The pillars of the so-called “Chilean model” come into jeopardy after the presentation of the reform of the pension system and the changes to the tax scheme. They are the most direct attacks on the engines of the economy since the 1980s.
The Government of Gabriel Boric presented an agenda to reform the pension system and reform the tax scheme in Chile. The reforms erode the effects of the main engines that, until now, have led the growth of the economy since the 1980s: exports, the domestic capital market and the investment to GDP ratio.
The tariff opening allowed Chile to become a country open to international trade and with a large share of exports in relation to the size of its economy.
The privatization of the pension system allowed the country to lay the foundations to establish a capital market in local currency, a key factor for real estate and business credit. Likewise, the tax system that Chile maintained in recent years was characterized by avoiding distortions and by expediting the efficient circulation of resources.
These pillars are threatened by Boric’s reforms. The Government’s tax reform aims to increase the maximum rate of Income Tax from 40% to 43%, at the same time that the rates are increased on the 3 preceding sections. This threatens the supply of labor and the accumulation of capital in the economy.
Likewise, the tax reform proposes to introduce withholdings on mining exports with ad-valorem rates of between 2% and up to 32%. Not only is it a disincentive to export, but it also distorts the investment of resources in the economy and adopts a tax that does not exist in the developed economies that Boric sought to emulate.
The Goldman Sachs firm warned that the anti-export bias of Boric’s tax reform discourages investment in one of the most dynamic sectors of the economy, and negatively affects growth.
It must be taken into account that with a lower exportable balance, the ability to import for an economy decreases, through the impact on the exchange rate generated by the shortage of foreign currency. An economy that is more closed to exports is also more closed to imports, and with it the ability to acquire foreign inputs and modern technology to sustain growth is also less.
The accumulation of capital would also be punished through the introduction of the wealth tax, with rates that vary between 1% and 1.8% on the annual tax valuation of taxable assets. It is a tax similar to Personal Property in Argentina.
The objective of the tax reform is not to correct the imbalances in public accounts, Chile has already managed to reach a primary and even financial surplus (paying debt interest) since August. The real objective is to attract a greater source of resources to allow a fiscal expansion without incurring a fiscal deficit.
The pillar of the domestic credit market would be directly attacked by the pension reform. Boric proposes creating a state entity to centralize and nationalize the tasks of affiliating taxpayers, fundraising and making payments of capitalized benefits, putting an end to the AFPs as they are known.
The role of the AFPs would be reduced simply to the investment of the capitalized funds but not to their administration. In addition, taxpayers will lose the freedom to choose what risk they are willing to tolerate in exchange for higher future returns, and the state will create its own autonomous investment fund to interfere in the segmented market of already relaxed AFPs.
Thirdly, the pension reform proposes to generate a significant increase in social security contributions, the so-called “work taxes”. The companies will pay 6% above the 5% rate that they already pay for each worker hired in white.
A scheme is presented that discourages formal hiring and, therefore, in practice could be counterproductive: all the gains that the social security system receives from more taxes on labor could be offset by the reduction in the tax base of wages that generates an increase in informality.
For JP Morgan, the pension reform will reduce the dynamism of investment in the coming years. Unlike countries like Argentina, it was not necessary for Chilean companies to resort to systematic external borrowing because the domestic capital market allowed them to channel all the necessary credit via pensioner savings.
The changes proposed by Boric deteriorate the development of the credit market in local currency, and for companies the fact of incurring external credit is more expensive, more volatile and more difficult to sustain. This compromises the sustainability of the relationship between investment and GDP for the next decade, with a harmful impact on growth.
With information from La Derecha Diario