1. Introduction, content and main conclusions
Uruguay is one of the oldest democracies in the world. Since its independence, in 1830, it has been a democracy for 138 years. Situated between Argentina and Brazil, the country has a total land area of 180.000 km2 and a population of 3.4 million inhabitants, of which 15% is older than 65 years old. The Uruguayan GDP per capita is approximately US$5.200 (US$9.050 at parity of purchasing power). The domestic economic structure is based on its agriculture (12% of the GDP and more than 50% of exports), manufacturing --basically agricultural related— (18% of the GDP), tourism services (6% of the GDP), and the rest is composed of public and private services.
Uruguay has a difficult fiscal stance characterized a public debt of 2.5 times its GDP – 180% of GDP of pension liabilities and 75% on foreign denominated bonds--, a tax burden slightly above 30% of GDP but has more than 60% affected to pensions and interest payments --5% corresponds to interest payment and 14% of GDP on pensions—
that leaves a small margin (11% of GDP) to provide for all public services. Additionally, in spite of a extraordinarily positive phase of the cycle –low rates and weak dollar, quite favorable terms of trade and booming trade partners--, it still runs fiscal deficits.
The second section of this paper is dedicated to the brief summary of the economic and fiscal evolution since 1970, with special emphasis on the tax reform of 1974 –the only one of the last 30 years-- and the tax system’s evolution in the 90‘s.
The third section presents a description of the characteristics of the main taxes of the current tax system, including its main problems. Lastly, this paper describes the tax reform recently approved. It analyzes the macroeconomic frame of the tax changes; the proposal for dual taxation “Uruguayan style” and its impact on equity; the new tax secrecy to fight evasion; the abolition of the employer’s contributions to social security;
and the simplification of the tax system proposed by the elimination of eleven low-revenue taxes and/or those with a high cost of administration and compliance.
2. General view of the tax system and its development since the 70‘s 2.1. Brief review of the economic and budgetary evolution
In 1973, after 50 years of uninterrupted democratic rule, there was institutional breakup in Uruguay, resulting in a military dictatorship. The economic changes were also
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significant, led by abandoning the substitution model of imports, strictly speaking useless since 1955, opting for an export promotion model. Since 1974, this was translated in a deep financial liberation, followed by a progressive commercial opening that was accompanied by a monetary and fiscal reform.
The fiscal reform of 1974, the only tax reform of the last 30 years, was design for a combined strategy of export promotion model and a financial center. Its main features were: (i) the introduction of a VAT abolishing a traditional sales tax; (ii) the abolishion the personal income tax (PIT), which had been pioneered in Latin America in the early 60‘s, with a cedular design too complex for the level of the tax administration, thus, it never ended up collecting more than 0.3% of the GDP; and (iii) the simplification of the system, eliminating a slew of minor taxes, including those of Estate and Inheritance.
Table 1
The period from 1975 to 1985, the year when democracy was recovered, was marked by the exchange rate crisis of 1982. This crisis was the result of the incompatibility between an expansive fiscal policy and an overvalued domestic currency. In terms of spending, the dictatorship reduced the salaries and public loans, but invested in large infrastructure projects of doubtful social profitability, which concluded in high deficits (see Table 1).
The first democratic administration, 1985-1990, increased public spending, including high debt services, a by-product of the debt crisis of the early 80s. To finance this, the government implemented extremely harsh and continuous tax adjustments1 with the
1 Those “adjustments” included, among other measures: (i) the increase of the general VAT rate from 20 to 22%; (ii) the rise of the corporate income tax rate (CIT) from the 30 to 35%; (iii) the implementation of the
1975 1980 1985 1990 1995 2000 2004
Total Expenditures, separated in 23.5% 20.9% 27.0% 31.1% 32.7% 34.0% 29.6%
Current Expenditures 13.2% 6.8% 6.7% 17.4% 15.1% 15.1% 11.9%
Interests 0.9% 0.5% 6.5% 1.7% 1.4% 2.0% 4.9%
Public Investment 1.8% 5.3% 3.5% 1.8% 2.1% 1.8% 1.5%
Social Security 7.5% 8.1% 10.0% 10.2% 13.8% 15.0% 11.2%
Total Taxes 19.5% 22.0% 20.4% 28.2% 30.2% 29.8% 27.7%
Total Taxes 13.8% 17.5% 15.4% 17.9% 19.0% 21.0% 22.1%
Social Security Contributions 5.7% 4.5% 5.0% 10.3% 11.2% 8.8% 5.6%
Total Deficit -4.0% 1.1% -6.6% -2.9% -2.5% -4.2% -1.9%
Sources: IMF, Vallarino (2005), De Haedo et alter (1987), BCU, BPS y CGN.
URUGUAY - EVOLUTION of REVENUE and SPENDING OF PUBLIC SECTOR in % of GDP
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subsequent upsurge in the tax burden, which jumped from 20.4% to 28.2% of the GDP between 1985 and 1990 (see Table 2).2
Table 2
2.2 The tax system and its structure from the ‘90s
As it had happened in the late ‘70s, Uruguay fell again, twenty years later, in an inconsistency between the foreign exchange regime and the fiscal policy. In the ‘90s decade, the country made two interrelated errors: i) it created a large deficit to finance the growing public spending on social security --doubling total public debt which includes transfers to the unfunded pension system and the foreign denominated long-term debt--, and ii) it allowed an overvalue of the domestic currency that exacerbated the loss of competitiveness as Uruguay’s productivity lagged the one of its trade partners.
During this period an explosive growth in spending was verified in social security that went from 10% to 15% of the GDP between 1990 and 2000 (Table 1). In the same period, the deficit of the social security system went from 4.5% to 10.8% of the GDP. As a result of the abuse of the mechanism of indexing retirement pensions by less than the inflation
Taxes on Bank Assets (IMABA) --which burdens bank loans at differential rates according to length of the credit, similar to the debit tax but on loans-; (iv) strong rise of the excise tax on petroleum products, which collected almost 2% of the GDP; (v) a significant increase of the employer’s contributions to social security; and (vi) a jump of almost 2% of the GDP in the property and net wealth taxation --punishing the agricultural sector with a fivefold increase in the assessment value of the land--.
2 This increase on fiscal burden was complemented with heavy price hikes that increased the surpluses of state-owned energy, water and telecommunications monopolies to more than 2.5% of GDP.
1975 1980 1985 1990 1995 2000 2004
Direct Taxes 2.4% 3.2% 1.9% 2.7% 4.0% 5.7% 5.8%
Corporate Income Tax 1.1% 2.4% 1.1% 0.9% 1.8% 2.3% 2.5%
Personal Income Tax (Shedular) 0.0% 0.0% 0.0% 0.6% 1.1% 2.1% 1.4%
Net wealth and property taxes 0.4% 0.8% 0.8% 0.3% 0.4% 0.7% 1.0%
Indirect Taxes 8.6% 12.7% 11.9% 13.0% 12.1% 12.3% 13.0%
VAT 4.0% 6.2% 5.7% 6.7% 7.8% 8.2% 9.1%
Excises 3.5% 3.4% 3.6% 4.0% 3.3% 3.4% 3.1%
Trade taxes 0.7% 2.4% 1.8% 2.3% 1.0% 0.8% 1.3%
Local Taxes 2.9% 1.6% 1.6% 2.1% 2.9% 3.0% 3.3%
Total Taxes 13.8% 17.5% 15.4% 17.9% 19.0% 21.0% 22.1%
Social Security 5.7% 4.5% 5.0% 10.3% 11.2% 8.8% 5.6%
Total Taxes 19.5% 22.0% 20.4% 28.2% 30.2% 29.8% 27.7%
Sources: De Haedo et alter (1987), Vallarino (2005), DGI y CGN
URUGUAY -TAX BURDEN in % of GDP
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rate during the dictatorship, through a referendum in 1989, it was established in the Constitution the obligation of adjusting them in function of the index of the last evolution of wages. Therefore, through the increase of public wages independently from their productivity, the Uruguayan governments “create” in productivity by decree, and the Constitution multiplies it.
Also, the continuous growth of public spending forced a great fiscal effort larger than the revenue capacity to cover it3, moving the tax system away as the instrument for the integration and development strategy, for which it was designed. Therefore, in the last decade a “tax spiral”-continuous tax adjustments as answers to the growing expense- has ensued, with two main consequences:
1) It “muddied” the tax system with the creation of several distortionary taxes, which affected competitiveness but at the same time, relatively easy to collect, 4Indeed, at least thirteen new taxes were created in Uruguay, exactly at a rate of one per year5. 2) It increased the regressivity of the system. Since it is difficult to tax the mobile factor
--the capital--, the load should necessarily fall upon consumption and/or salaries.
Between June 1984 and May 1995, the general rate of the VAT (“basic rate”) increased almost 30%, moving from 18% to 23%, which is the current rate.
Additionally, in May of 2001 the COFIS was created, a wholesale VAT, with a rate of 3%. Added together, VAT and COFIS impose a tax of more than 26% on consumption.
3. Features of the (current) main taxes