The 1991 Tax Reform in Chile
How was the situation like before the tax reform?
Chile became a democratic state, when in spring 1990 the new Christian Democratic Socialistic government, under the leadership of Aylwin, took over power and ended the long years of dictatorship under Pinochet. The new leaders had to face a lot of problems, left by the old government. Especially the situation for the poorest classes of society was desperate. Social equality was non-existent.
The new Aylwin government partly adapted the CEPAL (Comisión Económical para América Latin) concept of a "modern Latin American State":
Social equality was regarded as a basic part of a new and modern democracy.
As soon as the new government came into office, the Parties of the Concertación (the Parties around Aylwin) thought about one of the basic questions of Chilean politics: How to finance a programme that could bring a fairer distribution of money and wages. The government was clearly aware that the situation could no longer be like it was during the Pinochet dictatorship. The emphasis of the Social Policy was based on improving the situation of the poorest classes of Chilean society. A tax reform was introduced in order to finance those ideas. One of the first measures announced by the Aylwin government in early 1990 was that tax rates would be increased.
When the entrepreneurs were informed about the tax reform, the protest was, as expected, widespread. The entrepreneurs and Chilean companies argued that in case of a tax reform investments would decrease and that many jobs would get lost. They also mentioned that, under normal circumstances (this means: If all existent taxes were collected and used effectively), there would be enough money for financing the planned social reforms. Another idea was to privatise state firms and to use the money for paying the new social programme. At the same time, government expenditures should be minimised and used effectively. Entrepreneurs also asked for an equal and fair distribution of taxes on everybody.
Knowing that without the help of the entrepreneurs a tax reform wouldn’t be successful, the new government tried to win the support of this important group. The Concertación pointed out that social equity would be in the interest of entrepreneurs as well, because it would result in social stability.
The reform also needed the support of the most important opposition party, the Renovación Nacional, so the Concertación (the Aylwin government) also tried to win the support of this party. As the tax reform was taken as a test case for the success of the new democratical idea of communication and cooperation, the new Secretary of Finance, Alejandro Foxley, asked all Chilean classes for their support for improving the life of the poorest. Already in spring, a compromise between the Concertación and the Renovación Nacional seemed to work out.
What were the basic points of the 1991 tax reform?
In order to win and keep the support of the Renovación Nacional (the opposition party) and of the entrepreneurs, the Aylwin government raised taxes on consume and profits. So the profits of the entrepreneurs were taxed by 10% in the first year after the new government came into office, by 15% in the second and third year and by 10% in the fourth year. However, in the first year certain exceptions for some entrepreneurs were made.
Taxes on higher incomes than 300,000 Pesos were also massively increased and partially raised on incomes between 100.000 – 300,000 Pesos. Incomes under 100,000 Pesos were not taxed at all.
But not only profits were taxed higher. The VAT (Value Added Tax = Mehrwertsteuer) was increased by 2% from 16% to 18%. Not only entrepreneurs and richer classes of the society were taxed higher, but also all consumers. As the consume tax (VAT) was raised, everybody had to pay higher taxes. However, mainly the entrepreneurs and the richer classes had to pay more taxes.
Government could take different effects on private investments by changing or creating new taxes or fiscal measures, such as tax rebates to reward investment, fiscal measures such as accelerated depreciation, wealth taxes, taxes on profits, taxes on capital gains... The Aylwin government created the "Programme of Forced Savings" whose basic idea was that if private sectors didn’t invest enough, government could increase tax rates on profits and public sector investments and trade could be improved by the correct choice of tax instruments.
Yet, there were limits on how detailed fiscal policy could direct resources towards certain economic activities.
How successful was the tax reform?
The declared aim of the Aylwin administration was to redistribute income from higher earning classes to lower earning classes. Therefore, the mobilisation of additional resources to finance the social expenditures was required. The Aylwin government allocated all additional money that was made available in 1991 (obtained through higher taxation) to health, education and housing. The increase of social expenditures, financed by the tax reform, resulted in the following, successfully taken actions:
Looking back on all the taken actions, the Aylwin government was successful with the results of the tax reform. The situation of the poorest didn’t become easy, but it improved a lot.
Bibliography:
Hojman, D.E. 1993: Chile: The Political Economy of Development and Democracy in the 90s, London.
Imbusch, Peter 1995: Unternehmer und Politik in Chile, Frankfurt am Main.
Institut für Iberoamerika-Kunde 1991ff: Chile Jahresüberblick. Hamburg.
Messner, Dirk/Scholz, Imme 1996: Gesellschaft und Wettbewerbsfähigkeit in Chile, in: Eßer, Klaus et al. 1996: Globaler Wettbewerb und nationaler Handlungsspielraum . Neue Anforderungen an Wirtschaft, Staat und Gesellschaft, Köln, 249-270.
Nohlen, Dieter/Nolte, Detlef 1995: Chile, in: Nohlen, Dieter/Nuscheler, Franz (Hrsg.): Handbuch der Dritten Welt, Bd. 2: Südamerika, 277-338.
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