Can taxation reduce inequality? Lessons from Ecuador

Aid, Economics, Governance

Has Ecuador managed to fight inequality using tax reforms? As we publish three case studies on reducing inequality using development finance, Susana Ruiz Rodriguez shares lessons from Ecuador.

Latin America and the Caribbean continues to be the most unequal region of the world. This is in spite of rates of growth and economic prosperity which have not been seen for a long time, especially in South America. 

Development finance and inequality case study jacket Public finance and taxation policies are not fulfilling their basic mission, that of channelling wealth to cover social needs. In the region as a whole, tax collection is too low and the tax regime is poorly
designed. Too low, because the weight of personal and corporate income tax is below what it could be and well below the average for other parts of the world. Poorly designed, because the greatest burden falls on the average earner or the poorest. 

Salaries and consumption are taxed, but not wealth. The result is a narrow tax base, with high levels of tax evasion and informal work, as well as discretional tax breaks which are not effective and don’t result in lasting investment or quality employment.

The great unresolved matter is how to bring about comprehensive tax reforms, “the mother of all reforms,” as Alicia Bárcena Executive Secretary of CEPAL (Comisión Económica para América Latina y el Caribe) said recently. 

Some countries have begun initiatives which are heading in the right direction and Ecuador is one of them. 

Various changes in the tax system have been brought about since Ecuador’s historic new constitution was established in 2008. The ultimate aim was not just an increase in the efficiency of the tax system, but for the system to be more progressive in its approach, in particular significantly rebalancing the collection of direct and indirect taxes. 

The commodities boom has also led to significant budgetary increases. Under the presidency of Rafael Correa and the country’s ‘return to democracy,’ revenues from oil tripled. Partly as a result of developments in the international oil market and partly thanks to changes to the tax system in relation to the extractive industries.

Social spending accounted for 34% of the total Ecuadorian public investment in 2010. The tax reforms, together with a historic process of debt reduction, and a better focus on expenditure, has also led to a substantial increase in social spending, accounting for 34% of the total public investment in 2010. 

Health and education budgets have tripled in the last five years. But such a rapid increase in public expenditure without adequate growth mechanisms and with very high expectations from the public led to some failures, especially in hospital services. The primary health network continues to be below standard, especially in rural areas.  

The increase in investment has resulted in an overall reduction of inequality in urban areas, but there are still clear failings in rural areas.

Ecuador is proof that tax systems are above all the result of political will. In 2008, the new constitutional mandate led to a fairer and more equitable tax system, an ambitious example of how the economy can serve a social vision. 

But, despite political will, social focus and an increase in resources, significant gaps and serious challenges remain in Ecuador. It is still essentially, a country with oil revenues and major industrial concentrations so high that, in many sectors, one or two businesses control up to 80% of the market. 

In fact, now that President Correa has been re-elected with a resounding majority (92% of seats in the Assembly belong to his party Alianza Pais) he has recently announced reforms of the economic and productive matrix which will be accompanied by new tax reforms. It remains to be seen what form they will take, but they should include a combination of structural changes to industrial policies, together with the outstanding fundamental advances in tax reforms, like making personal income taxes more progressive or increasing taxes on
unearned income (capital and property taxes).

The key issue is whether there is political will to bring about fiscal reforms that will contribute towards redefining the model of development and of society. Taxation is after all a reflection of the government’s orientation which defines the extent of the redistribution of national resources, and justice over land ownership, as well as generational and social justice. Pushing forward fiscal reforms with a focus on equality and redistribution is what marks the difference between a government which places sustainable and social development above the privileges of the traditional

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Author: Susana Ruiz Rodriguez
Archive blog. Originally posted on Oxfam Policy & Practice.