Notes on Colombia’s failed tax reform

Since April 28, there have been massive protests across Colombia — which have tragically claimed the lives of over 30 people, and wounded over 1,000 people.

These protests are the natural result of an explosive social context, exacerbated by the COVID-19 pandemic. There’s a lot to be said about the state of the country and the widespread exhaustion, anger, frustration and social distress felt by many people. The immediate cause of the protests, however, was a tax reform bill proposed by the right-wing government of President Iván Duque (elected in 2018). A lot has been said about this tax reform proposal, some of which is inaccurate, so here are some rough notes about what it was.

A difficult social and economic context

A tax reform was made necessary by the financial impacts of the pandemic. As a result of the pandemic — which has claimed the lives of over 75,000 Colombians and infected nearly 3 million — Colombia suffered the worst recession in recorded history (-6.8%), and the first recession since 1999.

Naturally, government finances were hit hard. According to the finance ministry, revenue fell by 11% in 2020, while expenses grew by over 16% (to support economic recovery program, public health, vaccine procurement etc.). Government debt increased to 63% of GDP, the highest in decades. The budget deficit increased from 2.5% of GDP in 2019 to 7.8% in 2020, and is expected to grow to 8.6% in 2021, even as the economy begins to slowly recover.

Like in other Latin American countries, the pandemic had a devastating impact on society. The unemployment rate, already high before the pandemic at over 10%, increased to 21% in May 2020 and is still at 14% as of March. According to numbers recently published, 3.5 million fell into poverty last year. Poverty increased to 42.5%, wiping out all progress made in reducing poverty over the past decade, and extreme poverty increased to 15.1%. With the pandemic, poverty increased significantly in urban areas: urban poverty increased to 42.4%, while rural poverty fell slightly to 42.9%, closing the traditional urban-rural poverty gap.

“Sustainable solidarity” tax reform

The tax reform was rather ambitious and actually represented something of a paradigm shift for the government, which had previously followed standard right-wing ideas of lowering taxes and making things easier for businesses.

The tax reform set out to collect 23.4 trillion pesos (2% of GDP), by expanding the individual income tax base (17 trillion COP), VAT changes (7.4 trillion COP) and corporate tax changes (3.7 trillion COP). Much of the new income would be used to fill the the fiscal hole — but also to fund an expanded basic income for the poor, which was supposed to be its most attractive selling point. The government called it ‘sustainable solidarity law’ (because ‘tax reform’ is an eternally toxic name) and projected that, thanks to it, poverty would be reduced by 2.8% and extreme poverty by 5.8%.

In April 2020, during the pandemic, the government created a sort of basic income program, Ingreso Solidario, targeted to the 3 million poorest households, with no strings attached. It had a somewhat positive effect : without extraordinary economic relief programs, poverty would have been 2.2% higher. The tax reform proposed to expand it to 4.7 million households (18.8 million people) albeit with lower amounts (at least 80,000 pesos, at most 65% of the minimum wage). The tax reform also included tax incentives for job creation among specific vulnerable demographics, an extension of a pandemic wage subsidy program and increasing resources in order to fund up to 100% of poor students’ tuition fees in post-secondary institutions.

A broken tax system

Colombia’s tax system is inefficient, dysfunctional and unfair. Colombia collects only 19.7% of its GDP in tax revenues, compared to 22.9% for Latin America and 34% for OECD countries, of which Colombia is now a part of.

There are a large, confusing and inefficient array of tax expenditures which skews the system, usually in favour of the rich. Lost revenue from these tax expenditures is estimated to be 6.5%-8.7% of GDP, the highest in Latin America. The corporate tax rate is high (32% in 2020), and corporate taxes make up 24.5% of tax revenues (compared to 15.8% in Latin America), but special local taxes or loopholes and tax breaks that make it dysfunctional.

Colombia collects very little of its revenue from individual income taxes (6% of tax revenues), partly because the income tax threshold is quite high (about 3 times the average salary). It has various deductions and loopholes which end up favouring the very rich. Many experts have long said that Colombia needs to expand its tax base, meaning that more people — the middle-class — would need to pay income tax.

The VAT is one of Colombia’s main sources of tax revenue (29.6% of tax revenues), although only 39% of goods pay VAT, and the system is riddled with exemptions, exclusions and goods at a 5% reduced rate. Experts have long recommended to significantly reduce the number of exempted or excluded goods, tax more goods at the full 19% rate and eventually impose VAT on basic consumer goods (the canasta básica) with a compensation mechanism for the poor (introduced in 2020).

The problem is that while many of these recommendations are probably technically sound, they’re politically unpopular (especially the VAT on basic consumer goods, which causes massive resistance each time).

The tax reform

The tax reform did not propose to significantly expand the categories of goods and services covered by the VAT — only from 39% to 43% of goods, after Duque forced his finance people to walk back the toxic idea of VAT on coffee, salt, sugar and chocolate. It proposed to eliminate nearly all ‘exemptions’ (which allows producers to get a refund of taxes they paid to produce exempted goods), although basic consumer goods like eggs, milks, meat and rice currently exempted would be ‘excluded’ (taxed at 0% but with no refund for producers). The reform would have raised the VAT on certain things — most notably gasoline and diesel fuel (from 5% to 19%) and public utilities for socio-economic strata 4, 5 and 6. On the other hand, as a carrot, it would have extended the VAT compensation mechanism from 1 to 4.7 million households and increased it to 50,000 pesos.

Much of the new income would have come from expanding the tax base, gradually, so that by 2024, people earning ~2.5 million pesos a month ($660) would start paying income tax at a marginal rate of 10% (the current threshold is ~4.7 million pesos/monthly). Colombia’s minimum wage is around 900,000 pesos/month, and the average salary is not a lot higher. This would primarily affect the middle-class, who would also be hurt by the VAT increases and the lack of refunds or cash transfers.

The tax reform also proposed to extend the wealth tax (on assets over 5,000 million pesos, ~$1.3 million, at 1% or 3%) until 2023, increase the dividend tax rate (but also increase the threshold where dividends would be taxed), create another temporary tax on high incomes for the rest of 2021 (deductible from taxes in 2022–3) and tax pensions over 7 million pesos. While this may seem like a lot, it’s not: the reform did not, in reality, touch the richest few all that much.

It also would have created two corporate tax rates, which would benefit small businesses, who would have paid at a 27% rate (24% after 2024), while larger businesses would have had to pay a 3% surtax higher for two years before returning to 30%. Following experts’ recommendations, it would have eliminated many tax incentives, exemptions and deductions (several of which created by Duque’s previous tax reform in 2018–9, like the ones for hotels, tourism, the orange economy, green energy, agroindustry, social housing etc.) beginning in 2023.

Finally, it would have created or modified green taxes: including coal in the carbon tax, creating a local tax on vehicles based on how much they pollute and creating taxes on single-use plastics and non-organic pesticides.

In short, the proposed ‘sustainable solidarity law’ was a shift away from trickle-down economics favoured by Duque in his 2018 campaign and 2018/2019 tax reforms, towards a modest attempt at structural tax reform with some redistributive aims. But the middle-class would have suffered the main fiscal blow, rather than the rich, which is something very difficult to sell to voters during a pandemic…

Dead upon arrival

Tax reforms in Colombia are always unpopular. They are are even more politically difficult and unpopular a year out from elections, when most members of Congress are more concerned by their reelection. They are even more difficult in the midst of a pandemic.

The government hoped that its messaging focused on ‘solidarity’ and the social parts would help soften the blow, but it probably didn’t expect how strong the blowback to the idea of “middle-class tax increases” would be: regardless of the actual numbers, everybody, particularly urban Colombia (the one which the media focuses on), likes to think that they’re middle-class.

Even before the official text of the reform was presented, there was already widespread opposition — including from some the government likely expected would be friendly. The bases of the Centro Democrático (CD), the party of Duque and his mentor, former president Álvaro Uribe (2002–2010), disliked the tax increases, and demanded budget cuts and austerity, in line with traditional uribista rhetoric of small government and ‘austere state’. Former vice president and 2018 presidential candidate Germán Vargas Lleras published searing columns in El Tiempo attacking the tax increases on the rich, claiming it would “suffocate the productive sector” and “expropriate savings”, drawing comparisons with Venezuela. This pushed his party, Cambio Radical (CR), to oppose it.

The sectorial lobbies and associations voiced their opposition to the bits that would impact them — for example, the Colombian Agricultural Society (SAC) warned that prices would increase with the elimination of VAT exemptions. The national trades council (CGN) and the ANDI (the industrialists’ association) rejected the government’s proposals, and presented their own, more modest, counterproposals. The ANDI’s counterproposal aims to raise 13–14 trillion pesos, without touching the VAT or individual income taxes.

All of the political parties at least criticized specific proposals — mostly VAT changes, income tax increases and pension taxation. The CD, Conservatives, Partido de la U, Colombia Justa Libres and some Greens proposed alternative ideas, to avoid touching the VAT or income taxes. Other parties — the Liberals, CR and the rest of the opposition — called on the government to withdraw it altogether.

The CD, whose support was probably most crucial for the government, claimed to support the “social and savings” parts of the reform, but pushed for major adjustments to the rest. The government, which knew that it would have to make major concessions, claimed that it was open to modifying the text. But when the government made only very minor concessions, Uribe made an ‘anguished plea’ on Twitter for the government to propose a simple text.

With the willingness of the CD, La U and the Conservatives to sit down and talk about a far more modest reform, the government hoped to salvage something. Duque’s only red line was that he would not withdraw the reform. This, in turn, motivated protesters to demand exactly that.

Duque probably (arrogantly) assumed that the protests would not be as big as they ended up being — he likely thought that the third wave of the pandemic would kill off protests, just like the beginning of the pandemic in March 2020 killed off the 2019 protest movement. He badly misread the state of the country — the exhaustion, anger, frustration and social distress — which isn’t surprising given his personality and the type of people he surrounds himself with. On the other hand, Uribe, a much smarter politician, does understand how delicate (and dangerous, for him) the situation really is, and helps to explain why he was visibly annoyed by the government’s reticence to reduce its ambitions.

Duque also never really defended his own government’s reform with all that much passion: this was very much finance minister Alberto Carrasquilla’s project, shared with his vice minister, and well… Carrasquilla is a terrible communicator who has always been one of the government’s most unpopular ministers. Alberto Carrasquilla announced his resignation after Duque announced the withdrawal of the tax reform. It’s a surprise that he lasted this long, in fact.

A fatal blow to an unpopular, dead-ended government

Being forced to withdraw the tax reform, which is the one thing he didn’t want to do, is a major — fatal — blow to Duque’s government. Although he has over a year left in office, Duque’s government — in terms of major legislative and policy initiatives — is basically over. He’ll likely be able to get a much watered-down, mini tax reform that will barely be enough for anything (either repaying debt or funding social programs), and will require that the next president passes a bigger, structural reform in 2022–23.

There’s little he can (or wants to) do to respond to protesters’ demands and anger, besides more repression and the old politics of fear and stigmatization.

Note: This is a new blog to discuss Colombian politics and elections, looking ahead to the 2022 elections and the road leading to them. I hope you’ll keep reading!