February 11, 2021

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COLOMBIA: Another tax reform edges into view amid risk of ratings downgrade

BY Nicholas Watson

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( 3 mins)

President Ivan Duque on 8 February announced that a tax reform – the third of his presidency – would be presented in the next legislative period, which runs from March to June. While the need for fiscal reforms is ever-present, the pandemic-induced economic crisis has made it much more urgent in view of the gaping fiscal deficit (expected to have reached 8.9% of GDP in 2020) and rising debt burden (now over 60% of GDP). In this context, Colombia’s investment grade rating is at risk. However, Duque’s political weakness and the onset of the 2022 elections represent major obstacles to the passage of any reform.

Following Duque’s announcement, Deputy Finance Minister Juan Alberto Londono was sent out to provide some broad outlines of the reform. The basic target is to raise a minimum of 1.5% of GDP (around COP 15tn, or some USD 4bn), which is already a lower headline target than previously suggested by Finance Minister Alberto Carrasquilla. The main area the government plans to address is VAT, which is riddled with exemptions and special regimes that the DIAN tax office says amount to as much as COP 75tn. Carrasquilla has tried and failed to tackle this issue in the past but this time the government claims that it is much better placed to put in place a VAT rebate system targeted at low-income sectors, thereby compensating for the regressive nature of this type of tax.

The problem for Duque and Carrasquilla is that the current political and economic environment is strikingly unconducive to this type of initiative. The economic backdrop makes a tax reform a hard sell even if – as the government insists – measures passed this year would only take effect in 2022. GDP shrank by almost 8% in 2020. Unemployment rose to 15.9%. Recall too that social pressures pre-date the Covid-19 crisis. In this context, no legislator will be keen to back tax rises so close to the congressional elections scheduled for March 2022; in fact many will look to exploit the tax reform proposal for electoral purposes – even within the governing Democratic Center (CD) party and its allies. Furthermore, Duque has never been particularly skilful at navigating congressional waters or generating legislative consensus.

In the face of such adversity, Duque will use the threat of a ratings downgrade to cajole parties into supporting the reform, presumably alongside the type of pork and patronage campaign that the president once repudiated. Note that the CD cannot pass a reform on its own. At best, this approach could muster a modest reform that does just enough to stave off a downgrade. The CD leader, former president Alvaro Uribe (2002-2010), appears increasingly to recognize the need for a reform and could help rally the party to the cause. However, it was Uribe who scuttled VAT reform proposals back in 2018 and his arms-length relationship to the Duque administration raises the prospect of the CD leaving Duque high and dry as electoral considerations eclipse the need to continue supporting a weak president heading to his exit. The longer the debate drags on, the greater the risk that no reform is passed.

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