Tax regimes differentiated by company size harm productivity.
Latin American companies must dedicate an average of 320 hours a year to preparing their tax returns compared to an average of 177 hours in developed countries. Colombian firms are relatively fortunate, spending less time on these tasks than their other Latin American counterparts; even so, companies dedicate an average of 208 hours annually to tax procedures. Brazil, Bolivia, Ecuador and Venezuela are at the other extreme: between 600 and 2,600 working hours are wasted per company.
Since tax systems are so complex and smaller companies contribute a minimal amount to tax collection, it would seem reasonable to create simplified regimes for them. These regimes exist in 13 of the 17 Latin American countries analyzed in an IDB study to be published soon. In two other countries, the tax offices have simply decided to exempt small companies from their tax obligations.
At first glance, simplified tax regimes seem to be good for productivity because they save small companies costly hours of bureaucratic work. The problem is that since these regimes benefit firms that are below a certain sales or payroll threshold, small companies avoid expanding beyond these limits because their profitability would plunge. The profits of a small Peruvian company would fall 50 percent if it crossed the line, and the profits of an Argentine company would slide 25%. This helps explain why there are so few medium-sized firms in Latin America. More crucially, it is an important reason why many small, low-productivity companies survive, absorbing resources that would be more productively used in larger companies.
Given the complexity of tax regimes and the meager tax receipts that small- and medium-sized firms generate, tax administrations naturally concentrate their collection efforts on large companies—hence the large taxpayer units that exist in many countries. However, the effect is that many large companies with growth potential are reluctant to make investments that could increase their productivity because it might attract the tax administration’s attention. The larger the company, the more their investment decisions are susceptible to these tax risks. And the more investment is concentrated in a few large companies, the greater the temptation of the political system and the tax administration to impose heavy taxes on their income.
Latin American tax regimes bear much of the responsibility for the tragedy of productivity in the region’s economies because they encourage the survival of unproductive firms, obstruct the growth of small and large enterprises alike, and foster a deeply unequal and segmented business universe.
Simplifying, unifying and enforcing the tax provisions that apply to enterprises could contribute greatly to productivity. Regimes differentiated by sector, company size or for other reasons distort the allocation of resources, divert the scarce managerial resources of companies, and are an extra burden for the public administration.
A well-designed tax system should create incentives to pay taxes and prevent evasion. This is the great virtue of the value added tax because each company has an interest in seeing that its suppliers pay their VAT to obtain credit for its own payments. In contrast, taxes on financial transactions encourage companies to conspire with each other to keep operations outside the financial system, thereby destroying the payment system and the channels of information needed for overseeing compliance with tax obligations.
Simplified tax regimes for small companies are a collection of all the defects of a bad tax system: they discriminate by size, facilitate evasion, inhibit cross-control between firms and rarely generate useful information for tax control.
Note: The author is associated with IDB but his views are his own.
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