Impact case study database

The underpinning research has had a significant and direct influence on the design of a major tax reform in Chile, which was enacted into legislation in September 2014. The research has contributed to continuing parliamentary and public debate on the issue of tax and inequality, and its importance has been recognised by a former President of Chile. The reform has had its intended redistributive effect: average taxes paid by the top 1% of earners rose by 47.5% between 2014 and 2018, with the additional revenues contributing to increased social spending, notably in public education. Further details on these impacts are included below.

Direct influence on Chilean Government tax policy

Shortly after her inauguration in March 2014, President Bachelet’s administration seized the opportunity created by student mobilisation to propose an ambitious tax system overhaul. In the 1980s, the Pinochet dictatorship had established an integrated income tax regime: the corporate tax (20% in 2012) served as a credit against personal income taxes capital owners became subject to upon receiving dividends or distributed profits. Since the top marginal personal income tax rate was much higher (40%), capital owners left most of their profits in their firm, where they paid only the low corporate tax. While this system was intended to promote investment, the large gap between the corporate and personal income tax rates also stimulated massive tax avoidance and evasion [1], which meant that in practice, capital owners in the top 1% paid low effective tax rates of roughly 15% [2] [3].

To eliminate these problems, the Bachelet government proposed an innovative imputed profits tax regime. This was designed by Jorratt, who was known to the administration as a previous Head of the Studies Division at the Chilean Internal Revenue Service. Jorratt has subsequently confirmed that the government’s proposal drew extensively upon the underpinning research. Particularly, its previously unavailable data on undistributed profits provided an evidence base that “ had a major impact on the design of the reform” [A] in four key ways:

1. By quantifying the scale of the problem of undistributed profits (in the form of under-declared business withdrawals and dividends).

2. In identifying the high concentration of the Taxable Profits Fund (FUT) - the mechanism by which companies could gain tax exemptions on reinvested profits - held by the richest (at least 70% of the retained earnings on which income tax had not been paid belonged to the richest 1%).

3. In identifying the high concentration of accrued earnings (not currently subject to the higher rates).

4. By revealing the low tax rates paid (the richest 1% in Chile paid just two-thirds of what the richest 1% were paying in the USA) [A].

According to the government proposal, the FUT would be eliminated, meaning all profits, whether reinvested or distributed to owners, would enter the individual income tax base [A]. These important modifications, while having only a small impact on the vast majority of Chileans, would ensure that wealthier taxpayers would pay higher effective rates.

An International Monetary Fund (IMF) analysis welcomed the tax reforms, noting how the substantial increase in tax revenue would finance greater outlays on education and health, and also help to address inequality in Chile: “ Improving access to high-quality education will help improve both Chile’s long term growth prospects and reduce Chile’s skewed income distribution. And eliminating the structural fiscal deficit will help preserve Chile’s strong public finances and fiscal buffers” [B]. The key Fairfield and Jorratt paper [3] is cited in the IMF analysis [B]. Press reports at the time (e.g. CIPER-Chile) also make clear the critical contribution of the underpinning research [3] [C].

The extensive reform package included multiple other measures to curtail evasion and avoidance [D], many of which were considered in prior years but deemed politically infeasible given business’s strong instrumental power. This has been acknowledged by former President (2000-2006), Ricardo Lagos, who also paid tribute to the research: " To increase taxes in Chile has always been very difficult politically, but today we have the opportunity to make a very important advance in this matter, thanks to the contribution of Fairfield and Jorratt” [E].

Overall, the government’s projections for increased tax revenues were equivalent to 3% of national GDP [D].

Informing parliamentary and public debate on proposed tax reforms

The underpinning research continued to have an important role informing parliamentary and public debate in Chile following the announcement of the reform initiative in March 2014. Findings from the research [2] [3] were cited in a June 2014 parliamentary session by a legislator speaking in favour of the reforms [A], while copies of the original working paper itself [3] were delivered to the Finance Commission where they were made available for review by senators [A]. Fairfield also presented the research to informal groups of academics and party activists and discussed its findings during informal meetings with members of the governing coalition [4]. National news reports (e.g. El Mostrador, Diario Financiero) picked out Jorratt as a key figure in the reforms and noted the circulation of the key paper [3] among private sector tax lawyers and their clients [F].

Changes to tax legislation and subsequent social and economic benefits

In September 2014, Chile’s Congress approved the tax reforms bill [G]. According to the Reuters report: “ The passing of the bill into law is Bachelet’s biggest political success since she returned to the presidency of Chile” [G].

While the administration succeeded in moving the tax reforms quickly though the lower house with only minor modifications, in December 2015, concerted opposition from business and associated concerns regarding investment in the context of an unforeseen economic slowdown prompted the Finance Ministry to draft a compromise bill in the senate, introducing some amendments to the original proposals. The imputed profits regime was adjusted, meaning taxpayers could instead opt into a partially de-integrated income tax system with a 27% corporate tax, where 65% of the tax paid by the firm is creditable against the personal income tax [H]. Even in spite of this politically-imperative compromise, the reform remained a major tax increase on the wealthiest Chileans - the most significant since democratisation in 1990 - and, crucially, government officials indicated that the proposed simplifications would not result in a reduction of projected tax revenues, and the bill would not fundamentally affect the redistributive changes that were at the core of the original 2014 legislation [H].

The reforms have proven successful in redistributing income in Chile, a country known for its extreme levels of inequality [2] [3] [I]. Increased tax revenues have helped, for example, to finance a major education reform, which extended scholarships for low-income university students (i.e. those in the bottom 60% of the household income scale), among other measures to strengthen public education [J]. Citing World Bank data [K], Americas Quarterly reports the success of the reforms in achieving their primary goal of increasing tax revenues from the highest earners: “ Above all, the reform made the tax code more progressive, raising taxes on corporations and top earners. The top 1%, for example, saw their average taxes rise by 47.5% according to the World Bank. The reform also removed opportunities for tax evasion and implemented new excise taxes on tobacco, alcohol, and sugary drinks, and ‘green taxes’ on carbon and motor vehicles – part of the reason Chile is now a regional leader in renewable energy, with half of Latin America’s installed solar capacity” [I].

The reforms have helped to underpin a gradual increase in social spending from 15% in 2014 to 16.4% in 2018 [L]. More detailed analysis of the tax reform’s impact on revenue and inequality is a pending project for economists to carry out, that will require extensive additional data and assessment of many complex modelling assumptions.

Continuing contributions to public debate on inequality in Chile

The findings and analysis of the underpinning research continue to inform public commentary and debate on wider issues relating to inequality in Chile. The research [1] [3] has been cited in media articles on the strategies of control used by political elites [M], on corporate corruption [N], on Thomas Piketty’s analysis of inequality in Chile [O], and in various pieces on tax avoidance and evasion [P]. More recently, anecdotal evidence conveyed to Fairfield by a previous member of the Bachelet administration indicates that the research [3] played an important role in strengthening the centre-left coalition’s campaign to push back against the subsequent right-wing Piñera administration’s (2018-present) unsuccessful efforts to overturn the 2014 reform and revert to the less equitable integrated income tax system that previously prevailed [Q].

The enduring impact of the research is perhaps best exemplified by former President Lagos: " I believe that the document written by Tasha Fairfield and Michel Jorratt [3] is very important. For a long time this document will be the source for discussing the issue of income and wealth distribution in Chile...I believe that there will be a before and an after in Chile in this matter. It will be very important for Chile in light of the debate that is taking place, especially after Thomas Piketty's work" [E].