US$ 50 Million Loan Approved to Modernize Uruguayan Tax System

(Sources: Inter-American Development Bank (Press Release, October 4, 2006); UruguayInvest)

On October 4, the Inter-American Development Bank (IADB) announced it had approved a US$ 50 million loan to fund efforts to modernize Uruguay’s tax system. This loan is the first phase of a flexible, programmatic loan that will total approximately US$ 250 million. The loan is the latest move in a partnership between IADB and Uruguay designed to promote economic growth and make the country more competitive in the global market.

The IADB and Uruguay will attempt to achieve these objectives with programs that will restructure the country’s administrative framework, making expenditures more efficient, decreasing the frequency of tax evasion, and increasing the standard of living. These programs will be administered by the Ministry of Economic Affairs and Finance, as well as the Internal Revenue Bureau, the National Civil Service Office and the Planning and Budget Office. Restructuring the administrative agencies will not only improve efficiency, but will also encourage foreign investments, resulting in additional jobs and revenue.

Situated between South America’s two largest economies (Brazil and Argentina), Uruguay is in a position to capitalize on foreign investors seeking to conduct business within the country or with its neighbors by proxy. Uruguay’s membership in MERCOSUR (Southern Common Market) ensures free trade between the country and its neighbor members.

The business environment the country is fostering is conducive to foreign investments for myriad reasons. For instance, Uruguayan law does not favor local investors over foreign ones. There are no additional restrictions, such as taxes or tariffs, on foreign businesses wishing to operate in Uruguay. Moreover, there are no caps or restrictions regarding the amount of participation that foreign investors may enjoy. In other words, companies and businesses may be either partially or 100% foreign-owned. Furthermore, capital repatriation (i.e., the transfer of money from a foreign country back to its home country), as well as profit remittances abroad (i.e., the return of profit earned by a subsidiary in one country to the parent company in another country) are not restricted. Finally, with some of the world’s strictest banking-secrecy laws, anonymity of investors is ensured.

Questions:

The tax systems of emerging-market economies differ from those of industrial countries in many respects. For example, in emerging-market economies, total tax revenues expressed as a fraction of the GDP are lower than those in an industrial country. Generally speaking, the income tax base in an emerging-market economy is lower since only a small fraction of the population pays income tax. In Uruguay, however, there is no personal income tax. (Still, social security taxes against employers and employees, value-added taxes on goods, and consumption taxes on luxury goods are levied.) In addition, in an emerging-market economy, property taxes account for a much lower fraction. And, as suggested above, tax evasion is more pervasive. This is exacerbated by the fact that transactions are frequently conducted in cash. Despite the absence of personal income tax in Uruguay, corporations are charged income tax for income generated within the country. There is one rate (35%) charged to both Uruguayan and foreign-owned companies.

Another significant feature of emerging-market countries is that social programs must typically rely more on expenditures than on the tax system. Will a modernized tax system, together with foreign investment in Uruguay, produce more tax revenues that could be used for social programs, such as free higher education? (Note: education at the national university in Uruguay is free.) To what areas of development should tax revenues be directed? Could too much reliance on foreign investment as a source of revenue for social programs backfire? Is it preferable to fund social services and programs with tax revenues levied against the citizens of the country? Should Uruguay charge an income tax on working individuals?