Monday, December 5, 2011

Why Don’t We Tax the Rich? Inequality, Legislative Malapportionment, and Personal Income Taxation around the World

While general tax collection has been on the rise in recent years across Latin America, personal income taxation remains below the international norm. For example, the average Latin American country collects 5 percentage points of GDP less than what would be expected given its level of economic development, which tends to be one of the determinants for implementing a tax that requires self-reporting and enforcement technologies.

As shown in Figure 1, every Latin American country lies below a simple regression line relating personal income tax revenues and the level of development, measured by per capita GDP at the beginning of the period.1 Given that the most standard economic determinant cannot explain this finding, could the answer lie in political factors?

A natural starting point is to look at the role of the political regime. After a long history of democratic interruptions and the beginning of the third wave of democratization during the 1980s and 1990s, scholars and pundits alike expected that the transition to democracy would increase pressures for the mobilization of revenue drawn from taxes on income, which in principle should be more progressive than other forms of collection such as indirect taxes.
According to the classic median voter model of redistributive politics (Meltzer and Richard, 1981), in a context of high inequality and democratic decision-making (as is the case in contemporary Latin America), it is expected that a relatively poor median voter would demand relatively higher taxation on the wealthy in order to bring about income redistribution.

That a majority of citizens in the region perceive the income distribution to be unfair or very unfair—more than 60 percent in every country except Venezuela (Figure 1 in the Appendix)—and that they also tend to favor redistributive policies (Figure 2 in the Appendix) would initially seem to support the theoretical arguments that link democracy with greater income redistribution.

Inter-American Development Bank.(IDB working paper series;No. IDB-WP-282). Author(s):Ardanaz, Martin,Scartascini,Carlos.Published: November 2011.Code: IDB-WP-275.