Corporate Tax Hike Signals End of Chilean Miracle

September 30, 2014

Chile has for many years had one of the lowest corporate tax rates in the developed world, and also one of the fastest rates of economic growth. Between 2000 and 2010, Chile’s corporate tax rate was 15 to 17 percent, lower than that found in any developed country except Ireland. Over the same period, Chile’s economy grew about 45 percent, more than any country in South America and more than all but 4 other developed countries. See the chart below.

In 2011, Chile hiked the corporate tax rate to 20 percent, one of only two developed countries to do so that year (Iceland was the other). Now, as of this week, Chile's new government signed into law a further increase in the corporate tax rate to 27 percent by 2017 and to 35 percent thereafter.

This would be an interesting experiment, except that we already know what’s going to happen with a pretty high degree of certainty. The economy will tank, it is only a matter of time. Indeed, it appears investors, businesses and other forward thinking economic actors are already reacting:

An economic slowdown continues to grip world No. 1 copper producer Chile, government data showed on Tuesday, as manufacturing production posted its biggest monthly drop in two years and the jobless rate crept higher.

Factory output fell 4.9 percent in August from a year earlier, well below market forecasts, while the jobless rate for the June to August period rose to 6.7 percent.

"In August, there was reduced dynamism in the domestic economy, in particular in manufacturing production," the government's INE statistics agency said.

There are two lessons, which even the slightest regard for history reveals:

1) Don’t increase the corporate tax rate. It doesn’t help the workers or lead to “better opportunities for inclusive development”, as Chile’s president claims.

2) Businesses and other planners are forward thinking, so they will immediately reduce activity in response to a scheduled or even publicly discussed future increase in taxes.

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