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Cablegate: Colombia's Comprehensive Tax Reform

VZCZCXYZ0004
RR RUEHWEB

DE RUEHBO #6759/01 2072009
ZNR UUUUU ZZH
R 262009Z JUL 06
FM AMEMBASSY BOGOTA
TO RUEHC/SECSTATE WASHDC 7379
INFO RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS BOGOTA 006759

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD EINV CO
SUBJECT: COLOMBIA'S COMPREHENSIVE TAX REFORM


1. SUMMARY: Taking advantage of President Uribe,s decisive
electoral victory, the GOC presented its comprehensive tax
reform bill to Congress on July 20. The revenue neutral
reform includes an overall reduction in the income tax
(including reduced marginal rates), offset by a significant
expansion of VAT coverage. The administration proposes the
gradual elimination of the tax on financial transactions and,
is requesting authorization to make permanent a "war tax" on
the wealthy to raise 2 trillion pesos (USD 800 million) for
democratic security programs. The vote in Congress will be
the first test of the strength of the Uribe Congressional
coalition; given his putative allies in the Cambio Radical
party have already launched a competing comprehensive
proposal. End summary.

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Income Tax
----------

2. Uribe,s proposal would reduce the highest effective rate
on income from 38.5 percent (one of the highest in the
region) to 33 percent in 2008, and 32 percent in 2009. The
first 34 million COP (approximately 13,000 USD) of an
individual,s or company,s income (indexed to the minimum
wage) would be exempt from income tax. GOC plans to tax the
next 13,000 USD to 47,999 USD at 15 percent, while all income
of 48,000 USD or more will be subject to the highest rate.
Income tax payments would be withheld from salary payments or
due on a pay-as-you-go system (similar to the United States).
The overall effect of the reform would be a reduction in the
income tax burden, especially for businesses that would
benefit from the lower marginal rate. The new payment regime
should increase compliance rates.

-----------------
Business Stimulus
-----------------

3. According to senior Finance officials, President Uribe
directed the Ministry to include a package of incentives for
capital investment in the tax reform proposal. The most
significant of these incentives would allow businesses to
shield all profits redirected toward the purchase of capital
goods. Many experts have expressed concern this will place
an undue burden on collection efforts, as businesses could
adjust depreciation schedules on capital goods to maximize
the benefits of this tax shelter, in effect reducing the
overall marginal tax rate.

------------
Expanded VAT
------------

4. Currently, Colombia,s VAT applies nine different rates
ranging from 0 to 16 percent on approximately 53 percent of
the GDP. Uribe,s reform package would reduce the number of
VAT categories from nine to three and apply the VAT to nearly
seventy percent of GDP. The general VAT, covering most
goods, would increase from 16 percent to 17 percent, while a
new rate of 12 percent would apply for items in the basic
basket of goods. The VAT on luxury items, including cars,
perfumes and cellular phones would increase from 16 to 25
percent. Education, utilities, health, and rent would remain
exempt from the VAT. To meet constitutional obligations to
protect the poor, the GOC plans to pay the lowest wage
earners about 120 USD annually to compensate for the increase
in VAT on basic necesities via Colombia,s welfare system
(SISBEN).

-------------------------
Financial Transaction Tax
-------------------------

5. Uribe,s proposal includes a gradual phase out of the
financial transaction tax. The tax has created a significant
distortion of economic activity away from traditional
banking, but is difficult to repeal because it is a reliable
source of considerable income for the GOC. In 2004, the
financial transaction tax generated 2.2 trillion COP
(estimated 916 million USD), while in 2005, the collection
increased 7.3 percent to 2.4 trillion (estimated 1 billion
USD), representing 5 percent of total revenue generated.
Resistance to the complete elimination of this tax is
hardening. Recent counter proposals suggest the number of
accounts taxed could be cut in half or that the tax could be
reduced, but not eliminated entirely.

----------------
Dinosaur Hunting
----------------

6. The stamp tax, document tax, and numerous tax shelters

protecting assets in pension funds and construction savings
accounts (AFCs) would be eliminated under Uribe,s proposed
reform. The stamp tax and document tax, two holdovers from
colonial times, no longer generate revenue and are seen by
most experts as a barrier to efficiency. Pension fund -
Construction Savings Accounts or AFCs, created in 1999 to
stimulate the housing construction market also are
eliminated. According to Vice Minister of Finance Maria Ines
Agudelo, these shelters are used by the wealthiest 10 percent
of Colombians and cost the GOC close to COP 70 billion
(approx. USD 29 million) in lost tax revenue. Mauricio
Cardenas, president of an influential economic think tank and
author of part of the tax reform proposal, further explained
that the exemption is a particularly important form of tax
relief for those earning between USD 25,000 and 50,000 per
year as the shelters effectively reduce marginal tax rate on
this wage group from 38.5 percent to 30 percent.

------------------------------
The Permanent One-time War Tax
------------------------------

7. On July 12, the President met with 40 Congressional
representatives to lay out his request for an extension of
the current net worth tax intended to raise two billion COP
for democratic security programs - the third iteration of the
wealth tax. In 2003, President Uribe presented the wealth
tax as a war tax to finance particular expenditures, much
like this tax. It was then extended in 2004 to 2006 as a
simple wealth tax with a much wider base and smaller rate (.3
percent on declared liquid net worth after specific
deductions). In the extension of the tax, Colombians and
Colombian companies with a net worth in excess of 1.5 billion
COP (approximately 600,000 USD) will be taxed at a rate of .4
percent and will have two years to complete their payment to
the GOC. The GOC estimates it will collect two billion pesos
(800 million USD) from nearly 11,000 contributors under the
proposal. The GOC surprised many experts by proposing to
Congress that this tax be made annual, during the
presentation of the tax reform package on July 20.

--------------------
Next Step - Congress
--------------------

8. Initial congressional reaction to the tax reform have
generally been positive, but the Cambio Radical party
(generally Uribe-supporting but headed by a Senator with
presidential asperations for 2010) presented a competing
version, indicating early in the process he will seek a
compromise on key elements with the other of the "Uribe
block" parties. Cambio Radical's plan is a less significant
reform, but it is also revenue neutral. It proposes a slight
cut in the income tax, retention of various tax shelters, and
the immediate elimination of the tax on financial
transactions.

-------
Comment
-------

9. Strong economic growth, a negotiated free trade agreement
with the United States and Uribe's decisive electoral victory
have created an environment where comprehensive tax reform is
a strong possibility. It is unclear, however, how Congress
will react to the Uribe proposal. On a daily basis, new
press reports discuss one element or another of the reform to
be scaled back or reconsidered. The elimination of the
financial transaction tax and increases in coverage of the
VAT have generated the most public discussion. There is much
public handwringing that the increased VAT coverage will make
the system more regressive. The motives of Cambio Radical in
preparing a competing, less sweeping, reform are unclear, but
may have much to do with the presidential ambitions of its
leader, German Vargas Lleras. Colombia's professional middle
class will bear a majority of the burden under the proposed
reform. Facing a significant increase in VAT charges and the
elimination of popular tax shelters, the potential exists for
a vocal middle class push back that could affect the outcome
of Uribe's reform efforts. End Comment.
WOOD

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