Eonomics

1. Strategies for Taxing Economic Elites:
The Chilean Experience
Tasha Fairfield
T.A.Fairfield@lse.ac.uk
Dept. of International Development
London School of Economics

2. 2
When can governments increase taxation of economic
elites?
How much scope for reform can they create?
Overview
Obstacles to taxing elites
investment power & political power
Reform Strategies
Cases from Chile
Research Questions

3. Obstacles to Reform
Taxing economic elites will be difficult when either
Investment Power or Political Power is strong
3

4. Investment Power
(Structural Power: Block 1977, Lindblom 1982, Przeworski & Wallerstein 1988)
Market-coordinated investment decisions
Source: Perceived threat of reduced investment
Taxing economic elites will be difficult when either
Investment Power or Political Power is strong
3
Obstacles to Reform

5. Investment Power
(Structural Power: Block 1977, Lindblom 1982, Przeworski & Wallerstein 1988)
Market-coordinated investment decisions
Source: Perceived threat of reduced investment
Political Power
(Instrumental Power: Mills 1956, Miliband 1969)
Deliberate political actions
Sources: Relationships and Resources
Taxing economic elites will be difficult when either
Investment Power or Political Power is strong
3
Obstacles to Reform

6. 4
Obstacles to Reform
Sources of Political Power
Relationships
Partisan Linkages
Institutionalized Consultation
Recruitment into Government
Election to Public Office
Informal Ties
Resources
Organization
Expertise
Media Access
Money

7. 5
Reform Strategies
Mechanism
Tempering Elite Antagonism Mobilizing Public Support
Fiscal
Policy
Domain
Tax-Side Attenuating Impact
Obfuscating Incidence
Legitimating Appeals
(Horizontal Equity)
Legitimating Appeals
(Vertical Equity)
Benefit-Side Compensation
Emphasizing Stabilization
Linking to Popular Benefits
Facilitate modest tax increases
on powerful economic elites

8. 6
Strategy Primary Mechanism Policy Choice /
Technique
Limitations / Drawbacks
Attenuating
Impact
Tempers elite
antagonism
1. Incremental reforms
2. Phase-ins
3. Temporary reforms
4. Dispersion
1-3. Fiscal cost
3. Over-use undermines
effectiveness
4. Antagonizing
multiple groups
Obfuscating
Incidence
Tempers elite
antagonism
1. Low-visibility taxes
2. Burden-shifting
Inherently difficult
2. Uncertain incidence
Legitimating Appeals
1. Vertical equity
2. Horizontal equity
1. Mobilize public
support
2. Tempers elite
antagonism
1. Elite-targeted taxes
2. Anti-evasion reforms,
eliminating exemptions
Politicians may ignore
public opinion
1. Fiscal cost,
May antagonize elites
Emphasizing
Stabilization
Tempers elite
antagonism
Taxes that raise
revenue quickly
Relevant during crisis
Compensation Tempers elite
antagonism
1. Separate negotiation
2. Inclusion in
reform package
3. Contingent benefits
4. Earmarking
Potential fiscal cost
1. Requires credible
commitment & capacity to
deliver benefits
3. Requires exclusive
executive initiative
4. Budgetary rigidities,
Politically undesirable
Linking to
Popular Benefits
Mobilizes public
support
1. Discursive
2. Inclusion in
reform package
3. Contingent benefits
4. Earmarking
Politicians may ignore
public opinion,
May antagonize elites
3, 4. See above
Reform Strategies

9. Successful cases of
market-oriented tax reform
Chile, Argentina & Bolivia
But recurrent revenue needs
in 1990s and 2000s
Value-Added Tax Revenue
(percent of GDP, average: 1995-1999)
Latin
America
Chile Argentina Bolivia EU-15
5.1* 8.0 6.9 6.6 7.2
Sources: Sabaini 2005, SII, DNIAF, SIN, ECTCU 2006
*Includes other consumption taxes as well.
7

10. Chile, Argentina & Bolivia
Income, profits, and wealth are
major, under-taxed revenue bases
Differences Between Actual and Predicted Tax Revenue
(percent of GDP, 1990s average)
Latin America Chile Argentina Bolivia
Personal income tax –2.7 –4.0 –4.4 –1.5
Corporate taxes –0.7 –2.4 –1.2 –1.5
Source: Perry et al. 2006, 96. Predictions from regressions based on per capita GDP.
Governments considered
increasing direct taxes
8

11. 9
Explaining Tax Policy Outcomes
Chile: marginal increases
Strong business power  key reforms off agenda
Argentina: significant increases
Weaker business power  more leeway to tax
Bolivia: mixed results
Business power + Popular mobilization
 Domestic elites not taxed,
but big hydrocarbon royalty increases

12. 9
Explaining Tax Policy Outcomes
Chile: marginal increases
Strong business power  key reforms off agenda
Sources of Political Power
• Organization
• Partisan Linkages: right parties strong in senate

13. 12
Chilean Tax Reforms
Attenuating
Impact
Legitimating
Appeals
Compensation Emphasizing
Fiscal Discipline
Linking to
Popular Benefits
Aylwin
1990: CIT, PIT & VAT
increases
Temporary Vertical Equity No direct tax increases
for 4 years.
Finances Spending Discursive
Multiple social programs
1993: Made 1990 CIT
permanent
Top PIT rate cuts; no
direct tax increases
for 4 years.
Prevents fiscal
deficit
Frei
1995: Excise tax
increases
Vertical Equity Finances spending Contingent:
Pension Increases
1997: Made 1990 VAT
permanent
Finances spending Inclusion:
Education reforms
1998: Anti-evasion
reform
Some measures
temporary
Horizontal
& Vertical Equity
Savings Incentives Finances spending Contingent:
Pension increases
Lagos
2000: Anti-evasion
reform
Phased-In Horizontal
& Vertical Equity
Sumptuary &
capital gains tax cuts
Finances spending Discursive:
Lagos’ program of
government
2001: CIT increase Phased-In Top PIT rate cuts:
revenue-neutral reform
Finances
compensations
2003: VAT increase Temporary,
Phased-in
Vertical
Equity*
Tariff reductions
(legislated separately)
Finances spending
& compensations
Discursive:
Health care, targeted social
spending programs
2005: Mining tax Phased-In Nationalism Tax invariability clause
2005: Eliminated
57 bis
Vertical Equity Finances spending Inclusion:
Student scholarships
Bachelet
2006: Made 2003
VAT permanent
Finances spending Contingent:
Pension increases
2008: Restricted home-
construction VAT benefit
Phased-In Vertical Equity Contingent:
Gas & stamp tax cuts:
revenue-neutral reform
Finances
compensations &
popular benefits
Contingent:
Gas tax cuts

14. 12
Chilean Tax Reforms
Attenuating
Impact
Legitimating
Appeals
Compensation Emphasizing
Fiscal Discipline
Linking to
Popular Benefits
Aylwin
1990: CIT, PIT & VAT
increases
Temporary Vertical Equity No direct tax increases
for 4 years.
Finances Spending Discursive
Multiple social programs
1993: Made 1990 CIT
permanent
Top PIT rate cuts; no
direct tax increases
for 4 years.
Prevents fiscal
deficit
Frei
1995: Excise tax
increases
Vertical Equity Finances spending Contingent:
Pension Increases
1997: Made 1990 VAT
permanent
Finances spending Inclusion:
Education reforms
1998: Anti-evasion
reform
Some measures
temporary
Horizontal
& Vertical Equity
Savings Incentives Finances spending Contingent:
Pension increases
Lagos
2000: Anti-evasion
reform
Phased-In Horizontal
& Vertical Equity
Sumptuary &
capital gains tax cuts
Finances spending Discursive:
Lagos’ program of
government
2001: CIT increase Phased-In Top PIT rate cuts:
revenue-neutral reform
Finances
compensations
2003: VAT increase Temporary,
Phased-in
Vertical
Equity*
Tariff reductions
(legislated separately)
Finances spending
& compensations
Discursive:
Health care, targeted social
spending programs
2005: Mining tax Phased-In Nationalism Tax invariability clause
2005: Eliminated
57 bis
Vertical Equity Finances spending Inclusion:
Student scholarships
Bachelet
2006: Made 2003
VAT permanent
Finances spending Contingent:
Pension increases
2008: Restricted home-
construction VAT benefit
Phased-In Vertical Equity Contingent:
Gas & stamp tax cuts:
revenue-neutral reform
Finances
compensations &
popular benefits
Contingent:
Gas tax cuts

15. 13
Chile
Anti-evasion reform, 2001
Equity appeals:
Vertical: “When you go to buy a kilo of bread, you pay 18% VAT. You
have no trick, no mechanism for paying less. The poor pay all their taxes.
And it is just [fair] that the rich pay all their taxes.”
Horizontal: “Tax evasion entails great inequity between those who comply
with their tax obligations and those who do not. …from an ethical
perspective, no one can oppose an initiative that pursues compliance with
the law?”
Applied to income tax base-broadening measures:
–Reform Proposal
–Pres. Lagos
Use of legal tax benefits ~ avoidance ~ evasion ~ morally unacceptable
Fighting evasion, not increasing taxes
“Trojan Horse”

16. 14
Chile
Anti-evasion reform, 2001
Modest success:
The right was in an “absolutely defensive position.”
“The [bill’s] title—evasion—it suggests going after criminals. It’s very difficult
to oppose someone who presents that framing”
–Right-party senator (interview)
–Former senate president (interview)
Right abstentions (vs. rejection) in finance committee: “otherwise, President
Lagos would have said that the opposition is against combatting tax evasion ”
–Right-party senators (El Mercurio)
Limitations: insufficient to enact reform
Significant concessions negotiated with business and right
Voter-party linkages: right draws support from popular sectors through
clientelism and charismatic appeals (Luna 2010)  minimal electoral impact

17. 15
Chile
Stock-owner tax benefit elimination, 2005
Opportunity: Competition from the Right over inequality

18. 15
Chile
Stock-owner tax benefit elimination, 2005
Opportunity: Competition from the Right over inequality
“Inequality, Mr. President, continues. There is a Chile that grows,
but it is for the few, and the great majority have not yet benefited.”
–Pres. Candidate Joaquín Lavín (El Mercurio 5/7/05)

19. 15
Chile
Stock-owner tax benefit elimination, 2005
Opportunity: Competition from the Right over inequality
“Inequality, Mr. President, continues. There is a Chile that grows,
but it is for the few, and the great majority have not yet benefited.”
Vertical Equity Appeal:
“The infamous article ‘57 bis’ [tax benefit] represents a tremendous
support for inequality. Instead of just talking, why don’t we agree to
eliminate ‘57 bis’ in less than 24 hours?”
–Pres. Ricardo Lagos (El Mercurio 5/10/05)
–Pres. Candidate Joaquín Lavín (El Mercurio 5/7/05)

20. 15
Chile
Stock-owner tax benefit elimination, 2005
Opportunity: Competition from the Right over inequality
“Inequality, Mr. President, continues. There is a Chile that grows,
but it is for the few, and the great majority have not yet benefited.”
Vertical Equity Appeal:
“The infamous article ‘57 bis’ [tax benefit] represents a tremendous
support for inequality. Instead of just talking, why don’t we agree to
eliminate ‘57 bis’ in less than 24 hours?”
Success: High salience of inequality during campaign
–Pres. Ricardo Lagos (El Mercurio 5/10/05)
–Pres. Candidate Joaquín Lavín (El Mercurio 5/7/05)

21. 15
Chile
Stock-owner tax benefit elimination, 2005
Opportunity: Competition from the Right over inequality
“Inequality, Mr. President, continues. There is a Chile that grows,
but it is for the few, and the great majority have not yet benefited.”
Vertical Equity Appeal:
“The infamous article ‘57 bis’ [tax benefit] represents a tremendous
support for inequality. Instead of just talking, why don’t we agree to
eliminate ‘57 bis’ in less than 24 hours?”
Success: High salience of inequality during campaign
–Pres. Ricardo Lagos (El Mercurio 5/10/05)
–Pres. Candidate Joaquín Lavín (El Mercurio 5/7/05)
“The opposition accepted things that usually it was not willing to
accept so as not to harm the presidential option.”
–UDI Deputy (author’s interview 12/23/05)

22. Findings and Implications
Argument:
• When economic elites have strong political and/or investment
power, substantial tax increases are unlikely.
• However, reform strategies can make incremental progressive
tax increases feasible.
22
Policy Implications:
• Pursue incremental rather than comprehensive reform
• Employ multiple strategies where possible
• Reform design and reform strategies must be tailored to the
context at hand

23. 12
Chile Tax Reforms
Attenuating
Impact
Legitimating
Appeals
Compensation Emphasizing
Fiscal Discipline
Linking to
Popular Benefits
Aylwin
1990: CIT, PIT & VAT
increases
Temporary Vertical Equity No direct tax increases
for 4 years.
Finances Spending Discursive
Multiple social programs
1993: Made 1990 CIT
permanent
Top PIT rate cuts; no
direct tax increases
for 4 years.
Prevents fiscal
deficit
Frei
1995: Excise tax
increases
Vertical Equity Finances spending Contingent:
Pension Increases
1997: Made 1990 VAT
permanent
Finances spending Inclusion:
Education reforms
1998: Anti-evasion
reform
Some measures
temporary
Horizontal
& Vertical Equity
Savings Incentives Finances spending Contingent:
Pension increases
Lagos
2000: Anti-evasion
reform
Phased-In Horizontal
& Vertical Equity
Sumptuary &
capital gains tax cuts
Finances spending Discursive:
Lagos’ program of
government
2001: CIT increase Phased-In Top PIT rate cuts:
revenue-neutral reform
Finances
compensations
2003: VAT increase Temporary,
Phased-in
Vertical
Equity*
Tariff reductions
(legislated separately)
Finances spending
& compensations
Discursive:
Health care, targeted social
spending programs
2005: Mining tax Phased-In Nationalism Tax invariability clause
2005: Eliminated
57 bis
Vertical Equity Finances spending Inclusion:
Student scholarships
Bachelet
2006: Made 2003
VAT permanent
Finances spending Contingent:
Pension increases
2008: Restricted home-
construction VAT benefit
Phased-In Vertical Equity Contingent:
Gas & stamp tax cuts:
revenue-neutral reform
Finances
compensations &
popular benefits
Contingent:
Gas tax cuts