August 7, 2014

Chile’s Senate approved a controversial tax reform package on 16 July that threatens to harm the economy as growth is decelerating. President Michelle Bachelet introduced the reform shortly after she took office earlier this year and it took the Senate four months of debate to approve it. The initial proposal was that the corporate tax would increase from 20% to 25%, but the reform was amended and the Senate instead agreed to create two corporate tax systems.



Under the new rules, corporations can either pay 27% tax and receive discounts for reinvesting profits, or pay 25% tax with no discounts. In addition, the revised package provides more incentives for investment and savings for small and medium-sized companies. According to the Senate, the reform will receive final approval on 7 August and it will be implemented gradually through 2017.



The approval of the tax reform marks a milestone for Bachelet’s administration. The money raised will be used to finance the overhaul of the education system and other important social projects aimed at tackling Chile’s high level of inequality, which was one of Bachelet’s major campaign promises. The reform is expected to generate approximately USD 8.2 billion per year in revenues, which is equivalent to 3.0% of GDP. The funds will not only come from raising the corporate tax, but also from eliminating the Taxable Profits Fund (FUT), meaning that corporations can no longer park undistributed funds there and potentially evade taxes. The FUT, unique to Chile’s economy, was initially designed to boost investment, but it also facilitated tax deferral.



The new tax reform has raised concerns regarding its impact on the economy, especially in terms of investment and business confidence. Gustavo Canonero, Regional Head Economist for Latin America at Deutsche Bank says that:



“The reform, does represent an important increase in the burden affecting the private sector (up to 3% of GDP at the end of the process), which could initially have negative demand effects unless properly compensated by fiscal expenditure.”

The government expects the economy to grow 3.2% in 2014. LatinFocus panelists are taking the latest developments into consideration and have downgraded their growth forecasts for both this year and the next. The LatinFocus panel now sees the economy growing 2.8% in 2014, which is down 0.2 percentage points from last month’s forecast. Panelists expect growth of 3.8% in 2015, which is down 0.1 percentage points from last month’s estimate.