The TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Foundation’s recently released 2022 International Tax Competitiveness Index (ITCI), measures the extent to which a country’s tax system adheres to two important aspects of tax policy: competitiveness and neutrality. Over the years, our Index has helped many European countries like Austria, Greece, and the UK design tax reform proposals. As the Index continues to grow, policymakers from Latin American countries now have the opportunity to compare and reform their tax systems, making their countries more attractive for entrepreneurs and residents while raising sufficient revenue for government priorities.
In the last year, Colombia advanced from 35th to 32nd (out of 38 countries) due to a slight improvement in its individual tax score and the fall of Ireland and Spain in the rankings.
| Category | Score (out of 100) | Ranking (out of 38) |
|---|---|---|
| Overall | 57.8 | 32 |
| Corporate Income Tax | 32.5 | 38 |
| Individual Taxes | 99.2 | 2 |
| Consumption Taxes | 56.5 | 18 |
| Property Taxes | 54.2 | 24 |
| International Tax System | 46.5 | 36 |
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Source: Tax Foundation, 2022 International Tax Competitiveness Index. |
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Colombia scores well on individual tax policy, ranking 2nd out of 38 countries. This is due to a combination of factors. First, a Colombian worker earning the nation’s average wage faces the lowest tax burden in the Organisation for Economic Co-operation and Development (OECD). Second, Colombia taxes dividends and capital gains at very low rates.
On the other hand, Colombia is one of four OECD countries to raise revenue through non-standard social security contributions. Though these revenues make up a relatively small portion of Colombia’s total tax returns (9.9 percent, compared to a place like Costa Rica with 31.4 percent), the non-standard contributions add complexity to the tax code and make individual taxes less transparent.
Colombia scores worse on its property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. , ranking 24th. This is mainly because Colombia levies both a net wealth taxA wealth tax is imposed on an individual’s net wealth, or the market value of their total owned assets minus liabilities. A wealth tax can be narrowly or widely defined, and depending on the definition of wealth, the base for a wealth tax can vary. and a financial transactions tax. Nevertheless, while capital gains resulting from inheritance and gifts received are subject to a 10 percent tax, there is no comprehensive estate or inheritance taxAn inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate. .
Another weakness of the Colombian tax system is its corporate tax component, where Colombia’s rank dropped from 35th in 2021 to 38th in this year’s edition of the Index due to an increase in the corporate tax rate from 31 percent to 35 percent. Colombia levies the highest top combined corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate followed by Portugal (31.5 percent), Australia, Costa Rica, and Mexico (all at 30 percent). Additionally, the corporate income tax rate is significantly above the OECD average (23.6 percent).
Colombia also ranks 22nd on its value-added tax (VAT) base. Less than 50 percent of consumption is covered by the VAT due to exemptions that complicate the overall system and distort consumer choices. A broader VAT base could create fiscal space for lowering the overall VAT rate of 19 percent.
A New Tax Reform Threatens to Reduce Colombia’s Tax Competitiveness Even Further
Colombian President Gustavo Petro has launched an ambitious tax reform plan seeking to raise additional revenue by 23 trillion pesos ($4.7 billion), the equivalent of about 1.5 percent of GDP. The deputy finance minister argues this will bring in “more revenue to finance the fiscal spending needed for physical and social infrastructure.”
The latest draft of the bill, pending approval from Colombia’s congress next week, makes royalty payments by oil and coal companies non-deductible for corporate tax purposes and imposes a new tax on oil and coal exports tied to international prices. Among other tax measures, the tax reform also includes the double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of dividends and a permanent estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. .
If these policies are implemented, they will reduce the country’s overall ranking in the 2023 ITCI from 32nd to 35th. The income tax rank will fall from 2nd to 6th and the property tax rank will drop from 24th to 32nd. And they might not raise the projected revenue.
These tax reforms will wipe out most of the Colombian tax code’s few strengths. Policymakers should refrain from introducing new taxes that undermine economic growth and instead consider repealing wealth and inheritance taxes, as well as the double taxation of dividends that negatively impact entrepreneurial activity, savings, investment, and work.
Alternative Pro-Growth Tax Reform
According to research from the OECD, corporate taxes are most harmful to economic growth, with personal income taxes and consumption taxes being less harmful.
Therefore, Colombia should consider full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. for capital investment to increase private investment and accelerate economic growth. Colombia could also increase revenue with minimal economic harm by reforming the VAT and broadening the base by eliminating exemptions and reduced rates for certain goods.
Broadening the VAT base to the OECD average (increasing to a 54 percent VAT efficiency ratio from the current 35 percent) would increase VAT revenues by nearly 60 percent from the 2020 level of 54,000 billion pesos to 85,000 billion pesos. This would be a dramatic expansion of the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. . However, if one took a more reasonable expansion of the VAT base to have an efficiency ratio of 40 percent, this would increase VAT revenues to 62,000 billion pesos. The additional 8,000 billion pesos is about 60 percent of the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. revenue collected in 2020 and 17 percent of the corporate tax revenue in 2020. Additionally, this reform would increase VAT tax revenue as a percentage of GDP from 5.4 percent, in 2020, to 6.2 percent (or 8.5 percent if the VAT efficiency ratio is raised to 54 percent).
This VAT reform would bring in additional revenue of about 0.8 percentage points to 3.1 percentage points of GDP, well above the 1.5 percentage points of GDP that the current tax reform plans to raise. The government can then implement compensation measures for poorer households, such as targeted tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s or direct transfers to low-income earners.
Relative to the baseline ranking of 32nd in the Index for 2022, a VAT base with a 40 percent efficiency ratio would increase Colombia’s rank to 30th. Additionally, if immediate depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. for machinery was also adopted, the rank would improve to 28th.
Colombia should consider shifting its planned tax reforms from harmful corporate and individual taxes to less harmful consumption taxes. Tax hikes implemented in the near term might undermine economic growth. Colombia should focus on implementing tax reforms that have the potential to stimulate growth by supporting private and foreign direct investment while increasing its international tax competitiveness.
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