Taxes or cutbacks? Latin America’s challenge of sustaining spending without causing debt to skyrocket

*Guest blog post from Latinoamerica21. 

The expansive fiscal policies of Latin American governments after the 2008 global financial crisis were not truly countercyclical, rather they were maintained even as the economy kicked back into gear. “This, then, led to a period of growing deficits, which has now forced several countries to pursue pro-cyclical contractions,” says Andrew Powell, author of the report Routes to Growth in a New Trade World, coordinated by the Inter-American Development Bank (IDB).

The great challenge for Latin American countries in these circumstances is to make adjustments without impacting growth. This means that countries with high tax rates should focus on cutting costs without disrupting public investment, while countries with low tax rates should focus on increasing revenue, according to the report. Within this framework, there have been several positive developments along these lines in the last year. However, in some cases this has not been enough to stop the upward trend in public debt.

Over the past two years, the average primary fiscal balance in the region deteriorated from a deficit of 2.4% of GDP in 2015 to 2.6% in 2016, and the debt-to-GDP ratio increased slightly to reach 51%. These figures, however, conceal the diversity of these different countries, as the primary balance during those years strengthened in 8 countries, while weakening in 8 others, and holding stable in the remaining 11 countries.

The report explains that this is due to the fact that several countries embarked on a period of procyclical adjustments to keep debt from rising further. This adjustment may have been risky because of the effects it could have on both GDP and fiscal balances, “thereby rendering the adjustment effort counter-productive.” However, the strategies have been prudent and fiscal consolidation has improved markedly compared to 2016. While some countries relaxed their fiscal position and pursued a countercyclical policy, others adopted a more restrictive fiscal position, while a third group maintained virtually neutral fiscal policies.

While Latin American governments worked hard to achieve a primary fiscal balance last year (the fiscal deficit minus interest payments on debt), it still came close to 0.8% of GDP due to a 0.6% decrease in public sector revenues. For this year, however, revenues are expected to increase by 0.2% of GDP, and expenditure will fall by 0.4%, so the primary deficit would be only 0.2% of GDP. If these estimates are met, debt will continue to increase throughout 2017 as it has since 2011.

Beyond this data, the countries of Latin America and the Caribbean continue to have low tax revenues, according to the Economic Commission for Latin America and the Caribbean (CEPAL) report, Tax Sustainability and Tax Reform in Latin America. In fact, this represents only 21% of GDP, unlike in developed countries where this figure exceeds 30% of GDP.

Within this framework, some 15 countries in the region have medium-term fiscal consolidation plans—approaches deemed reasonable to avoid short-term shocks—with which they are expected to increase their fiscal revenues and reduce expenses considerably. In fact, in recent years, countries such as Mexico, Chile, Colombia and Uruguay have adopted structural tax reforms in order to increase income, improve equity, reduce distortions, promote savings and investment, and simplify tax obligations. However in addition to this progress, the region still has a lot to do to improve fiscal institutions in order to address current fiscal consolidation needs.

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Jeronimo Giorgi, a Uruguayan journalist dedicated to international issues, is pursuing a master’s degree in Latin American Studies. He has collaborated with various media outlets in Latin America and Europe, and has received distinctions such as the Premio Rey de España for Journalism.

Latinoamerica21 is a blog about current economic, political and social topics in Latin America that is currently published within the newspaper El Observador de Uruguay and will soon be published in other media outlets within the region. The original version of this blog post is available in Spanish: ¿Impuestos o recortes? El desafío de mantener el gasto sin que se dispare la deuda

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*Guest blog posts do not reflect the views of FocusEconomics. 

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