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Income inequality and income taxation in Latin America
Latin America remains one of the most unequal regions in the world and the fiscal system shows modest effects in reducing income inequality
On average, the tax benefit systems in Latin America decrease inequality, measured by the Gini coefficient, by around 3 percentage points; while it does by around 20 points on average in the European Union. The limited effect of personal income tax has been highlighted as one of the main factors contributing to the modest redistributive role of policies in the region.
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Cross-country characterisations and comparisons of the redistributive role of tax-benefit policies in Latin America require flexible and harmonised microsimulation models. The recent development of such models, under the modelling structure of EUROMOD, has enabled to assess the extent to which differences in the design of tax-benefit policies explain differences in inequality across countries.
Tax-benefit microsimulation models for Latin America include so far Argentina, Bolivia, Colombia, Ecuador, Peru, Uruguay and Venezuela, with others under development (Paraguay and Mexico). In addition to their academic value, these models represent powerful tools to enable governments to assess the margins they have to enhance social protection and increase fiscal capacity.
Our results show a wide variation in the redistributive role of tax-benefits systems across Latin America 11 . Bolivia and Colombia, which present the highest levels of income inequality, are also characterised by limited redistribution from the tax-benefit system, with inequality decreasing by less than 3 percentage points after taxes and benefits.
In contrast, the less unequal country, Uruguay, is also that with the most redistributive tax-benefit system, with inequality decreasing by 9 percentage points when measured by the difference between the Gini coefficient from market income relative to disposable income’s Gini.
Our work further exploits the advantages of harmonised multi-country microsimulation techniques to focus on the potential of personal income tax to reduce inequality in the region. More precisely, we simulate a counterfactual scenario where Uruguay’s (the most redistributive country) personal income tax system replaces national personal income tax systems in all other countries.
Applying the Uruguayan personal income tax to other countries increases the redistributive effect of tax-benefit systems, although to different degrees. Uruguay’s personal income tax would have a particularly important effect in Venezuela, where inequality would decrease by 1.06 percentage points. Argentina, Colombia and Bolivia would also experience a decrease in income inequality but by a lower 0.15, 0.14, and 0.53 percentage points respectively. In Ecuador, this swap would have no major effect. The main drivers of the effects are the differences in the value of the exempted tax threshold, and the prevalence of tax deductions.
Modelling the tax-benefit system and understanding its potentiality in reducing income inequality and poverty is a necessary first step to consider public policy reforms in Latin America.
The development of harmonised tax-benefit microsimulation models for Latin America goes in this direction and aims at providing evidence to design reforms to improve the redistributive impact of the tax and social protection systems in the region, by learning from the comparative analysis between systems of different countries.
