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Prospects for an Integral Tax Reform With Equity: Toward a Fiscal Covenant in Peru

Author: G Mostajo
Date: 2004
Size: 8 pages (286 KB)

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Summary

Since the 1990s, Peru has undertaken a series of tax reforms with the aim of improving collection. Although these have had some positive impact, the tax system is still not functioning well enough to meet the needs of the population. This study, commissioned by the Department for International Development, argues that reforms must address issues of governance and equity if they are to help the poor in the longer term.

Although Peru has enjoyed economic growth in recent years, successive tax reforms have not led to more and better public services. They have not rectified the inequalities of the tax system or widened the tax base. The key problem is that the taxation process is not rooted in a strong social contract between the state and society, and this makes it unsustainable. The best solution would be to generate a consensus through broad-based dialogue between the state and society. That would help forge a fiscal covenant to sustain the fiscal pact between government and citizens. If the tax system gains legitimacy, fiscal policy will become more stable and public finances more predictable. As a result, taxation can contribute to reducing poverty and inequality, as well as strengthening institutions and democratic governance.

Peru’s tax system suffers from major structural weaknesses that prevent add-on policies solving issues of income redistribution and equity. Despite advances, the system has moved away from the principles that shaped reforms at the beginning of the 1990s, and is too focused on short-term collection goals. Other key problems are that:

Political factors often take precedence over technical considerations.
There is an over-reliance on indirect taxes, which puts greater pressure on the poor and has a regressive impact on income redistribution.
Taxpayers do not view the system as credible or legitimate, partly because of its lack of transparency. This has resulted in a large, informal economy and widespread tax evasion.
The tax system has been re-designed to incorporate the principles of sound policy, but it has deteriorated over the last few years.
New mechanisms to achieve equity and redistribution have actually eroded the system and produced effects opposite to those intended.
Frequent modifications to the system have created instability and complexity, which works against institutionalisation.

To increase tax collection in a more equitable manner, the main challenges are to broaden the tax base, formalise the economy and reform the state. The system must be modernised, simplified and made more progressive. Specific proposals include:

Firstly, initiating an open, well-informed process of dialogue on the foundations of taxation, involving all actors. This should result in agreement on a social contract to underpin the fiscal covenant.
Secondly, reaching consensus on longer-term development objectives, which can give taxation a sense of purpose and enhance the consistency and legitimacy of public finances.
Thirdly, implementing integral tax reform based on a covenant consisting of a group of mechanisms to guarantee compliance.
At the same time, considering short-term policy decisions, such as weighting priorities according to political and socio-economic conditions, taxing personal profit more efficiently and widening the general sales-tax base.

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Source: Mostajo G., R., 2004, ‘Prospects for an Integral Tax Reform With Equity: Toward a Fiscal Covenant in Peru’, Executive Summary of Report for DFID, Lima.
Author: Department for International Development (DFID), http://www.dfid.gov.uk