OECD Recommends Countercyclical Fiscal Policies For Chile

by Leroy Baker, Tax-News.com, New York

02 February 2010

In its latest economic report on Chile, the Organisation for Economic Co-operation and Development (OECD) stated that the fiscal framework is working well and receives wide support, but could be improved further.

The OECD said Chile’s structural fiscal rule, inflation targeting and flexible exchange rate had been largely successful in shielding the economy against overheating in the last copper price boom.

However Chile could "consider the experiences of OECD countries that complement their fiscal rule with a ceiling on expenditure growth." During booms, such ceilings help to accumulate additional funds, which can then be used counter-cyclically in sharp downturns.

According to the OECD, fiscal policy could also be made more counter-cyclical by strengthening the automatic stabilizers, including through an enhanced unemployment benefit system.

The OECD descibed how severance pay rights are often several times higher than unemployment benefits, contributing to slower adjustment of the economy after adverse shocks. Severance pay is only available to workers on indefinite contracts; the OECD suggests that this "discourages employers from offering indefinite contracts, thus contributing to the comparatively large share of workers on fixed term contracts."

Existing social programmes to reduce poverty and inequality are described as "well targeted and efficient, but they remain small by OECD standards, despite significant expansion in recent years." The OECD recommend an increase of public spending in these areas, although it "should continue to be well targeted, efficiently implemented, and sustainably financed."

The OECD advised a broadening of the tax base could be achieved by abolishing some of the less efficient and regressive tax exemptions and working to increase the yield of the income tax system. Having already limited the VAT tax credit for housing construction, the OECD also proposed a reassessment of the highly regressive exemption from VAT of health and education services, which benefit mainly higher income households.

The OECD applauded the recently introduced opportunity for medium-and low-income earners to opt for a pension subsidy instead of a tax allowance. The OECD recommended further strengthening of subsidies for low- and medium-income earners while capping tax benefits for high-income earners. The OECD pointed out that refundable tax credits or flat subsidies could ensure that support for savings reaches those who need it most.

The OECD suggested closing down the tax loophole which allowed incentives for high income individuals to keep their savings in corporations often solely created for this purpose, such as sociedades de inversión, as a result of the large difference between the corporate and the top marginal income tax rates.

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