Bibliography
IV. Current Tax Policies and Some Policy Options
These levels of legal insecurity are much higher than those perceived on equiva-lent items in other countries. In similar surveys conducted by the World Bank, more than 70 percent of Peruvian businessmen rated uncertainty over economic and reg-ulatory policy as a major or serious obstacle. In contrast, only 20 percent of business owners in India and Malaysia viewed uncertainty as an obstacle of such magnitude, while in China this perception was less than 35 percent.
Although this high level of concern in Peru pertains to legal uncertainty in gen-eral, it is also applicable to the constant tax changes, as summarized in Annex 1. In a highly volatile economy like Peru’s, fiscal policy needs to be capable of responding to unforeseen events, and flexible enough to take prompt corrective measures, includ-ing some changes in the tax legislation. However, the frequent changes in the tax laws are often responses to other factors and tend to accentuate rather than mitigate economic volatility.
As shown by a World Bank study on institutionality in Peru (Matsuda 2002), there is a tendency in the country to make decisions with a short-term view despite the possibility of adverse long-term results, including their impact on the investment climate and macroeconomic stability.19Significant changes in tax laws not backed by serious evaluations increase business uncertainty. Therefore, it is important to insti-tutionalize certain filters for issuing new tax provisions, including prepublication and a serious cost-benefit analysis that supports the change, as is usually done in developed nations. The MEF has recognized the importance of this point and has just announced an approach for improving quality in proposed laws and regulations.
Long-term changes in the composition of taxes follow a trend throughout the region and in developed countries. The lower percentage of revenues from taxes on foreign trade and to a lesser extent from income tax has been offset by higher rev-enues from the VAT.
Several long-term trends in the tax structure are noteworthy (Table 3):
1. Income taxover time shows a U-shaped pattern. These taxes played a more important role in the 1970s when, on average, they represented nearly 30 per-cent of tax revenues. Later, during the 1990s, their revenue declined by some 10 percentage points, but they have recovered during the current decade (espe-cially over the past few years).
High revenues during the 1970s resulted from the high tax rates (both indi-vidual and corporate) that prevailed at the time in most countries. These rates have decreased almost continuously in developed nations as well as in most of the region’s countries. A return to high income tax rates would be quite harm-ful to the Peruvian economy’s competitive position and would affect the poten-tial to attract new investments, especially given that the rate is higher than that of most of the neighboring countries. If the obligatory employee profit-sharing program is included—which is essentially a surcharge on income tax ranging from 3.5 to 7 percent of income20—the corporate tax burden is even higher.
In addition, it is necessary to strengthen the degree of compliance. This means that it is important to reintroduce a minimum tax by raising the appli-cable base for nearly all companies regardless of their size, while at the same time increasing the number of taxpayers who pay personal income tax. In Peru the threshold for the obligation to pay personal income tax is very high with respect to per capita income, and clearly higher than average for the region.
Although this high threshold simplifies tax administration, it affects the cul-ture of paying taxes.
Table 3. Central Government Tax Revenues, Long-Term Trends (percent)
1971–80 1981–90 1991–2000 2001–04
Income tax and taxes on assets 31.5 23.4 21.7 27.1
Taxes on foreign trade 25.7 22.8 12.5 10.1
Value-added taxa 25.6 17.4 38.1 40.2
Selective taxes 11.5 28.9 19.3 16.0
Other 5.7 7.5 8.4 6.6
Total tax revenues (% of GDP) 14.2 12.3 13.0 12.6
Source: BCRP.
a. Based on tax payment documents, basically in connection with refunds to exporters.
Constant changes in corporate income tax rates and other taxes generate uncertainty, limit investments, and probably shift the investment structure toward those investments that mature more rapidly and those that lock fewer funds into a given project. This detracts from the ability to improve the qual-ity and productivqual-ity of investments, especially for sectors such as mining, hydrocarbons, and infrastructure with high investments “locked” into a project.
2. The value-added tax(VAT), which was second in importance as a share of tax revenue during the 1970s, declined in the 1980s when experiments were made that substantially lowered its rate in certain periods. However, since the 1990s the VAT has become the principal tax in Peru. This trend of growing impor-tance for the VAT is similar to most countries, where, in addition to an almost universal application of the VAT, the general rate has been increasing. Given Peru’s extensive business informality, the importance of the VAT is appropri-ate, since it produces fewer distortions and achieves a better horizontal redis-tribution.21However, exemptions from this tax must be reduced, because they not only weaken the tax’s effectiveness and administration but also the differ-ential approaches among sectors and regions.
3. Taxes on foreign trade continue to decline in percentage terms and currently represent only 10 percent of total tax revenues. This decreasing trend is preva-lent throughout the world as a result of globalization. Furthermore, it is expected and hoped that this tax will continue to diminish in the future as a result of freer trade and the implementation of new trade accords that reduce or eliminate protectionist barriers among nations. This is a positive change because taxes on imports or exports inhibit a sound allocation of resources, distort price indicators by creating false comparative advantages, and hinder productivity and the country’s economic growth.
Presented below is a descriptive summary of the principal taxes and suggested changes for each one.
Principal Taxes: A Brief Description and Policy Suggestions Value-added tax (VAT)
The VAT rate is 19 percent (including 2 percentage points that are transferred to the municipalities, called the Municipal Promotion Tax (Impuesto de Promoción Municipal—IPM).
COMMENTS
This tax has the most exemptions (72 percent of the estimated potential).
There is a special 4 percent regimen, but without tax credits, for hulled rice.
POLICYOPTIONS
• Do not extend sector exemptions other than on education and, in part, on the initial sale of agricultural products without industrial added value.
• Negotiate with the regions for the elimination of regional exemptions (emu-lating San Martín).
• Eliminate special treatments and do not introduce any new ones.
Corporate income tax
Companies subject to the general system are required to pay 30 percent of their prof-its when earned and an additional 4.1 percent upon distribution of their earnings.
Companies with annual sales below a threshold amount (S/. 240,000) that also meet other requirements may pay their income tax under the Special Income Regi-men (RegiRegi-men Especial de Renta—RER), which has a rate of 2.5 percent on gross earnings on trade and industrial activity and of 3.5 percent on services.
Small businesses may utilize the Standardized Simplified System (Régimen Único Simplificado—RUS), under which they pay a single tax (see other taxes).
COMMENTS
Principal exemptions include interest and other capital gains on the domestic finan-cial market and stock exchange.
Partial exemptions include the 15 percent rate for agriculture and ZafraTacna; 0 to 15 percent for Amazonía; 0 for exports from the special customs zone known as CETICOS (Centro de Exportación, Transformación, Industria, Comercialización y Servicios—Center for Export, Transformation, Industry, Marketing, and Services).
In addition to income tax, but with similar effects, companies with more than 20 employees are required to distribute a percentage of their profits to their workers (between 5 and 10 percent, depending on the sector).
Mining and oil companies must pay an additional 2 percent of their profits in order to benefit from the legal stability agreement.
POLICYOPTIONS
• Reintroduce a broad-based minimum tax on assets that is constitutionally viable and creditable against income tax, with the possibility of a long-range credit.
• Eliminate sector (basically agribusiness) and regional exemptions and at least introduce an offsetting surcharge paid at the usual rate when earnings are distributed.
• Eliminate obligatory employee profit sharing (which would be difficult to enact).
Personal income tax
Resident individuals are subject to a 15 percent tax on income between 7 and 27 UITs,2221 percent for income between 27 UITs and 54 UITs, and 30 percent for
income greater than 54 UITs. Income from rent, dividends, and similar items is sub-ject to withholding at the source in the amount of 12 percent and 4.1 percent, respectively.
COMMENTS
In comparison to other countries, deductions on taxable income are low and broad-based.
POLICYOPTIONS
• Eliminate the exemption on interest and capital gains.
• Reduce the threshold for minimum tax obligations from 7 UITs to at least 2 UITs, with the introduction of a fourth, lower scale (3 percent up to the first 7 UITs). Allocate revenues generated by the reduced threshold to the regional governments as a part of the decentralization process, as this tax has a low mobility and a greater correspondence to the educational and health services that these government levels could offer in the future.
Taxes on imports
There are four tariff rates (0, 4, 12, and 20 percent) plus a 5 percent surcharge on the CIF price, with a scale ranging from 0 to 25 percent.
The average tariff is 10.1 (weighted average for imports: 9.4 percent). Items by tariff category are shown in Table 4.
COMMENTS
Fiscally speaking, these taxes have gradually lost importance; however, from the microeconomic viewpoint they are still relevant, because their wide variation creates distortions.
POLICYOPTIONS
• Reduce tariff disparities among sectors by decreasing high tariffs. In particular, a single nominal rate of 8 percent should be established within a period of not more Table 4. Tariff Items by Category
Rate plus surcharge (%) No. of items
0 118
4 2,799
12 2,956
17 49
20 759
25 316
than three years following a specific timetable (especially for eliminating the sur-charges and the 20 and 25 percent tariffs, at a rate of 1 percent per month).
Selective consumption tax
This covers the sale of fuels, alcoholic and other bottled or canned beverages, ciga-rettes, and vehicles. The tax is specific on fuels and beer and ad valorem for the others.
COMMENTS
The specific tax on fuels should be increased as a function of the price index, but there is no explicit mechanism for doing so. Recently, this tax has been lowered in order to mitigate the effect of rising international fuel prices.
Vehicles imported through the CETICOS are exempt from the tax, and a differ-entiation is made between new and used vehicles.
In addition to the exemptions for fuel sales to electricity companies, payments made by ground transportation companies and export fishing business are refunded.
POLICYOPTIONS
• Eliminate the fuel exemptions for the Amazonía region.
• Make the selective tax uniform for all vehicles, eliminating the preferential treatment for CETICOS imports.
Other central government taxes
Two recently introduced taxes are temporary by law:
1. The Financial Transactions Tax (Impuesto a las Transacciones Financieras—
ITF), with a rate of 0.08 percent in 2006.
2. The Temporary Tax on Net Assets (Impuesto Temporal a los Activos Netos—
ITAN), with a rate of 0.6 percent on assets (after depreciation) surpassing S/.
5 million (approximately US$1.5 million). The payments are an income tax credit.
Businesses with annual revenues of up to S/. 240,000 can opt to come under the Standardized Simplified System (Régimen Único Simplificado—RUS) and pay a sin-gle tax (specified in nuevo sols for each category). No tax credit is given for purchases within the VAT system.
POLICYOPTIONS
• Respect the timetable for dismantling the ITF by eliminating it in practical terms in 2007 (it could remain with a rate of less than 0.05 percent, deductible from the corporate or personal income tax).
• Replace the ITAN with a true minimum tax; a broad-based income tax at a rate of 1 percent.
• It is extremely important to avoid new tax brackets and amnesties.
• Lower the threshold for electing to come under the Standardized Simplified System.
Subnational taxes
The regional governments are not responsible for collecting their own taxes.
Municipalities are responsible for collecting property taxes (on real property), vehicle taxes, and property transfer taxes (excise tax), in addition to other minor taxes. However, the tax rates and bases for these taxes are essentially set by national government regulations.
COMMENTS
The regional governments are supported by transfers from the central government, in particular those transfers granted discretionally under the budget. They are also financed by a share in certain tax revenues (basically fees and royalties) and certain nontax revenues.
On average municipalities receive more than 50 percent of their funding from transfers from the central government, including their share of certain tax revenues (the IPM, fees, and royalties).
POLICYOPTIONS
• Gradually reduce the vertical inequality among the government levels by assigning more responsibility for revenue collections to the subnational governments.