact, the resulting of paper overloaded the tax admlms-

tration. In addition, inadequate administrative procedures resulted in delays in processing and invited corruption. (For example, tax officials could conspire with taxpayers to “lose” papers, if convenient, or they could extort bribes to speed up the processing of refunds.) In 1988 Colombia addressed these problems by eliminating the requirement that documentation

opportunities for bribery has led to the resignation of some tax officials. Bank processing of data has cut lags in the of data needed for tax administration and policy making from two years to two weeks. In its effort to improve auditing, the Tax Department is now utilizing information from large bank transactions,

corporations and similar entities is taxed at a single rate, rather than under a graduated rate schedule. The exemption of dividends from the taxable income of shareholders is a surrogate for a more refined system of dividend relief, though one that many would question on distributional grounds. There are relatively few types of exempt income, and investment incentives have been eliminated; on the other hand, remains Both the measurement of income and amounts fixed in nominal terms are adjusted for inflation (or will be, once this policy is phased in). The presumptive income tax based on net wealth provides a backstop for the regular

INCOME TAX

- arguably some cost terms of by elimination of exemptions, most deductions, and limited income provided by ceding of Finally, recent reforms promise including more tive use tax administrators, access by authorities to information on faster processing claims for better service taxpayers, and of both and the needed for and policy on a timely basis.

TAX REFORM

VENEZUELA22

This begins with description of Shoup Mission’s for income reform and presumed effects policy. An view of for income reform made late 1989 a description the present

(a) The Shoup proposals and their effects Venezuela has had an income tax since 1942. In 1958, at the time of the Shoup Mission to Venezuela, there were nine separate schedular taxes, plus a “complementary” tax on global income. The schedular taxes were levied on wages and salaries, rents from real estate, interest and royalties, business profits, oil and mining profits, agricultural profits, income from noncommercial professions, gains from real estate, and gambling winnings.23 The schedular taxes were levied at flat rates, whereas the complementary tax on global income was levied at graduated rates. Under the schedular tax system there were separate personal exemptions for income from wages and salaries and from agriculture and a separate personal exemption that could be used to offset whatever income would otherwise be taxed at the highest schedular rate. The complementary tax provided a totally separate system of personal exemptions for the taxpayer, spouse, and dependents. Losses or excess deductions allowed under one schedule could not be used to offset income on other schedules. Indeed, excess exemptions for wages and salaries earned in one month could not even be used to offset labor income earned in another month. The system contained numerous technical defects. For example, the design of many deductions, tax incentives and the rate structure created notches - points where a few bolivars of

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additional income or expense caused far greater changes in tax. Some wage earners who had no residual liability for either schedular tax (because of withholding at source) or complementary tax (because of low income) might be required to file tax returns. Corporate income was subject to the same system of schedular and global taxes (and tax rates) as individuals. There was no integration of the corporate and individual taxes; indeed, dividends were not taxable. There were a few incentive provisions, and many types of interest income were also exempt. This system was extremely complex. The need to subject income to the proper schedule created important and difficult questions of line drawing. Certain items of expense were treated differently, depending on the schedule on which they were deducted. Moreover, the legality of different accounting standards (cash or accrual) depended on the type of income. The upshot was complexity, inequity, and distortion of economic decisions. The Shoup report noted that these anomalies were tolerable only because the rates were so low - and the differences between them so small.24 The complex system of schedular taxes, personal exemptions, an overriding global tax, and notches created both problems of compliance and administration and anomalous economic incentives, especially strange patterns of marginal tax rates. The Shoup Mission recommended switching from the existing system of schedular taxes to a global income tax. Itemized deductions were among the few bright spots the Shoup Mission encountered; compared to the situation in many countries, Venezuela allowed few deductions. Yet some deductions were allowed that could not be defended on grounds of public policy. These included deductions for automobile insurance, as well as those more commonly found in many countries. The Shoup Mission recommended eliminating those deductions that were totally inappropriate and greatly limiting others, especially those for personal expenses. The Shoup Report contains a detailed discussion of whether the corporate and individual income taxes should be integrated, and how. It concluded that corporations should be subject to a graduated schedule of rates different from that applied to individuals. If fragmentation of corporations to take advantage of reduced rates became too great a problem, consolidation of affiliated firms could be required. Dividends should also be taxed and subject to withholding at the source, with integration provided through a shareholder credit (the imputation method).

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There was no inflation adjustment, for either nominal amounts or the measurement of income. The Shoup Mission apparently did not consider whether this was appropriate.25 Only a few of the recommendations of the Shoup Mission have been implemented. The mission’s most important recommendation, the replacement of the schedular income taxes with a single global tax on the total income of individuals, has been adopted, though not without an exception for income from oil and mining and an interim regime involving substantial complication.26 Income from oil and mining is still subject to a separate rate schedule. Another notable success of the Shoup Mission was the elimination of the low-rate tax on gross receipts. Corporate income is taxed at graduated rates, and dividends are taxed, but without integration. For a while Venezuela did, however, use a defective form of shareholder credit.27 The Shoup Mission also recommended improvements in tax administration, several of which have since been introduced. Withholding and a system of advance payments of estimated tax help place the system on a pay-as-you-go basis. Self-assessment has also been introduced, but not without considerable difficulty.28

(b) The present system Venezuela currently taxes individual income at rates ranging from 4.5% to 45%. There are three corporate rates, 15, 35, and 50%) depending on the income of the firm. To combat “fragmentation” of corporations to take advantage of the lower rates, an extremely complicated (and apparently unworkable) provision for consolidation was enacted in 1985. In 1986 Venezuela departed from its long history of taxing only income deemed to have its source in the country (the territorial principle). It enacted a provision calling for the taxation of many types of foreign-source passive income, notably interest, dividends, royalties, etc. The wisdom of this move, intended to stem capital flight, as well as to enhance equity, is debatable. It is difficult to tax such foreign-source income, even with the aid of information provided by source countries.2y Many of the notches found in the pre-1959 income tax and continued in the 1967 reforms have now been eliminated. But the present law contains an equally egregious anomaly, a mathematical inconsistency between the filing limit, the personal exemptions, and the marginal rates applied to low incomes. A taxpayer may go from having no tax liability (becuase he or she is not

required to file) to owing Bs 3,335 by earning an additional bolivar of income.30 Withholding has been extended to 28 different types of payments, in addition to wages and salaries.31 This is a salutary development, but only if the information gained is used in auditing; the “voluntary” compliance induced by the fear of audits and the information that such withholding elicits may be as important as the modest amounts of money collected directly through withholding. In several cases the threshold for withholding is much too low; for example, withholding is required on payments as small as Bs.30 (professional services), Bs.50 (interest), or Bs.100 (contracts).32 The revenue gained from such requirements is not worth the trouble to taxpayers and tax administrators; indeed, if compliance were perfect, administrators could not handle the resulting paperwork. Much of the information supplied on small transactions would be of little use, as it only helps to identify those who have small incomes. Many Venezuelans who have only labor income are nonetheless legally obligated to file income tax returns; neglect of this requirement appears to be widespread. Matters are further complicated by the long list of itemized deductions, many with little or no policy justification. Itemized deductions - including deductions for personal expenses - have proliferated since the Shoup Mission. Among the most egregious new deductions is one for expenditures on certain public utilities. In addition, there are deductions for automobile insurance, educational costs, payments to professionals, mortgage interest, residential rent, life insurance premiums, and contributions to employee saving funds. To make withholding as accurate as possible employees must provide employers with estimates of amounts to be spent during the year on items for which deductions are allowed. It appears that neither employers (who have little interest or incentive to insist on accuracy) nor the tax administration have the capacity to verify the accuracy of such deductions. Since 1961 Venezuela has provided targeted tax exemptions and investment incentives for a wide range of activities. Incentives have been provided, inter alia, for agriculture, investments in pollution control, construction, fishing, mining, tourism, transportation, regional development, exports, and a variety of financial activities. From 20 to 100% of the income earned in certain activities is tax-free. In addition, the interest paid on loans to finance certain investments is tax exempt, as are the dividends paid from income earned in agriculture and some construction. Investments in some sectors are

INCOME TAX

eligible for credits against tax of 15% of the investment (25% in the case of producers of capital goods). Some of these incentives were extended in late 1988 by the outgoing government, despite repeated advice against doing ~0.~~ Without digressing to ask under what conditions incentives might be desirable, we can note several problems with the Venezuelan system. First, to the extent incentives are offered for the production of tradeable goods, they represent an attempt to swim upstream against the forces of comparative advantage; it is simply difficult for an oil-rich country to export anything besides petroleum because of the strength of its currency.34 Petroleum has accounted for more than 90% of Venezuelan exports in a typical year - and as much as 99% in some. The overvalued exchange rate essentially subsidizes imports and hampers exports.35 Second, incentives are offered for so many activities that the tax base is severely eroded. As a result, tax rates on the nonexempt sectors must be much higher than otherwise. High tax rates discourage many desirable activities, including work effort, saving, investment, and entrepreneurship, and they also distort other economic decisions. Moreover, with incentives offered for so many activities, the impact of incentives is much diluted. Third, the government of Venezuela has no idea of either the cost (fiscal or otherwise) or benefits of fiscal incentives.36 It is thus impossible to have any idea whether the existing incentives are desirable, based on comparison of costs and benefits. Fourth, firms benefiting from incentives are not monitored adequately. Thus the existence of incentives, as administered, creates opportunities for abuse that further erodes the ability of the tax system to produce revenue, undermines distributional equity, and causes resources to be misallocated. Finally, some of the Venezuelan tax preferences are structured in ways that produce economic incentives that are questionable, at best.37 Like most investment incentives, they encourage the substitution of capital for labor. All in all, one gets the impression that the design, implementation, and continued use of these incentives has never received careful consideration by those responsible for tax policy in Venezuela. Venezuela has two payroll taxes, in addition to the income tax. One finances social security, the other employee training; together they produce more revenue than the individual income tax. This creates unnecessary complexity, since the bases for the three taxes are different, and there is almost no coordination between the three

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agencies administering these taxes. Moreover, the various exemptions, tax rates, and ceilings combine to produce anomalous patterns of marginal tax rates. The Fiscal Reform Commission examined briefly whether Venezuela should adjust either nominal amounts or the measurement of income for inflation. In agreement with its technical advisers, it concluded that there were enough other flaws in the Venezuelan income tax that inflation adjustment should not take high priority in the agenda for reform. To date Venezuela does not allow (or require) inflation adjustment for either purpose.

(c) The I989 income tax proposals In November 1989, following negotiations with the International Monetary Fund (IMF), the government of Venezuela introduced proposals to reform the income tax and introduce a valueadded tax. As of June 1991 these reforms had not been enacted. They are discussed briefly here.38 The announced goals of the proposed income tax reform are: consistency with economic and social development; fiscal efficiency; horizontal and vertical equity; transparency in the assignment of tax burdens; and administrative simplicity. It appears that none of these is fully achieved. The proposed reforms simply do not go far enough in eliminating defects of the current laws. In many respects the proposed Venezuelan reforms resemble those enacted in Colombia in 198688. The taxation of dividends would be eliminated, an integrated system of inflation adjustment would be introduced (after a period of three years intended to ease transition), the certificate of solvency (similar to Colombia’s paz y salvo) would be eliminated, and tax rates would be reduced, to a maximum of 35% for individuals and to 15% and 35% for corporations.39 In addition, Venezuela would return to the territorial system of taxation and base estimated tax on sales of real estate on the gross sales price. As in Colombia, considerable simplification would be achieved for many individual taxpayers. The elimination of all credits and deductions for dependents and for personal expenditures would be compensated through a higher personal exemption for the taxpayer. The income level below which no tax return must be filed would be raised substantially for those who have only employment income from one employer who has withheld taxes. The proposal indicates that the number of

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cases benefiting from fiscal incentives would be reduced, that credits would be substituted for tax exemptions and exonerations, that incentives would be targeted more closely, that incentives would be subject to greater control, and that fiscal sacrifice would be monitored more closely. These are all steps in the right direction. It is, nonetheless, disconcerting that the proposed law would allow the executive branch to grant essentially the same exonerations and exemptions as current law. Incentives cause vexing complexity for some taxpayers, as well as distortions and inequities.

4. COMPARATIVE

ASSESSMENT

The comparison of the Colombian and Venezuelan income tax systems - and the history of efforts to reform them - is striking. Colombia has made continued and impressive progress (though not without some retrogression) throughout the period since (or even before) the Taylor and Musgrave Missions of the 1960s while Venezuela has made much less progress since the earlier Shoup Mission; indeed, many of the most important defects in the Venezuelan system are of relatively recent origin. Colombia has a cadre of tax “technocrats” - Venezuela does not. Finally, there is much more research on the effects of taxation in Colombia than in Venezuela. This section compares the evolution of structural tax policy, the roles of foreign and local tax experts, and tax research in the two countries. The next section investigates possible reasons for the differences.

(a) Structural tax policy Tax rates are much higher in Venezuela than in Colombia. The top individual rate and the corporate rate in Colombia are both 30%; in Venezuela these rates are 45% and (for corporations subject to the highest of the three graduated rates) 50%) respectively. The vocational training tax increases the Venezuelan rate over the range of labor income covered.4” Tax returns - including potentially very complicated ones continue to be required in Venezuela in situations in which withholding would constitute a final tax in Colombia. This requirement reflects the continued availability of itemized deductions and personal exemptions in Venezuela where the corresponding benefits have been abolished in Colombia, largely in a conscious effort to simplify the system. This

demand for tax returns creates compliance problems for Venezuelan taxpayers and their employers, as well as administrative difficulties. Venezuela continues to attempt to enforce the unenforceable, whereas Colombia has recognized the futility of the exercise. Moreover, many of the itemized deductions allowed by Venezuela make little or no sense from a policy point of view. The taxation of business in the two countries differs in important respects. Whereas Colombia applies a single rate of 30% to the income of both corporations and limitadas, Venezuela imposes graduated rates. Recent changes in the Venezuelan rate structure reduce incentives for fragmentation of corporations, but the remaining incentives justify complicated consolidation rules. Although Venezuela has experimented with several flawed schemes for integration since the Shoup Mission, it currently utilizes an unintegrated “classical” system under which it taxes income from equity-financed investment at both the business and shareholder levels. Colombia eliminated the taxation of dividends as a surrogate for integration, in part to combat the perceived decapitalization of the economy. Opinions differ on the propriety of this move - and Venezuela’s proposed imitation of it. Colombia long ago eliminated the last of its important investment incentives. By comparison, Venezuela has a remarkable list of incentives, some only recently extended. In addition, few items of income are explicitly exempt from tax in Colombia, whereas several are wholly or partially exempt in Venezuela. Colombia provides inflation adjustment in the taxation of income from business and capital, as well as for figures specified in nominal terms. Venezuela allows neither form of inflation adjustment; only recently has it reconsidered this policy. Of course, until recently inflation has been more of a problem in Colombia than in Venezuela. Passage of the 1989 proposals would make the Venezuelan system much more like the Colombian: tax rates would be only slightly higher than in Colombia; compliance and administration would be much simpler, as in Colombia; both countries would have eliminated certificates of tax payment; the tax rates applied to the income of corporations would be more sensible; dividends would no longer be taxable in either country; and both would be moving toward an integrated system of inflation adjustment. The most important remaining structural difference would be Venezuela’s continued reliance on tax incentives. In addition, less progress has been

INCOME TAX

made in administrative in Colombia.

reform

in Venezuela

than

(b) The role of foreign and local experts Changes in the source of tax policy advice in Colombia and Venezuela over the last 30 years deserve comment. Colombia has moved from primary reliance on foreign experts to primary reliance on local experts. Venezuela has made much less progress in this regard. Neither country has established an office of tax analysis of the type found in developed countries, staffed with a full complement of economists and lawyers41 (i) Colombia The Taylor and Musgrave Missions were staffed at the senior level essentially by foreigners. But both brought young “technocrats” into the process, and thereby began creation of a cadre of local experts knowled eable about tax reform and committed to it.4 4 The 1974 reforms were formulated by these technocrats.43 The combination of knowledgeable and committed technocrats and politicians also committed to reform is a potent force. Urrutia (1989, p. 285) has written, “the power of a group of technocrats supported by the president can be quite substantial.” Emphasizing the importance of political commitment, Bird (forthcoming) notes, “[E]ven the best-laid plans of technicians will come to naught unless key political and administrative figures are involved in the planning from the beginning, so that when the time comes to act they will both be ready to do so and committed to the reforms thay have had a hand in formulating.” Though based firmly on the Musgrave recom; mendations, the 1974 reforms reflected pragmatic modification and refinement to fit the Colombian situation of the period, for example, extension of the presumptive income tax to all taxpayers, substitution of credits for vanishing deductions, and starting down the road of inflation adjustment. The importance of a cadre of knowledgeable and committed technocrats continued to be seen during the period of “two steps forward and one step back” reforms and counterreforms between the 1974 and 1986 reforms. It reached its peak in the 1986 reforms, which were put together with a minimum of outside advice. The 1987-88 study of the taxation of income from business and capital, on which the 1988 reforms were based, was formally the product of foreign advisers. But the Director General of National Taxes and the immediately prior Director General (the Director at the time the 1987-88

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study was done, who was then acting as a government consultant) were intimately involved in the work leading up to the report and especially in the formulation of the resulting As in 1974, though based on a report reformsa by foreigners, the final 1988 reform proposals were adapted to the Colombian environment.45 The important administrative reforms of the period were done with the encouragement and advice of the IMF. (ii) Venezuela Venezuela seems to have bypassed an opportunity similar to that grasped by Colombia to nurture and utilize the germ of a cadre of local experts who had dealt with the Shoup Mission. Gittes (1968, p. 172) writes of the 1967 reforms, “Those responsible for the formulation of the new law no doubt studied their copies of the Report and found that its observations and recommendations had not lost relevance. One or more of those responsible for the new law were also members of the enthusiastic group of Venezuelans who took an active part in exchanging views with the members of the Shoup Commission at the time the Report was drafted.” In the early 1980s the Fiscal Reform Commission turned to the IMF, rather than to local experts, for technical assistance on tax reform. That a Tax Research Group of the type recommended by the Shoup Mission was never established in Venezuela has several important implications. First, it helps to explain why there has been no trained cadre of knowledgeable and committed technocrats.& Second, there has been no real capacity for the collection and processing of data needed for analysis of tax policy options. Third, many of the policies that have been adopted seem to reflect the lack of technical expertise. Among these were structurally unsound investment incentives and flawed techniques for integrating the corporate and individual income taxes. At a more basic technical level are e.g., the continued proliferation of notches and the belief that many marginal tax rates are needed to have a progressive distribution of burdens. Defects such as these suggest that without a trained cadre of local experts (and even with the help of outside experts) Venezuela is likely to continue to make mistakes in the design and implementation of tax policy. Gittes recognized this problem, but drew a different conclusion: that foreign advisors should continue to play an important role in tax reform beyond merely “turning out a report.” In particular, they should be involved in “working out the technical details” necessary to create a new law, since they probably “will not be the first persons

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in the host countries to suggest broad policy changes.“47 Experience in Venezuela and elsewhere, suggests that Gittes may be right.48 A country that lacks both continuing advice from foreign experts and a well-trained cadre of local experts is likely to make many questionable policy decisions. But an equally important observation, borne out by experience in Colombia, is that a group of local technocrats knowledgeable about the defects of the system and trained in tax analysis can also work out many of these details for themselves. (iii) Tax research in the two countries The nature and quantity of research on the effects of taxation in the two countries is also quite different. Colombia has produced an impressive amount of analysis of its tax system and the economic effects thereof. Bird (forthcoming) notes, “Colombian tax reform has also been more extensively documented than that in almost any country, not least because of the large number of foreign experts who have, at one time or another, contributed their part to what seems to be an on- oing and never-ending process of tax reform.“4 0 Among obvious examples of local research are the history of tax reform of Perry and Cardenas (1986), Urrutia’s work (1989) on the politics of fiscal reform, the analysis of taxation and capital markets (the decapitalization thesis) by Carrizosa (1986)) and work on income distribution and the effects of public policy, especially by Urrutia (e.g., 1985); other research reported in Spanish is less well known to foreigners. In addition to the three major tax reform studies described above, foreigners have produced, for example, Bird (1970), Gillis and McLure (1975), and McLure (1982), all of which are devoted explicitly to analysis of the Colombian tax system, and numerous studies of income distribution and tax incidence; see, for example, McLure (1975) and Gillis and McLure (1978), as well as the extensive research by Albert Berry.5” By comparison, there is relatively little research on the tax system of Venezuela, either inside the country or outside it. Notable exceptions are Shoup et al. (1959), Gittes (1967), and the work done for the Fiscal Reform Commission, including especially CERF (1983), Aguirre et al. (1986) and Griffith, Escobar and Pavesi (1986).5’ Analysis of the Venezuelan tax system by the IMF and World Bank are, unfortunately, commonly shrouded in confidentiality, contrary to the practice in Colombia, where such work is often made public.

Differences in the quantity and quality of research are also found in the tax offices on the two countries. This difference is epitomized by a simple but important example, the choice of “classifier” used to group individual taxpayers for statistical analysis. Colombia started in the late 1960s to try to extract from tax records and process the data that are needed for tax analysis, especially for individual taxpayers. At that time tabulations of information on taxpayers were based on classifications according to either gross income or taxable income, both relatively useless concepts for this purpose.52 Over the years the system has been improved in response to external advice and the needs of policy makers, and now classifications are generally based on net income, generally the best measure of economic income to be found on the tax return. The situation is again quite different in Venezuela. A report submitted to the Fiscal Reform Commission in 1982 pointed out the need for improved tax statistics for policy analysis, going so far as to describe a series of statistical tables that should, at a minimum, be prepared as a matter of course. Though some progress has been made in this direction, as late at 1988 tabulations were still being based on taxable income. As a result, they are essentially useless for the analysis of tax policy.

5. EXPLAINING THE HISTORICAL DIFFERENCES Colombia’s income tax system is far superior to Venezuela’s. It is interesting to speculate why there is such a striking difference between two countries that are so similar in terms of location, size, and historical background.‘” The explanation, it seems, is that Venezuela has important deposits of petroleum that Colombia lacks.54 It has been able to finance roughly two-thirds of public expenditures from oil revenues.55 With the nonpetroleum sector needing to carry only one-third of the tax burden, Venezuela appears to have been less concerned than Colombia with designing or implementing a tax system that is fair, relatively neutral, and amenable to compliance and administration. Similarly, it is hardly surprising that relatively little research has been devoted to a tax system two-thirds of which falls on state-owned oil companies. In Colombia, where almost all of the taxes are collected from the private sector, the need for tax research has been far greater. The IMF tax administration advisers to the Venezuelan Fiscal Reform Commission reached a similar conclusion:

INCOME

TAX

Twenty years ago, taxation in Venezuela was the subject of one of the classic studies of tax systems, the Shoup Commission Report. . At the time of the Shoup Report, and ever since, one of the main characteristics of the Venezuelan system has been the public sector’s great dependence on petroleum revenue. At the central government level, nonpetroleum revenue averaged 36 percent between 1977 and 1980. It is perhaps the consequences of this low contribution of non-petroleum taxes to the country’s treasury that there has been no sense of urgency as regards reform of the administrative system. After all, any inefficiency that may have existed in the Tax Directorate affected only the collection of one third of revenue. A change of a few dollars in the international price of petroleum would have a much more marked effect on government revenue than a difficult and costly improvement in administrative techniques for internal taxes and customs.56

Bird (forthcoming) has expressed the point in the following simple terms: “The almost total absence of significant reform in Colombia’s neighbor, Venezuela, illustrates the strength of a quite different adage in the tax reform business: as a rule, countries only reform taxes when they have to do ~0.“~’ The failure to enact the 1989 reform proposals is further confirmation of this thesis. Rather than using the breather provided by the increased oil prices resulting from the crisis in the Persian Gulf to enact tax reform, Venezuela has again temporized. The importance of oil is shown dramatically in Table 1, which provides figures on the composition of Colombian and Venezuelan tax revenues, as a percentage of both GNP and total tax revenues, for a group of three years in the late 1970s and early 1980s. Although Venezuelan Table

1. Composition

REFORM

taxes represent a far greater fraction of GNP than in Colombia (20.0%, compared to 12.2%), all major types of taxes other than corporate income taxes are larger, as a percentage of GNP, in Colombia than in Venezuela. The difference is, of course, found in the corporate income tax. Some 12 percentage points of Venezuela’s 14.1% tax to GNP ratio for this tax was represented by are taxes on the oil sector. 58 These differences even more striking in the figures on the composition of tax revenues. The individual income tax is almost three times as important in Colombia as in Venezuela (ll.O%, compared to 4.1%), and the nonoil corporate income tax is somewhat more important (12.8%, compared to about 1O%).59 With the decline in the price of oil, and with the eventual depletion of its oil reserves, Venezuela will need to rely more heavily on nonoil sources of revenue. In the short run it may turn to a value-added tax to provide the revenues it needs. But in the long run Venezuela will need to improve its income tax system. The Colombian experience provides important lessonsbO First, given the lack of a trained cadre of technocrats familiar with tax analysis, Venezuela will almost certainly need to rely heavily on foreign experts, as Colombia did in the days before 1974. Recently it has relied heavily on experts from the IMF. Second, it is important that an effort be made to create such a cadre of knowledgeable and committed local experts, as Colombia did, so that Venezuela can eventually rely more heavily on “home-grown” advice, as Colombia did in 1974 and 1986. Since such a cadre comes into existence only in response to a felt need, perhaps one will now begin to be created. Third, it is important to improve the

of Colombian and Ven?zuelan tax revenues, percentage of all tax revenue* Percentage Colombia

361

of GNP Venezuela

as percentage

Percentage Colombia

All taxes Total income taxes Individual income tax Corporate income tax Domestic indirect taxes Foreign trade taxes Social security taxes Wealth and property taxes Other taxes

12.2 2.9 1.3 1.6 4.0 2.3 1.9 0.3 0.8

Source: Tanzi (1987), pp. 210-211, *Data are from 1979-81 for Colombia US dollars was $1,380 in Colombia

214-215. and from 1977-79 for Venezuela. and $4,220 in Venezuela.

20.0 14.9 0.8 14.1 1.4 2.0 1.1 0.3 0.4

100.0 24.0 11.0 12.8 32.9 18.8 15.5 2.5 6.4

of GNP and as

of Taxes Venezuela 100.0 74.4 4.1 70.3 6.8 9.8 5.6 1.5 2.0

GNP per capita in 1981

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DEVELOPMENT

data base on which tax analysis relies; this task should be begun even in advance of a perceived urgent need for such data. Fourth, it should be recognized that tax reform in Venezuela, as in

Colombia, is likely to be an on-going process, rather than a one-time event; in Colombia reform has occurred through a process of groping toward an improved system.

NOTES 1.

Shoup

et al. (1959).

2. Comision de Estudios y Reforma Fiscal (1983). The reports by IMF experts were Aguirre er al. (1986) and Griffith, Escobar and Pavesi (1986). 3. See Fiscal Survey of Colombia (1965), Musgrave and Gillis (1971), and McLure et al. (1990). Shoup (1973) reviews the first two, plus Bird (1970). There were earlier studies of the Colombian tax system by the UN Economic Commission for Latin America and by Bird (1970). In 1982 there was also a relativelv minor income tax reform commission comprised entirely of Colombians. Proposals based on its recommendations and introduced under emergency powers were ruled unconstitutional by the Supreme Court. They became the basis of reforms passed in 1983. See Perry and Cardenas (1986), pp. 4>51, 277-283. 4. Many of the Musgrave recommendations repeated those from earlier studies, including especially Bird (1970). as well as the Taylor Mission. Little attempt is made in this paper to trace the “intellectual paternity” of various reforms. See, however, McLure and Zodrow (forthcoming). 5.

See McLure

and

Pardo

7. The taxation of the oil sector is not examined in detail, in part because most oil revenues are collected from state enterprises, but primarily because interest is focused on the taxation of the nonoil sector. This discussion draws heavily on McLure McLure and Zodrow (forthcoming).

12. Urrutia (1989, p. 264), refers to the “not very logical position of the Musgrave Report” that not indexing “would create pressure against inflation.” 13. See Gillis (1989b) for a discussion of the extent to which revenue enhancement has motivated tax reform in various countries. 14.

See McLure

and

Pardo

(1991)

15. Carrizosa (1986) was especially influential. See also Chica (1984-85). The fear was that the substitution of debt for equity in the financial structure of companies would increase vulnerability to insolvency and bankruptcy. It was felt that inappropriate tax policy was partly to blame for this phenomenon. 16.

See McLure

et al. (1990),

chapter

9.

17. For an appraisal of the 1988 changes in the procedures for inflation adjustment, see McLure (1990) or McLure et al. (1990). chapter 11.

(1991).

6. In 1965 Colombia introduced a general manufacturers-level sales tax, which it then converted to a value-added tax and continued to improve throughout the next two and one half decades. The sales tax was not introduced in response to foreign advice. It is not discussed in the text, which concentrates on the income tax. See, however, Perry and Orozco (1990).

8. and

11. Bird (forthcoming) notes that the 1986 reform “was much more modest in what it attempted to do in terms of achieving either horizontal or vertical equity.” It represents “a much more restrained approach to redistribution through the fiscal system.”

(1989a)

9. The intervening dozen years saw many reforms and counterreforms that cannot be covered here, despite their great interest. See, however, McLure (1989a) and McLure and Zodrow (forthcoming). 10. Thus Urrutia (1989, p. 261). writes, “the tax reform was designed to affect mainly the high income groups. Progressive taxes would lead to the wealthy classes carrying most of the burden. .”

18. That this is true can be seen from the emphasis in McLure ef al. (1990) on the need for inflation adjustment to prevent the erosion of the base of the net wealth tax. 19. It is true that the tax is plagued by administrative difficulties, including especially valuation problems. These were not cited as justifying repeal. 20. This subsection Pardo (1991).

draws

heavily

21. On the inability of “gimmicks” weak tax administration. see Bird

on McLure

and

to compensate (forthcoming).

for

22. This section draws heavily on McLure (1991). which relies for its description of the pre-1959 system on Shoup et al. (1959). See also Gittes (1968) and Shoup (1989) for descriptions of actions taken since the Shoup Mission and Bird (1976) for an earlier appraisal of the Venezuelan fiscal system that reaches essentially the same conclusions as this paper. 23. Shoup et ul. (1959). pp. 87-106, describes and appraises the schedular system in effect at the time of

INCOME

the Shoup Mission. See Gittes (1968), pp. 13&132, the rates prevailing during 1961-67.

TAX

for

24. The schedular tax rates ranged from one to three percent. The rates applied to global income ranged from 1.5 to 26%. 25. Carl Shoup has indicated in comments on an earlier draft of this paper that there was no inflation at the time of his mission and none in prospect, because of oil revenues. 26. Rather than providing separate rate schedules for corporations and for all the income of individuals, as Shoup recommended, the 1967 reforms provided three schedules of graduated rates to be applied to (a) commercial and business income, (b) income from oil and mining, and (c) salaries, wages, dividends, and other income of individuals not taxed under either of the other schedules. The higher rates of the first schedule applied to income derived by individuals from commercial and industrial activities, but not to that from “noncommercial” professional activities, which were taxed under the lower rates of the third schedule. The amounts of tax due under the various schedules were calculated by: first, applying the relevant rates toincome from oil and mining; second, taxing business income at rates determined by summing oil and mining income and business income; and third, applying to wages, salaries and other income the rates determined by taking into account all three types of income. The offsetting of losses (including those carried forward from prior years) against income from other sources was specified by equally complicated procedures. See Gittes (1968), pp. 13>142. 27.

See Aguirre

etal.

(1986),

pp. 117-130, for details.

28. For an assessment of actions on proposals for administrative improvements, (1989), pp. 263-266, 271-274.

the Shoup see Shoup

29. See McLure (1989b). Colombia adopted worldwide taxation of its residents in 1974, but receives almost no revenue from taxes on foreign-source income of individuals. 30. This was about US$60 at change rate prevailing at the end comparisons under the earlier exchange rates are difficult. This since at least 1981; see Aguirre

the free market exof 1989; meaningful system of multiple problem has existed ef al. (1986).

31. Some of these are payments to nonresidents. Among the covered payments to residents are honoraria, commissions on real estate transfers, interest, dividends, the purchase of real estate, merchandise discounts of employees, payments to contractors and subcontractors, rental of real estate and furniture, payments by credit card companies, payments to jockeys and veterinarians, payments to insurance agents, payments to hospitals and professional institutions, and gambling winnings. Many of these are covered only if paid by companies, state entities, and tax-exempt organizations.

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363

32. At the free market exchange rates prevailing in recent years, the smallest of these figures is less than one US dollar and the largest is less than three dollars - and less than two now. 33. See, for example, CERF (1983) and Aguirre et al. (1986). For a strong critique of exemptions and incentives in effect in Venezuela in the mid-1970s see Bird (1976). 34. See Karl (1986, chapter 3). This phenomenon is sometimes called “Dutch disease.” Karl (forthcoming, chapter 2) describes how the abundance of petroleum creates a structural bias against the development of agricultural and industrial activity, as well as references to literature on the subject. Karl notes that the debilitating effects of mining may begin during the colonial period, when efforts are devoted to realizing economic rents, and not development. Karl (forthcoming, chapter 3) chronicles how the rise of petroleum meant the death of agriculture in Venezuela. 35. A common prescription for this problem is to employ differential exchange rates for petroleum exports and for other purposes. A more rational solution -but one that is difficult to apply for political reasons - is to sterilize part of petroleum revenues, allowing them into the domestic economy gradually in order to avoid the adverse effects described above. See Karl (forthcoming, chapter 2). Harberger (1989, p. 25) describes the analogous problem in Mexico in the following clear and simple terms: “In spite of the promise of Mexico’s authorities to go slow with oil, to invest the proceeds abroad and to repatriate them only to finance projects of demonstrably high productivity, none of the above really happened. Mexico ended up not going slow with oil, and not investing the proceeds abroad, but instead borrowing heavily against future oil revenues to finance an investment package of low and in some cases negative productivity. How did this happen? It was the inability of the authorities in the later period to say “no” often enough. There is a true human lesson here; when Mexico had no oil, the authorities were able to deny requests. They could say, among other things, we won’t give you what you want because we can’t. Later the presence of the oil bonanza took that excuse away. The authorities had to say, to governors of Mexican states, to ministers of the national government, to regional leaders of the Institutional Revolutionary Party (PRI), that they were sorry, but they did not choose to finance those people’s favorite projects. What may have been a credible “no” in the days when there was no oil became a virtual insult to the party whose request was being denied. It should come as no surprise that the Mexican authorities found it difficult to resist this sort of pressure. Similar situations arose in other oil-rich countries as well, and in many of them the authorities ended up yielding to the pressure.” For an analysis of Venezuela’s mismanagement of its windfall resulting from the oil shocks, see Gelb and Associates (1988), chapter 15. For a discussion of Indonesia’s much more appropriate response to the same environment, see Gillis (1985).

364

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DEVELOPMENT

36. That estimates of fiscal cost are lacking is especially troubling, since the tax return has a place for calculating fiscal sacrifice. Hardly any taxpayers bother to complete this portion of the return. This is not to say that such a calculation would give an accurate indication of the true fiscal or economic cost of incentives. But such a calculation is a starting place. 37.

For examples,

see Aguirre

etaf. (1986), chapter

7.

38. The discussion that follows is based on Proyecto de Ley (1989a). The VAT is described and justified in Proyecio de Ley (1989b). The proposed 10% VAT appears to have the now-conventional features: credit method, consumption base, and destination principle. It does, however, suffer from several peculiarities and potential defects, notably the exemption of independent professionals (which will cause both vertical inequities and distortions), the exemption of telephone service (which needlessly sacrifices revenue from a potential source of progressive taxation), the exemption of construction (a source of distortion and evasion, as well as revenue loss), and the extension of the tax to the retail level (a move that, except for the small business exemption of Bs.2 million, might be premature, given the lack of experience with sales taxation). 39. The official government explanation indicates that this might be the first step toward a proportional tax on corporate income. It is presumably for this reason - as well as the impracticality of the consolidation provisions of current law - that the government thought it could repeal the complicated provision for consolidation of accounts of related firms without fear of excessive fragmentation. 40. Social security taxes would increase marginal tax rates on labor income in both countries. They are not included here, since association of benefits and taxes may be strong enough in the minds of taxpayers to avoid disincentive effects. 41. The Shoup Mission recommended that a Tax Research Group be established in Venezuela to “advise the Minister of Finance on economic policy and legal aspects of taxation.” This group would also oversee the compilation of statistical data needed for the analysis of tax policy. Shoup et al. (1959), pp. 236, 239. 42. This commitment appears to be primarily public spirited and altruistic, since many of the young technocrats who have passed through the national tax office, being from wealthy families, might actually be harmed financially by the reforms they have proposed. 43. Gillis (1989b), p. 505, notes, “[T]he Colombian 1974 reforms were designed and implemented essentially by the same team of Colombian economists that had participated in the 1968 package that was the precursor of the 1974 reform.” See Perry and Cardenas (1986) and Urrutia (1989) for accounts of the preparation of the 1974 reforms. Perry was a participant in the process who later became responsible for implementing them as Director of National Taxes. Urrutia (1989). pp.

262-263, notes that President “Lopez not only wanted this group to prepare an economic programme, but also expected to build amongst its members an esprit de corps which would guarantee that as soon as the new government had taken over the agreed programme of action would be implemented speedily.” 44. The immediate past Director General of National Taxes went to Chile to investigate the operation of the Chilean system before that approach was endorsed. This episode and the fact that several former Directors General have recently been involved in advising the Government of Ecuador on tax reform indicates how far Colombia has come since the 1960s. when it lacked the local expertise to appraise recommendations of foreign advisers. 45. A final aspect of the Colombian experience deserves mention. The fundamental reforms of 1974 were enacted through the use of emergency powers provided under the constitution, rather than through normal legislative processes. As a result, exemptions for labor income could not be abolished, and many important administrative provisions were declared unconstitutional as being inconsistent with the exercise of emergency powers. Though the Congress ratified the substantive changes made under the emergency powers, one must wonder whether the reforms could have ever been enacted without the initial use of the emergency powers. On this experience, see Perry and Cdrdenas (1986) and Urrutia (1989). Urrutia notes (1989, p. 272) that in 1982 the judiciary ruled that emergency powers could not be used to introduce substantive tax reform. Urrutia (p. 281) has also written, “The structurally consistent tax reform of 1974 would have been very difficult to pass through Congress intact using the normal procedures. Negotiations in Congress can produce tax legislation that increases revenues, but the system cannot easily produce a structurally consistent tax system.” There is, however, room for optimism on this score, since in the 1986 reform package the Congress provided “extraordinary powers” of limited duration under which the President could modify administrative procedures and change the system of inflation adjustment. It was under these powers that the administrative reforms described above and the 1988 reforms were implemented. 46. Karl (1986, chapter 3) notes that Venezuela “suffered from a legacy of extreme administrative weakness that is remarkable - even in the context of Latin America.” It does, however, have a fairly large group of tax experts in the private sector who have had experience with prior tax reform efforts and who remain committed to the goal of reform. 47. Gittes (1968), Shoup (1991).

p. 172. For a contrary

48. See Bahl (1989) and Gillis (1989a) evidence from Jamaica and Indonesia.

view,

see

for supporting

49. In a similar vein, Shoup (1973, p. 59) has written, “No country, developed or developing, has had its tax

INCOME

TAX

system described, analyzed, and potentially improved by so many published studies in so short a period .” 50. See Berry and Urrutia (1976) and Berry and Soligo (1980). Some of the work on income distribution and tax incidence is reviewed in McLure and Zodrow (forthcoming). 51. It appears that almost all Venezuelan interest in tax reform over the last three decades can be attributed to (and has perhaps been largely limited to) a single farsighted individual, Dr. Tomas Enrique Carrillo Batalla. Carrillo Batalla was the driving force behind the Shoup mission to Venezuela 30 years ago, and it was he who convened the Fiscal Reform Commission in the early 1980s. Without his interest in tax reform, Venezuela would probably have an even poorer record in both tax research and tax reform. 52. Gross income is useless for analytical purposes because it does not allow the deduction of costs of earning income, such as depreciation. The use of taxable income suffers from the fact that deductions, including those of questionable justification, have been subtracted from economic income. To the extent that credits replace deductions, taxable income resembles net income. 53. It should be emphasized that this discussion is intended only to explain gross differences in the experience of the two countries, and not the details of the experience of either country. It can, of course, do no more than scratch the surface of political forces operating in the two countries. For discussions of the political forces shaping tax reform in Colombia, see Perry and Cardenas (1986) and Urrutia (1989). Martz (1984), Romero (1989), and Karl (1986); (forthcoming) provide more general overviews of the history and present state of political affairs in Venezuela, especially as they have been affected by the abundance of oil. 54. Another important difference in recent years is the presence of the drug trade in Colombia on a scale not found in Venezuela. This appears to have had little impact on differences in tax policy; certainly it could not have done so until recently. Nor does the slightly higher level of GDP per capita in Venezuela made possible by oil appear to explain much. 55. This includes both income taxes and profits of the state-owned petroleum monopoly. Venezuelan nationalized foreign oil companies in 1975.

REFORM

365

56. This is a translation of Griffith, Escobar and Pavesi (1986), pp. 13-14. This view has been repeated in the final report of CERF (1983), p. 24 (p. 4 of the English translation). Shoup (1989, p. 252), notes that while Venezuela did not face a fiscal crisis in the late 1950s “it seemed important to have in place a tax system that could be called upon to supply large increases in non-oil taxes when petroleum reserves dwindled.” What ultimately mattered was the fact (p, 276) that “In Venezuela in 195859 there was no urgency for improving the tax system. . .” 57. In a similar vein, Karl (forthcoming, chapter 2) has written of experience in many oil-rich nations: “Given their easy access to “easy” revenues from petroleum, few rulers sought to supplement state income through substantial increases in domestic taxation - an action which was bound to cause political turmoil. . Indeed, nonoil taxes in producer-countries remained extremely low by international standards, and frequently were only half the level of countries at comparable stages of development.” The abundance of petroleum revenues also had other effects that are better known. Karl (1986, p. 215), for example, has also written about Venezuela: “petroleum provided the fiscal revenues upon which democratic administrations depended to maintain the ambiguous, and expensive, situation of fomenting the growth of a private sector while simultaneously granting favors to the middle and working classes. Concretely, each government granted expensive subsidies, contracts, and infrastructure to entrepreneurs while charging the lowest taxes on the continent and allowing some of the highest profits. At the same time the democratic governments could afford to support collective bargaining for the highest wages on the continent, price controls, huge food subsidies, and an agrarian reform.” 58. It has been estimated that during the years in question about 85% of corporate revenues in Venezuela were from the petroleum sector. 59. For overviews of the development of the patterns of taxation over time, see Bird (1976) and Karl (1986, chapter 3) for Venezuela and Perry and Cardenas (1986, chapter 1) for Colombia. 60. For more on the lessons from the Colombian experience, see McLure (1989a) and McLure and Zodrow (forthcoming).

REFERENCES Aguirre, Carlos A., Peter S. Heller, John P. Lipsky, and Charles E. McLure, Jr., El Sistema Tributurio en Venezuela (Caracas: Comision de Estudios y Reforma Fiscal [CERF], 1986). Bahl, Roy, “The political economy of Jamaican tax reform”, in Malcolm Gillis (Ed.), Lessons from

Fundamental Tax Reform in Developing Countries (Durham, NC: Duke University Press, 1989). pp. 115-176. Berry, R. Albert, and Ronald Soligo, Economic Policy and Income Distribution in Colombia (Boulder, CO: Westview Press, 1980).

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