Chile's Presidential Election: Taxes at the Core - Bloomberg Tax

Chile's Presidential Election: Taxes at the Core – Bloomberg Tax

By Ignacio Gepp
As Chile’s voters prepare to make a final decision on the presidential candidates, Ignacio Gepp of Puente Sur looks at the proposed tax reforms from both contenders, and what these might mean for Chilean taxpayers and foreign investors in the country.
In October 2019 Chile’s President, Sebastiàn Piñera, lost control of the country in the midst of peaceful protests demanding better pensions, education and health care, mixed with violent riots that led to the burning of churches and attacking of police stations, all while demanding the head of the president.
In order to contain what was uncontainable, the political elite understood that what people wanted was a new constitution (later backed by of 78.28% of voters), which is being drafted as we speak by a group of 155 elected individuals leaning heavily to the hard left, and in which the ruling center-right coalition could not even obtain a third of the total members.
With a president that seems to have lost the confidence of the Chilean people (with 16% support), two impeachment processes, the hard left accusing him of violating human rights and the hard right accusing him of giving up on law enforcement with the hope of saving himself, inflation that rose from a steady 2%-3% to 6%, and a political class desperate to get virtual “likes” by means of populism, such as allowing citizens to empty their pension savings for a fourth time since the pandemic started, we now have to choose a new leader for our country.
Chile held its presidential election Nov. 21, 2021, which ended with two first-round winners: José Antonio Kast and Gabriel Boric. These two men will have to face each other once again in a final vote on Dec. 19, 2021.
Kast is a right-wing proponent of economic liberalism, yet morally conservative, committed to law and order, wary of government and suspicious of bureaucracy.
Boric is a left-wing politician who believes in the role of a stronger government to deal with inequality by collecting more from the rich, and a proponent of a new social contract.
Both have been dubbed extreme in their views by their opponents, with Kast making some of the same core economic proposals of the Pinochet era such as popular capitalism, and Boric forming a coalition with the Chilean Communist Party, a staunch supporter of the regimes in Cuba and Venezuela.
It seems that Chile’s voters have somehow tired of the political moderation that shaped the country from 1990 to 2020 and reduced poverty from 40% to 8.5%, which means these two individuals are left in a fierce battle, in which the art of politics will be challenging.
For the left-wing Boric, it is key to raise tax revenue (8% of GDP in six to eight years) and primarily use taxation as a means of redistributing wealth and reducing income inequality. As argued in his proposals, this would make Chilean society more cohesive, with better public education, production, and a leader in the response to climate change.
For his opponent Kast, an unsustainable increase of inefficient public spending (from 13% to 30% of GDP in 13 years) along with an overwhelming tax burden (increased by 60% in 13 years) has prevented Chile from becoming a prosperous nation with a thriving economy.
Kast’s plan is set on dramatically reducing public spending, cutting taxes and reducing regulation—for instance by inviting 30,000 public employees to retire and cutting by half the number of ministries currently in place—which in his view would increase private investment by 19%-28% of GDP and take growth to annual rates of 5%-7%, from the current 2%-3% that has been predicted.
As if a presidential election were a Black Friday sale of tax ideas, both candidates have gone all out.
While neither candidate is proposing an increase in corporate taxation, there are key differences in their approach.
Kast aims to lower corporate income tax from 27% to 17% for all companies and to 0% for businesses with sales under $930,000; Boric vows to keep it at 27%, with the exception of the mining industry, where a mining royalty with an ad valorem component would be proposed.
From a structural standpoint, Boric distrusts the Chilean tax system—put in place by Pinochet in 1984 and roughly preserved until today—which favors the deferral of taxes as a reward for reinvesting business profits. Hence, he is proposing a tax on undistributed profits (excluding those held by small and medium-sized enterprises (SMEs)), at a rate yet to be disclosed.
In addition to the above, Boric would limit the use of carryforward losses and would abolish a capital gains exemption for publicly traded stock, unless the seller is an institutional investor.
Kast on the other hand strongly supports the notion of private investment, and thus would favor the deferral of taxes associated with undistributed profit, and would even allow SMEs to consider 100% of such reinvested profits as tax deductions.
This is another strong point of disagreement between both candidates.
The left-wing Boric sees the need for higher taxation on wealthier individuals. He does so to stay true to his political commitments, but also to provide some sense of fairness to the Chilean tax system and enforce additional income and wealth distribution.
To that effect, he proposes an increase of rates and brackets that would impact individuals with a monthly income exceeding $5,600. Further, he proposes a wealth tax at rates of 1.5% and 2.5%, depending on whether the individual has net wealth above $5 million or is sitting on top of $22 million.
The right-wing candidate Kast, on the other hand, would abolish property tax, inheritance tax (which his competitor would make applicable to payments arising from a life insurance policy) and gift tax, as in his view such measures in conjunction with income taxes would just lead to double taxation and further inhibit the incentives for private citizens to contribute to public life.
Further, Kast proposes applying a negative tax of 17% for individuals with monthly income ranging between $400 and $800, supporting Chile’s low fertility rate by giving tax incentives to parents who choose to expand their families, and allowing individuals to use their pension savings, tax free, as down payments for housing.
Coming from a system that, at its inception, tried to make taxation on capital income equal to taxation on labor income, both candidates have very different approaches to this idea of fairness.
For Kast, it is essential that regardless of the source (capital or labor), equal income must be subject to the same taxation. This would mean a system wherein the corporate income tax of the enterprise is consolidated with the shareholders’ tax of the investors, thus leading to an overall tax burden on business income of 35%–40%, depending on whether it is local or foreign.
Boric, on the other hand, understands that investors have the option of investing and deferring taxation, something that workers cannot do, and thus this would give investors an unfair advantage relative to workers. Hence, his quest is for separate taxation on dividends alone, regardless of the personal tax situation of investors, which can lead to overall taxation on business income of something close to 43.4%.
To achieve this, and maintain the corporate income tax rate at 27%, Boric would need to impose a tax on dividends in the range of 20%–25%, but, as with many other proposals, details are still pending (just to maintain the excitement).
Notwithstanding the above, Boric’s proposal would exclude investors in SMEs and investors from treaty countries. I guess, with some sense of reality, Boric does not want to fight the U.S. and the Chinese at the same time, wisely.
The answer is—with caution. While the right-wing Kast’s proposals can be seen as business-friendly, a society with strikes, riots and political infighting is not typically good for business.
One point of concern for many is how Kast will succeed in reducing tax revenue and public spending and still be able to comply with the demands millions voiced during the demonstrations of 2019.
For left-winger Boric, on the other hand, the challenges come from trying to pass a substantial tax program at a time when his political allies tend to generate alarm among businesses and investors, following statements from key members of his coalition that they intend to introduce instability into a system they wish to change.
No one can deny that Chile is going through a rocky period, where a new constitution is being drafted by a majority that has stated at times that their wish is to create a brand new version of what Chile is (a somehow stable democracy that embraces the free market, maybe too much for some); where populism has dominated the actions of Congress, tarnishing both the left and right; and a presidential election where the options on offer exclude the notion of moderation.
Tax-wise, the proposed measures aren’t revolutionary, per se, with Kast trying to return to the investment-friendly tax system that was in place from 1984 until 2017, and Boric trying to double down on the efforts of the Bachelet administration to increase the tax contribution arising from capital income versus labor income. In other words, both men are just trying to recreate aspects of the past, with a few tweaks (e.g., green taxes, taxation of collective investment vehicles).
Considering the above, and the fact that neither man should enjoy a majority in Congress nor a strong grip over their own coalitions, one might think that this is more of a bodybuilding competition than a fight between two heavyweights.
Even then, and assuming both candidates get the votes they need to turn their ideas into actual legislation, neither choice should impact foreign investors directly (mining industry aside).
In essence, Kast would maintain the same level of taxation on dividend income paid to nonresidents; Boric, meanwhile, would not change the current rules applicable to investors from treaty countries (probably out of fear of what that would mean for the 37 tax treaties Chile has signed), and neither would his proposed changes directly affect foreign investors from non-treaty countries (already in a pretty bad position).
Unfortunately, this is not true.
Should he win, Kast will have to fend off what promises to be the fiercest opposition since 1990, given his unrepentant links to and outspoken thoughts on the Pinochet era.
Further, members of the Constitutional Convention have already voiced the idea of proposing an extraordinary short term for the winner of this race, particularly if he is not to their liking.
With Boric, the story should not be drastically different, as he would have to rule over a collation of parties that do not seem to be in agreement even as to what a democracy is—no easy answers there for the Communist Party allied with Boric.
Economically speaking, the enthusiasm Boric’s economic team has for fighting the deferral of taxation may lead to a divestment from cash-rich businesses. Why keep cash invested in a country that believes investors do not react to taxation? Should that happen, investors should start getting worried about controls on capital repatriation as Boric starts getting worried about not obtaining the revenue that would sustain his promises.
It is difficult to be optimistic right now, but not impossible.
Throughout its history, Chile has looked with mistrust at radical political change, and tends to favor institutional solutions when pressed by extreme positions, as the November 2019 agreement for organizing a Constitutional Convention to tackle the October riots seems to suggest. Further, the work of the Constitutional Convention still has to be put to a general vote.
The current period of extremism might be seen for some as a hangover, and one Chile may wish to cure sooner rather than later.
Hoping for the best, once elected, both candidates would do well to stop speaking to the hearts of their support bases, start listening to the unavoidable reality of an empty bank account, and accept the fact that without long-lasting majorities, they have no power. Hence, changes to both programs should be expected, as the moderate voter needs to find something to identify with, in absence of the candidates themselves.
However, planning for the worst scenario—a flexible exit and cash repatriation strategy might be something to consider.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Ignacio Gepp is a Partner with Puente Sur in Chile.
The author may be contacted at: igepp@puentesur.cl
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