Last week, Chile’s lower house of Congress rejected President Gabriel Boric’s ambitious tax reform bill. The proposal fell short of the 78 votes required to pass, with only 73 in favor, 71 against, and 3 abstentions. This new blow to the government comes six months after a new constitution backed by Boric was also rejected by Chileans.
The tax reform sought to raise additional revenue of about 3.6 percent of GDP. The draft bill capped the current unlimited use of carry-forward tax losses at 50 percent, raised the top marginal dividend tax rate from 33.3 percent to 43.06 percent, and proposed an additional 2.5 percent tax on top of the undistributed profits tax. Additionally, the reform proposed a new wealth tax. There is also a separate tax bill to increase mining royalties that the government still plans to move ahead with.
These policies would have reduced the country’s overall ranking in the 2023 International Tax Competitiveness Index (ITCI) from 27th to 35th (out of 38 countries). And they might not have raised the 3.6 percent of GDP projected revenue. According to the latest Organisation for Economic Co-operation and Development (OECD) data, between 2020 and 2021 Chile increased its tax revenue from 19.4 percent to 22.2 percent of GDP, achieving the second-highest tax revenue increase among the OECD countries after Norway. Almost half of the additional revenue came from increased Value-Added Tax (VAT) collection as the economy continued to grow. Therefore, Chile would be better off implementing a neutral tax reform that promotes economic growth.
One of the weaknesses of the Chilean tax system is its 27 percent corporate tax rate, which is significantly above the OECD average of 23.6 percent. However, as a response to the COVID-19 pandemic, Chile temporarily reduced its corporate income tax rate to 10 percent for smaller businesses. Additionally, it temporarily allowed businesses to immediately write off investments in buildings and machinery and to immediately amortize intangibles.
These temporary policies introduced during the pandemic to spur capital investment were timely, but temporary policies are generally not a helpful approach to generating long-term growth. Since these measures expired in 2023, Chile is in urgent need of pro-growth tax reform.
As Chile looks to the future, policymakers might want to follow the UK’s example. The accelerated deductions for capital investment costs should be extended and made permanent while unnecessary tax hikes on individuals and capital should be avoided. Chile should consider shifting its tax reform plans from harmful corporate taxes and take advantage of its better-designed consumption taxes. Policymakers should focus on growth-oriented tax policies that encourage private and foreign direct investment, savings, and entrepreneurial activity, increasing Chile’s international tax competitiveness.