Tax rates on corporate profits in the LAC region are high by international standards and may jeopardise competitiveness and investments. This is a particular concern given the low level of private investment in LAC countries.
The perception that tax burdens on corporate profits are high in the LAC region is based on two factors. First, average CIT collections are relatively high, in 2021 they amounted to 3.1% of GDP in, versus 2.8% of GDP in OECD countries. Second, statutory CIT rates (STRs) are also high. While the average CIT rate is 21.5% in the OECD, it is 25% in the LAC region.
However, revenue levels and STRs do not show the whole picture of the tax system’s impact on businesses investments. For instance, STRs do not consider tax provisions that affect the definition of corporate tax bases. These provisions include allowances for fiscal depreciation, deductions for interest payments, and equity financing. Because these provisions can significantly affect tax liabilities, their generosity is key for the correct measurement of effective taxation across tax systems.
To best gauge the tax burdens on companies, (Hanappi et al., 2023[1]), calculated forward-looking effective tax rates (ETR) for 21 LAC countries. Their methodology is based on the OECD’s Corporate Tax Statistics (OECD, 2022[2]) and allows comparison across 77 jurisdictions. This methodology does not require information from tax returns since the calculations are based on assumptions about the financial returns of hypothetical investment projects, to which existing tax laws are applied to determine the amount of tax owed. Two types of ETR are calculated: (i) the effective average tax rate (EATR), which measures the percentage of profits companies allocate to paying the CIT and (ii) the effective marginal tax rate (EMTR), which measures the extent to which taxes increase the marginal cost of capital (for more detail see (Hanappi et al., 2023[1])).
Results show that LAC countries have high average and marginal effective tax rates. In 2021, the average EATR in the 21 LAC countries was 23.9%, compared to 21.9% in the OECD countries and 17.1% in the remaining countries analysed by the OECD. In the case of EMTR, the average rate was 13.8% in the LAC region, almost double the average of 7.6% in OECD countries and 7.8% in the remaining countries (Figure 1.10). At the country level, Argentina, Brazil, and Chile have the highest EATR of the 89 jurisdictions analysed. In the case of EMTR, Argentina, Bolivia, Chile, Jamaica and Peru appear in the top ten.
Figure 1.10. Statutory tax rates and effective tax rates, 2021
Source: (Hanappi et al., 2023[1])
The high ETRs in LAC countries are mainly explained by the high statutory CIT rates but also ungenerous tax provisions that in some cases can even increase ETRs. The effect of tax provisions on ETRs can be observed by analysing the difference between STR and EATR. This difference is on average only 0.2 p.p. in LAC, while in OECD countries it reaches 1.7 p.p., and 0.8 p.p. in the remaining countries in the sample. The LAC figure, however, is skewed by important outliers that present large decelerating tax treatment of capital expenditures. These countries are Argentina, Bolivia, and Chile, where the tax treatment of acquired software drives high EATRs. While the actual annual economic depreciation rate of software is estimated from the literature at 40 percent, the Chilean legislation does not allow software to be depreciated and the depreciation rates allowed in Argentina and Bolivia are very low (2 percent and 5 percent, respectively) (Hanappi et al., 2023[1]).
Another factor that reduces ETRs in LAC countries less than in other countries is a larger bias in favour of debt financing. The average bias favouring debt in terms of EATRs is 4.8 p.p. in LAC, while in OECD countries it is 4.0 p.p. This is in part because there are no LAC countries with a classical allowances for corporate equity (ACE) system. While Brazil has implemented some provisions resembling an ACE since 1996 (interest on capital), this system operates by making dividends deductible upon distribution,20 which is not equivalent to a classical ACE, which operates through a notional interest deduction applied to the CIT base ( (Boulton, Braga-Alves and Shastri, 2012[3]; Klemm, 2006[4]). The absence of ACE provisions, combined with higher STRs, generates larger biases, on average, in favour of debt financing.
References
Boulton, T., M. Braga-Alves and K. Shastri (2012), “Payout policy in Brazil: Dividends versus interest on equity”, Journal of Corporate Finance, pp. 18(4): 968–979, https://doi.org/10.1016/j.jcorpfin.2011.09.004.
Hanappi, T. et al. (2023), “Corporate Effective Tax Rates in Latin America and the Caribbean”, Technical Note No IDB-TN- 2782, http://dx.doi.org/10.18235/0005168.
Klemm, A. (2006), “Allowances for Corporate Equity in Practice”, IMF Working Paper WP/06/259, https://www.imf.org/external/pubs/ft/wp/2006/wp06259.pdf.
OECD (2022), Corporate Tax Statistics: Fourth Edition, OECD Publishing, https://doi.org/10.1787/5c8d8887-en.
