A recently released study on tax regimes in Latin America and the Caribbean has cautioned that special tax regimes instituted by some countries to ensure the viability of small and micro businesses can have harmful long-term effects on productivity in those countries.
The findings of the study, part of an upcoming IDB book titled The Age of Productivity: Transforming Economies From The Bottom Up deals particularly with the impact of tax systems in the hemisphere on investment decisions by the business sector. According to the study, while special tax regimes for small and micro businesses are applied with “good intentions”, they can have “harmful effects on productivity and, therefore, erode long-term economic growth.” According to the study the main problem with these regimes is that they can deter growth of small companies because they lose the special tax treatment if they grow beyond a certain point. “At the end, these regimes create incentives for firms not to grow beyond a certain point. If they invest and grow they will not be entitled for such a special treatment and their taxes will increase dramatically. The additional taxes that they will have to pay will, many times, not pay for the investments they make. So they simply do not invest,” the study says.
Tax ‘breaks’ and other tax-related mechanisms are a fashionable form of entrepreneurial incentives to support small and start-up businesses in the Caribbean and, specifically, to reduce labour contributions by employers and to expand labour benefits for low-income workers. These measures are also designed to reduce costs for government in administering taxes on small companies in order that more resources can be allocated to combatting evasion among larger business enterprises.
Meanwhile, the IDB study asserts that high tax rates and transaction costs in the hemisphere continue to contribute to high levels of tax evasion. The study says that particularly in Latin America tax evasion has become commonplace, with both small and micro companies paying no taxes in many instances and larger companies under-reporting sales by as much as 40 per cent. The practice, the report says, is prevalent in Panama and Brazil.
The IDB report alludes to a study undertaken by the firm Mckinsey and Company, quoting study coordinator Carmen Pages as saying that high levels of tax evasion hurts productivity since it prevents government from investing in productivity-enhancing public goods like infrastructure and education. Additionally, Pages says that an unfair advantage is created in the market place against those who pay their taxes.
The study says that by international standards Latin America and the Caribbean have low tax collection levels driven by collection regimes that focus on large, highly visible business enterprises. Tax rates in the hemisphere as a percentage of profits are reportedly high reaching an average of 48 per cent compared with 41 per cent in high-income countries.