Colombia - Current economic position and prospects (Vol. 2 of 2) : Public finance

RETURN To REPC)RTSDESH RESTRICTED WITHIdN aRCULATING COPY Report No. WH- 172a ONE WEEK T BE RETURNED rO REPORTS DESK - IN GENERAL FILES This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION CURRENT ECONOMIC POSITION ANI) PROSPECTS OF COLOMBIA (in two volumes) 'VOLUME II PU13LIC FINANCE [ay Z3, 1967 Western Hemisphere Department  CURRENCY EQUIVALENTS 1 US $ 13.58 Pesos 1 Peso (Ps. ) US$0. 074 1 million Pesos US$73, 637  F'REFATORY NOTE This anne!x reflects the work of several missions to Colombia made between November 1965 and January 1967. The purpose of this Annex has been to give a detailed analysis of the complex fiscal system of Colombia and to indicate those areas in which future policy decisions might be needed. This Annex was prepared by Anthony A. Churchill.  TAELE OF CONTENTS Page No. PREFATORY NOTE ................................... I. The Public Sector and Economic Development ... 1 A. Introduction ............................ 1 B. Developments 1961 to 1966.2 C. Policy Measures September 1965 to March 15,67 ............................ 6 D. The Outlook 1967-70 ..................... 8 E. Summary and Cconclusions ................. 16 Appendix ............................. 20 II. The Central Governirent . . 26 A. The Revenue System ...................... 26 B. Expenditures ............................ 56 III. Local Governments . . 71 A. Introduction.71 B. Departments ............................. 71 C. MunicipalitieE .......................... 77 IV. The Decentralized Agencies ................... 85 A. The Data....- ........................... 85 B. Income and Expenditures ................. 8 C. Decentralized Agencies by Economic Sectors ............................... 91 D. Conclusions arid Recommendations ......... 100 V. Social Security Sy:tem ............. 101 A. Introduction .......... ................... 101 B. Rate Structure .......................... 102  Pa,ce No. C. Population Covered ..................... 103 D. Benefits.104 E. Financing ............ 108 F. Analysis ............ 109 G. Administration .112 VI. Taxation of the Oil Industry . .. 11 A. Colombia and the International Oil Market ...... 11l B. The Cost Structure of the Colombian Petroleum :'ndustry ................... 115 C. The Present Tax System ................. 117 D. An Alternative Tax System .............. 120  I. THE PUBLIC SECTOR & ECONOMIC DEVEIDPMENT A. Introduction 1. The central or national government is the dominant fi'scal authority in Colombia, but in addition a substantial role is played by local governments and public institutions subject to varying degrees of control. The public institutions are responsible for carrying out many public services and account for a major portion of public invest- ment. Local governments have tended to have a rather static role in the economy as many of their functions have been taken over or supple- mented by the actions of the central government or the decentralized agencies. 2. In examining the financial structure of the public sector primary emphasis has to be placed upon the central government not only because of its importance in the decision making process but also because it is the major source of public savings. The public institutions rely primarily on the central governmentts current account surplus to finance their investment expenditures as they generate only minor surpluses internally. The savings of loca] governments Uend to be tied to certain types of local expenditures.-V The followling table shows the relative importance of the public sector in channelZ'ng the resources of the economy: Table I-1: TAX INCOMIE OF THE PUBLIC SECTOR (in millions of Pesos) Central-/ Depts. Munic. Agencies Total o of GDP Govt. 1961 2199 638 315 ho 3192 lo.L4 1962 2114 729 386 53 3282 9.8 1963 3069 969 h78 71 4587 10.7 1964 3847 1164 586 134 5731 10.9 19?65 3948 1271E/ 60!2/ 143c/ 5966 10.1 1966 6o2S-' 13722/ 653J/ 157$' 8210 11.1 a/ Current Account Income bD/ Preliminary T/ Estimated Source: Table I-7, III-1, III-4, IV-1 1/ See Chapter III for a further discussion of local governments.  - 2 - Colombia ranks near the bottom of the list in taxes collected as a percen- tage of national income in Latin America, and in South America only Paragua.r is lower. This seems to suggest that there still is additional taxable capacity. B. I)evelopments 1961 to 1966 3. The period fronm 1961 to 1966 has been a difficult period in Colombia with many diverse economic forces affecting the fiscal situation. Exchange rate problems, inflation, and export market difficulties have all contributed their share in making this a very unstable period. In spite of this Colombia has emerged from this period with a much sounder fiscal policy and with a tax system more suited to the needs of the economy. This has been a period in which Colombia has tried to adjust, and to some extent, isolate itself from the external shocks generated in the world market for its major export, coffee. At the same time, an ambitious development program was undertaken compounding the difficulties and instabilities. 4. Many of the problems were the result of the inability to manage the economy in the face of conflicting pressures which at different times battered the politically weak central government. The fall in world coffee prices in the last half of the 1950ts necessitated some internal adjust- mKents that were difficult to make and slow in coming. The politically powerful coffee sector resisted the decline in its real income by attempting to place the burden on other sectors of the economy. This was done from 1959-1962 by large scale financing of coffee stocks on the part of the central bank with consequent pressures on prices and the exchange rate. In late 1962 (with the financing of the coffee crop in the second and third quarter) these pressures became great enough to force a major change in the exchange rate together with a rapid rise in prices. Public Revenues 5. This process of adjustment was further compounded by the vulnerability of the tax system to inflation and by the tax reforms intro- duced in 1961 and 1962. The 1962 tax reforms introduced many desirable refinements into the tax system, but they failed to take into account the :impact upon government revenues. The result was a 20 percent decline in revenues at a time when a substantial development program was initiated. Part of this decline in government revenues was offset by central bank borrowing which further increased the inflationary pressures. All this culminated in the over 25 percent increase in prices experienced during 1963. Since 1963 the process has been one of attempting to stabilize the economy with varying degrees of success from year to year. 6. Monetary policy has since improved, but as a result of its re- lationship with an inflexible management of the exchange system, the tax base of the fiscal system was eroded. In order to maintain the level of government revenues, new tax measures were introduced. In 1964 sur- charges on income tax liabilities were introduced, together with increases in stamp taxes and inheritance taxes. A gasoline tax of 10 percent and a change in the income tax provision providing for the use of livestock losses  - 3 - on income earned in other areas also helped to increase revenues. They resulted in a temporary respite for the government, but failed to impart any long-run flexibility into the tax system, particularly under inflation- ary conditions. Table I-2: CENTRAL GOVERNMENT REVENUES AND EXPE1DITURES 1A A PERCENTAGE OF GDP (1958-1966) Current Currenit Investment Total Rate of Change Revenues Expenditures Expenditures Expend. in Pricesa/ 1958 7.9 1959 8.2 1960 8.0 6.0 1961 7.3 5.0 n.a. n.a. 7.9 1962 6.3 5.7 3.1 8.8 5.6 1963 7.2 4.8 2.6 7.4 2h.5 1964 7.3 5.4 2.6 8.o 15.7 1965 6.7 5.1 2.3 7.h 8.7 1966 8.2 5.5 2.6 8.1 17.5 a/ Consumer Price Index (employees) of the Banco de La Republica, Mid-year changes. Source: 1956-196O, OA/IDB Joint Tax Program Report Fiscal Survey of Colombia, John Hopkins, 1965, p.4 1961-66, Table I-7. 7. In 1965 the income tax surcharge was extended and with a clevaluation of the exchange rate in September of 1965, the taxation of coffee became more effective. The yield from import duties also increased. These changes were not, howevesr, of sufficient magnitude to offset the real decline in government revenues (Table I-7) and central bank borrowing was again required to maintain the level of government expenditures. 8. In 1966, a major improvement took place in the financial structure of the public sector. This was the result of a more realistic exchange rate combined with higher customs duties and the introduction of a major new tax, the sales tax. These succeeded in increasing the real level of government income and expenditures from the previous low levels of the past few year and in providing sufficient income to avoid the necessity of central bank financing. 9. One of the more unfortunate results of the current system has been the necessity for the government to impose new or additional taxes every year. This has created an unfavorable political climate and engenders a good deal of tax-payer hostility even though the relative tax burden has not shown much change. These annual exercises have also made  - 4- it difficult for the government to effectively engage in any but vely short-term planning of exqend:itures as such an air of uncertainty surrounds the revenue prospects. Expenditures 10. The difficulties associated with maintaining the real level of government tax income necessarily resulted in considerable differences between planned targets for saving and investments and the actual levels achieved. Table I-3: COMPARISON BEWEEN ACTUAL AND PROJECTED INVESTMEITS ANiD SAVINGS (in million of 1961 pesos) 1962 1963 196L 1965_ A. Savings 1962 Mission Recommendations 1668 1932 2151 2432 Actual 872 1226 1311 1157 Difference -7 - 706 - 7L5 -127 Difference as I of .1ecommendations - 48 - 36 - 34 - 52 B. Investment 1962 Mission Recommendations 2327 2863 3330 3.451 Actual 2335 21L1 1830 18hB Difference - 722 -T:73 -1rD1 Difference as % of Recommendations -- - - !44 - 47 Source: Recommendation from Ii3RD Report WH-119a, Table 1a. Actual savings and investment from Table I-6. Price deflator, BOR consumer price index (employees). 11. Another factor that also affected the plans of the public sector was the much lower level of exiiernal aid available (55 percent less than planned). The short fall in excternal aid can be directly related to the performance of the public sector which was such that it resulted in sub- stantial difficulties in obtaining local financing for externally aided projects.  - 5 - Table I-4: RECOMMDlDED AIJD ACTUAL MET DISBURSIMENTS OF EXTERNAL AID TO THE PUBLIC SECTOR (in millions of US Dollars) Difference as 1962 Mission percent of Recommendations Actual Difference Recommendations 1962 80 54 26 - 33 1963 149 72 77 - 52 1964 187 60 127 - 68 1965 163 74 89 - 55 Total: 1962-1965 579 260 319 - 55 Source: IBRD Report ETH-119a, Table 16, and Table I-6 with net external aid converted to dol:Lars at a rate of Ps.9.00 = US$1.00 12. The decline in investment expenditures was not the result of increased current account expenditures, but ratlher the result of lower levels of tax revenues. Current expenditures in general remained relatively constant in real terms over most of this period. Table I-5: CURRENT iACCOUNT EXPEJDITURRS OF THE CENTRAL GOVERYMET (in miillions of 161 pesos) 1961 1962 1963 1964 1965 1966 Personal Services 792 847 893 946 943 1097 General Expenditures 265 260 345 184 171 156 Transfers 389 590 538 633 587 651 Interest 69 114 132 130 120 200 Total 2.515 1811 1908 1893 1821 2094 Source: Table I-7. Price deflator BOR consumer price index (employees).  - 6 - 13. It is only in 1966 with some increases in public salaries that the average pay of civil serVants in real terms reached its pre-1962 level. The atmosphere has been one of general austerity in the public sector with little or no expansion taking place. In an economy with a growing population, in the judgment of the mission, this cannot but have had serious effects upon bothl the quantity and quality of public services offered and in the long run a detrimental effect upon the rate of economic growth. C. Policy Measures September 1965 to March 1967 14. This period of approximately eighteen months has seen a major improvement in the fisca:L po:Licy of the government. Substantial efforts were taken to halt the declille in resources going to the public sector by increasing the effective rate of taxation and lessening the reliance on domestic credit. These iiiprovements do not, however, leave any room for complacency; in general, they restored levels of investment and savings to the real levels prevailinrg in the late fifties. An important factor has been the direction of these changes which has tended to lessen the reliance of public revenues on a poorly enforced and inadequate system of income taxation. 15. The main impact of the policy measures taken in September of 1965 was upon the rate of exehange, but this in turn had major effects upon government revenues. In 1966 two taxes alone accounted for most of the increase in government revenues, the sales and import taxes. Part of the increase in both saleS and import taxes was due to increased rates (an improved enforcement in the case of the sales tax), but an important part was due to the greater vrolume of goods imported at higher exclhange rates. A more liberal import policy combined with more effective exchange management made possible a hlgher volume of imports, particularly of thlose items (e.g. automobiles) which account for a large part of import duties and sales taxes. 16. This increase has not been sustainable over time because of the cyclical nature of the increaLse in imports. The past use of a stop-and-go crisis policy for exchange management has built into the Colombian economy an unstabilizing capital stock adjustment process which leads to periodic upswings in the demand for many imports. This cycle is particularly notice- able in the demand for and the age structure of automobiles in Colombia (see pages 43-h6). In 1966 the government was able to take advantage of this upswing by imposing a higher level of taxation which both modified the cycle and increased goveriment revenues. 17. The exchange crisis that took place at the end of 1966 brought to an end the upsurge in imports. This in turn has affected government revenues. Lower imports and a policy of restricting the import of automobiles (to conserve exchange and to stimulate domestic assembly operations, but also because of the cyclical decline in demand), has  - 7 - meant that for 1967 new sources of taxation have had. to be exploited in ordar to provide the neces3ary level of public revenues for the execution of the investment program. 18. As in 1966, a further move was made in the direction of more indirect taxes. The introduction of a one peso tax on gasoline and a 45 centavo tax on diesel oils in December of 1966 will account for an estimated 57 percent of the increase in government revenues expected during 1967. The other major source of increased revenues is to come from the lower subsidies to be given to some classes of imports. In the past, a large part of the tax on coffee, through the mechanism of an exchange differential and exchange funds, has been used to finance certain imports, thus the proceeds accruing to the government have been consider- ably less than the tax borrm by the coffee sector, Through the operations of the new exchange system (see Main Report) coffee is to be taxed directly and import subsidization avoided. The impact of this measure is estimated at accounting for 21 percent of the projected increase in government revenues in 1967. These two rmeasures thus account for 78 percent of the projected increase in revenues (of the remaining 22 percent, 19 percent is estimated at being the result of increases in the collection of sales taxes). If these two specific measures had not been taken, government revenues would have increased by 7 percent or by less than the expected increase in prices. 19. In addition to the major changes discussed above, se,oral minor taxes were introduced or reformed, A 500 peso stamp tax on foreign travel by Colombians, plus a 15 percent surcharge on the income tax liabilities for residence abroad, were put into effect in 1966. Automobiles were sub- ject to a higher level of stamp taxes and cattle raisers were required to purchase bonds on a bsis of the number of animals slaughtered. An attempt was also made to improve the 'Legislation authorizing betterment assess- ments on public works. 23. Some attention has also been directed toward improving the system of direct taxation. During 1967 an attempt is being made to introduce a system of retentions for the income tax (Decree 2933 of 1966). Initially, the amounts retained are to be between 5 and 10 percent of current tax liabilities (see pages 28&29), but the decree provides for discretionary increases in the amounts to be retained in subsequent years. The Govern- ment has expressed its intentions of completing the change over to a current system of payments over a period of 5 years. The successful introduction of such a system will go a long way in improving what in the past has been the major weakness of the income tax, its erosion in real yields due to price increases.. The Government is also considering several measures to improve the performance of income tax collections by decreasing the opportunities for evasion.. These measures, if put into effect, twill have only a minor impact on revenues and, while improving the equity of the tax system, do not do more than touch on the periphery of the problem (see pages 29-36).  - 8 - 21. On the expenditure side, policy has been one of restraining current expenditures. In 1966 a blanket one percent per month dacrease in current expenditures was decreed for the central government. This crude measure reflects the coritinued preoccupation of the Government with what it regards as excessive levels of current expenditures. As is pointed out elsewhere (Table I-5), this is an unjustified concern and inay, in fact, be detrimental to the administration of the public sector. In 1967 the Government intends to continue its policy of restraining current expendi- tures. D. The Outlook 1967 - 1970 22. In the appendix to this chapter, an attempt has been made to illustrate the probable magnitudes of the resources and requirements of the public sector for the four-year period from 1967 to 1970. The results are summarized in Table I-6 tc I-8. These projections are necessarily based on certain assumptions regarding the policy of the Government and m1 formulating these assumptions, the expressed intentions of the Government were taken into account. The basic goal of the exercise is the Government's 6 percent increase per year in output. Once this goal is accepted, it implies certain levels of savings and investment, of exchange rates and monetary expansion. 23. The results of this exercise suggest to the mission that the policies followed with respect to the exchange rate and the rate of price increase are of crucial importance in determining the level of resources available to the public sector. TheAincreasing reliance of the tax system on indirect taxes, particularly on foreign commerce and sales, has made revenue yields very sensitive to shifts in the exchange rate and the volume of imports. Failure to adjust exchange rates to changes in the domestic price level will rapidly decrease the rssources available to the public sector. Closely allied to the exchange rate policy is monetary policy. The system of direct taxes, plus the numerous specific indirect taxes, particularly at the local level, still leaves the tax system very vulnerable to rapid increases in price levels. Thus a policy of moderate price increases followed closely by adequate management of the newly established exchange systemis of the utmost importance if the public sector is to operate at the levels implied by a 6 percent rate of growth. The projections assume that the Government's policy of reducing the rate of price increases is successful and that any changes in price levels are compensated for by appropriate changes in exchange rates. 24. Given the success of exchange and mcnetary policy, the tax system can be expected to provide the Government with sufficient resources to carry out its goals. This foes not mean, however. that no further action is required on the part of the Government; on the contrary, it assumes that the Government undertakes without undue delay its proposed program of tax reform. If the efforts of the last eighteen months are not sustained, Colombia will continue to be plagued with a serious fiscal problem.  Table I-6 PUBLIC SECTOR INVESTMENT AND ITS FINANCING 1961-1970 (in millions of pesos) Projected 1961 1962 1963 1964 1965 I966 1967 19Poc 1969 1970 I. Resources i* Current Account Surplus of a. Central Government 684 200 560 969 938 1959 2430 2786 3005 3778 b. Decentralized Agencies 37 91 126 281 203 266 310 355 401 446 c. Municipalities 390 360 558 622 702 829 967 1107 1250 1391 d flepart"iiernts 298 24Y 346 112 119 139 162 185 209 233 e. Social Security System 27 21 21 10 - 50 - 32 --- --- __ --- total 1436 921 1611 1994 1912 3161 3869 4433 4865 5848 II. Investment a. Central Government 648 649 668 771 666 852 b. Decentralized Agencies 636 856 995 1145 1385 2159 c. Municipalities 334 667 813 813 878 1005 d. Departments 295 294 337 129 119 139 e. Social Security System --- --- --- --- --- --- total 1913 2466 2813 2858 3048 4155 5118 6311 7622 9047 III. Financed by Credit 477 1545 1202 864 1136 994 1373 2266 3235 2865 a. External Net n.a. 370 648 535 569 538 717 1346 2508 2247 (Amortization) (307) (186) (310) (330) (315) (560) (805) (933) (1003) (1188) b. Internal Net n.a. 1056 554 329 467 265 306 350 395 440 c. Counterpart Funds (U.S. Program Loan) n.a. 119 --- 3 100 191 350 570 332 178 Deficit (+) or Surplus (-) - 388 - 478 334 Export Subsidy _441 584 766 Unfilled Requirements (+) or Surplus (-) - 124 53 106 1100 Source: Historical Data, 1961-66, Table 1-7, III- 1, III-4, IV-1. Projections, See Appendix, Chapter I.  Table I-7 CURRENT ACCOUNT OPERATIONS CENTRAL GOVERNMENT (cash flows, in millions of pesos) Projected 1961 1962 1963 1964 1965 1966-/ 1967 1966 1969 19_70 I. Current Account Income 2199 2114 3069 3847 3948 6028 7162 8401 9591 11416 1. Income Taxes 990 1065 1383 1881 1961 2292 2646 3286 3882 4876 2. Custom Duties 592 540 565 659 670 1901 126i I -___ I_l_._ 9101 3. Exchange Differential-' - _ 532 626 340 346 630 827 839 914 4. Sales Taxes - - - - 222 544 800 916 1034 1151 5. Stamp Taxes 88 98 117 152 153 231 363 405 448 489 6. Gasoline Tax - - - 44 56 62 713 743 774 807 7. Petroleum Revenues n.a. n.a. - 39 53 54 54 54 92 109 8. Other 529 411 472 446 493 598 692 785 878 969 c I. Current Account Expenditures 1515 1914 2509 2878 3010 4070 4732 5615 6586 7638 1. Personal Services 792 895 1175 1439 1560 2059 2400 2885 3419 3997 2. General Expenditures 265 275 453 279 283 313 365 439 520 608 3. Transfers 389 624 707 962 970 1310 1603 1927 2283 2669 4. Interest on Public Debt 69 120 174 198 198 388 364 364 364 364 a. External 29 50 71 90 83 119 b. Internal 40 70 103 108 115 269 I. Current Account Surplus 684 200 560 969 938 1959 2430 2786 3005 3778 Preliminary Coffee Tax after 1966 urce: Historical Data 1961-66, Tesoreria; Banco de la Republica, Contraloria, Mission estimates. Projections 1967-1970, see Appendix Chapter I.  - 11 - Table I-8: SAVIWGS AND INVESTMENT OF THE PUBLIC SECTOR (1961-1970) Pate of Growth Savings Investment GDP of GDP Millions Percent M'illions Percent Eillions Current Constant of pesos of GDP of pesos of GDP of pesos Prices Prices 1961 1,436 4.77 1,913 6.36 30.1 14.0 5.2 1962 921 2.74 2,466 7.34 33.6 11.6 5.0 1963 1,611 3.77 2,813 6.59 42.7 27.1 3.1 1964 1,994 3.78 2,858 5.42 52.7 23.4 6.1 1965 1,912 3.25 3,o48 5.18 58.8 11.6 3.2 1966 3,161 4.28 4,155 5.63 73.8 18.4 4.7 1967 3,869 4.49 5,118 5.94 86.1 16.6 6.0 1968 4,433 4.5o 6,311 6.41 98.5 14.5 6.o 1969 4,865 4.38 7,622 6.85 111.2 12.9 6.0 1970 5,848 4.72 9,047 7.31 123.8 11.3 6.o Source: Table I-6  - 12 - Central Government bvenues 25. Thlie revenues projected for the central government for 1967 represent a realistic appraisal of the revenue measures already taken by the Government, Additional measures proposed, but not enacted as of this date (April 1967), are not expected to yield large revenues. Existing sources of revenue should provide sufficient resources to carry out the 1967 program of expenditures, but care must be taken to work for the maximum yield possible on all taxes. In the last two years the performance of the income tax has been very poor and in order to collect the projected sum of Ps. 2646 million, a substantial administra- tive effort will be required. Care must also be taken to avoid an eros:.on of the yield of the coffee tax without providing alternative sources of revenue. 26. In the period beyond 1967 a further effort will be required to raise public revenues and the most obvious source for such additional revenues is the income tax. Recent changes have emphasized indirect taxation and further changes should be aimed at the system of direct taxes. The projections of Table I-7 assume that no new taxes are intro- duced and instead relies solely on the retention system to pro-vide the necessary revenues. If the rate at which the retentions are increased is as suggested (Appendix page 21 ), sufficient revenues should be generated for 1968 and 1969 after which. further measures will be required. Central Government Expenditures 27. The mission feels that current Government policy has placed too much stress on the curtailing of current expenditures and that present levels of current expenditures are too low to be consistent with the stated goals of economic growth. It is neither equitable nor efficient that public employees (and thus public services) bear the burden of in- flation imposed by an ineffective tax system. For 1967 the Government has expressed its intention to hold doun the level of current expendi- tures, particularly wages and. salaries. As the real wages of public servants has declined in recent years, some doubt can be expressed as to the Government's ability to continue this policy without generating con- siderable labor unrest such as was experienced in 1965. The projection for 1967 assumes that the relative position of public salaries remains unchanged, that is, that salary increases will be equal to the increase in prices and real income. The mission has grave doubts as to the wisdom of this policy and as to the G'overnment's ability to carry it out. 28. The expenditure estimates for 1967 should be regarded as being underestimated, which reinforces the conclusion that great efforts must be taken to insure the maximum yield of all taxes in 1967. 29. After 1967 the projections have included an additional 5 per- cent increase per year in all, current expenditures (except interest) over and above the projected increases in income and prices. This is an extremely modest rate of increase and assumes that there is no marked increase in the number employed and that by 1970 the relative position of  - 13 - public service salaries in the economy will be approximately that of 1962 where they were 20 percent below that of the private sector (see Chapter II, table II-19). Resources for Investment: Public Savings 30. The projections indicate no substantial increase in public savings (Table I-8) as a percentage of GDP because of the necessity of increasing current expenditures. Central government revenues are, howv- ever, projected at rising as a percentage of GDP: Total Current Revenues Public Savings (Millions of pesos) /O of GDP as 5 of GDP 1966 6028 8.16 .28 1967 7162 8.32 4C.9 1968 8h01 8.53 4.50 1969 959l 8.63 4 38 1970 114a.6 9.22 4q72 31. The quality of the data of the local government and decentral-. ized agencies does not make it possible to other than indicate the order of magnitude of their resources available for investment. It was assumed that they remained the same proportion of GDP as in 1966. This understates the potential resources available in that with improvements in tax col2lecticnrs and more realistic utility rates this group of institutions could become a significant contributer to public savings (See Chaper III). Public Investment 32. The improvements that have been made in the organization and training of those who prepare and administer the public investment program has reached a stage where the capacity exists for the undertaking of an investment program of the size envisaged in the projections of Table I-6, The exchange crisis of November 1966 together with the uncertainties it generated, has slowed down the formulation of the 1967 investnient program, thus the target of Ps.5118 million is not likely to be met. A slightly lower level of investment should, however, ease the situation izEth respect to current expenditures and, at the same time, permit a greater build-up of international reserves (see iMIain Report). 33. The estimates of public investment are based on simple macro- economic analysis which only can indicate approximate orders of magnitude3 The relationship between investment and the rate of growth, at least in the short run, is uncertain, Equally uncertain is the division between public and private investment. The projections of public investment assuime Ute continuation of the historical trends in the relationship between  - 14 - public and private investment. There is no economic reason why this relationship cannot be altered in the future, but it appears unlikely that the direction, at least in the long run, will be one of less public investrnent given the dominant position of the public sector in economic infrastructure. Public Credit 34. The estimates of e.:ternal assistance are based on the Govern- ment's proposed list of projects together with some rough estimates about the availability of non-projelCt type of assistance (see M4ain Report, Ch. III Section C ). Here again the estimates are subject to considerable variation and revision depencing on the delays encountered in project pre- paration, construction and financing. As with the figure for investment, the 1967 external financing available may be overstated due to the delays experienced in late 1966 and early 1967. 35. The projected pattern of these credits over time shows a decrease in external credits available in 1970. This is due to the estimatedi diminishing role of external assistance as the effort to develop exports gains momentum. Many of the new projects proposed will not reach the stage of large disbursement by this date. There is no reason why, in the inter- vening period, suitable projects cannot be prepared to fill i.n this gap - *the projections merely indicate that some thought should be given today when project preparation is in the initial stage, to their fu;ire disburse- ment pattern. Some of the projected decrease is the result co projected increases in external financing to the private sector through instituticns that are not included here in the public sector - the Private Investment Fund and the Agricultural. Bank. 36. The projections shcw the following division between domestic and external financing of public investment (percents): External Domestic To be Financed 1966 17.5 82.5 1967 20.8 79.2 1968 30.4 69.5 0.1 1969 37.3 62.6 0C1 1970 26.8 61,0 12.2 The percentage to be externally financed is close to the one-third recoinmen- ded in the previous IBRD Report (WH-119a). The lower levels of externaL assistance available between 1964 and 1967 have, of course, raised the percentage of domestic financing of a lower level of investment over this period.  - 15 - The Deficit and the Expor-t Susidy 37. In 1968 and 1969 a surplus is generated by the projected levels of income and expendituires. This surplus is, however, offset by the export subsidy introduced in the exchange lawi of 1967. This subsidy is to be 15 percent of the value of minor exports payable one year from the time of sale an(d given the assumption of the success of this measure (combined with other means used to stimulate exports), the impact upon Government revenues becomes substantial by 1970. In view of this impact, some reconsiderai;ion of this policy might be called for be- fore 1970. This reconsideration will have to be made as soon as the incentives for exports generated by the new exchange system and the pro- motional efforts of the Export Development Fund prove sufficient to sustain an adequate growthl rate of exports. As a principle, the size of the subsidy required shou]d diminish the more the exchange rate is allowed to reflect the domestic external cost structure. The danger inhiereiit in this type of subsidy is that it may continue long after necessary and may be used as a substitute for a realistic exchange policy. It may, however, prove a useful way of getting an immediate increase in exports without the disturbances that would be generated by a rapid devaluation of the exchange rate. The measure is an experimental one and should continue to be regarded as such, Tax Policy and International Reserves 38. The negative reserve position of Colombia has made it imperative that some resources be channeled into the building up of reserves, This means that some group or groups in the economy will experience a decline in income. This can be done through some combination of monetary policy (lower levels of credit expansion), a flexible exchange policy, and taxatiorn The tight monetary situation that will be the result of any attempt to moderate the rate of price increases will make it extremely difficult to use monetary policy and serious thought should be given to using the tax system to generate a surplus. The projected surplus for 1967 should be of great assistance in carrying out the Govern-ment's international reserve policy. The surplus to be generated beyond 1967 will be very much depen- dent on what happens in 1967, but carc should be taken to see that mone- tary, fiscal and exchange policies are closely coordinated to yield the desired results.  - 16 - E. Sunmary and Conclusions 39. Since the late l'9O0s Colombia's monetary, fiscal and exchange policy have been badly cooreinated and unable to prevent periodic financial crisis from having; a detrimental affect upon economic growth. Much of the uncertainties and instabilities of this period were the result of the failure to adjust fast enough to the external shock generated by world coffee price declines. The political donLinance of the coffee sector has meant that this has been a period in which an attempt was made to shift the adjustment burden (lower real income) to other sectors of the economy which in turn have tried to maintain their relative positions. The resulting instability, chiefly in the form of irregular monetary expansion, has had adverse affects upon Government revenues, which were based upon an ineffective arLd weak tax system. In the last two years, several hopeful signs hcave Emerged, which could mean an end to the past pattern of instability. Major steps have been taken to protect Govern- ment revenues from the adverse affects of inflation which should elimi-nate one of the unstable elements in the economy. In the past, Government deficits have been both the result and the cause of instability, This difficult period has also developed an increasing awareness within the Government of the compleXities of a modern economy which require the close and careful coordination of all parts of public policy. 40. The management; of public revenues and expenditures has, in particular, shown a marked improvement, but unfortunately this inprovement has been offset by difficulties in both monetary and exchange policy. The Government has, however, expressed its intention and taken the initial steps towards improving all aspects of public policy. The mission feels that if the proper mix of monetary exchange and coffee policy is under- taken, the measures already implemented, or in the process of implementa- tion, should provide Colombia with a fiscal policy that will adequately provide for its needs over the immediate future. If, however, the necessary coordination of p.blic policy is not forthcoming, the fiscal situation could once more be a source of concern. 41. Throughout this arnex, the mission in its examination of the various aspects of the public sector has made a number of suggestions as to the future direction of policy anid the following pages atteAmpt to d2raw these suggestions together. In many cases these suggestions have merely formalized steps that the Government already has under active considera- tion. Tax Policy 42. The basic steps have already been taken to provide the country with a sounder and more realistic tax system. The most significant of these steps for the future has been the provisions made to place the income tax system on a current payment basis through retentions at the source. The mission in its projections has emphasized the introduction of this system as the source: of revenue for public expenditure over the  - 17 - next four years. This will allow the Government sufficient time to irmprove the existing tax system through various reforms which should provide a sound basis for development. Future reforms should concentrate on improving the existing tax system rather than in the introduction of any new taxes. 43. The Income Tax. In expanding its system of retentions the Govern- ment should focus more on tax liability rather than working wTith a percentage of monthly income, that is, the increasing bite of the retention system should be felt on estimated tax liabilities. The failure to do this results in an inequitable distribution of the burden, In addition, pro- visions should be made to place all new taxpayers immediately on a 100 per- cent retentions system. Those, for example, who did not submit a tax return last year (or paid no taxes) should be required to pay all taxes currently on their estimated liability for the year in progress. 44. Aside from the retention system a major concentration of effort should be made to improve the system of income taxes through a simpli- fication of their structure. Past attempts at administrative reform and enforcement have been frustrated by the overwThelming complexity of the tax system. Before greater taxpayer compliance can be expected the taxes must be made easier to pay. Towards this end the mission suggests four main areas of emphasis: (1) the simplification of the rate structure; (2) the elimination of many c,f the deductions; (3) the eliminatation of all surcharges and additional taxes on income (such as the steel and housing tax); and (4) the incorporation of the net wealth ta,c Lnto the property tax. The aim of these reforms (to be introduced gradually) would be to provide a personELl income tax with about ten marginal brackets and a drastically simplified system of exemptions. One such system of exemptions (such as is used in Mexico) would be to provide a basic 10 or 20 percent exemption (after a basic minimum) on gross income up to a specified amount. This wrould avoid much of the present complexities of the system of deductions. A!1 alternative would be to substitute a tax credit for dependence allowances only and to combine it with a flat per- centage for all other deductJIons. The difficult to administer rnet wealth tax could become part of a more effective system of property taxation0 45. The taxation of business income should also be simplified so that it does not discriminate against either size or form of organiza- tion. At present, much of the effort to counteract evasion arises because of a tax system which encourages complicated forms of organization and income splitting. The direction toward which business taxes should move is to a proportional tax on business income regardless of organizational form. Special development ilcentives should be avoided or replaced by more direct forms of subsidization. Consideration also might be given to making the business tax a form of withholding or tax credit for the personal income tax.  - 18 - 46. Regardless of the chaanges introduced great care should be taken to estimate the affect on Government revenue. The tax reform of 1961, which did not pay enough attention to this fact, resulted in a 20 percent reduction of the central government's revenues. Towards this end it is imperative that better income tax statistics be developed. At present very few useful statistics come out of the income tax office and before any meaningful analysis of proposed changes can be made, these statistics must be forthcoming. 47. Indirect Taxes. There are still many steps that can be taken that would lead to a simpler and more equitable system of indirect taxa- tion. Most of these measures would have a minor impact and the mission feels that of these indirect taxes two in particular, the gasoline tax and the import tax, need some revision. In recent years there has been an almost constant manipulation of customs duties with the result that they contain inconsistent tariffs (from the point of view of stated policy) and give in some cases excessive levels of protection. Often these tariffs are exaggerated by exchange and import controls. A thorough review of these tariffs is needed to establish a less complicated and more rational structure. It would also be a good idea to place the gasoline tax on an ad valorem basis to avoid the erosion of real yields during periods of changing price levels. Sales taxes might also be expanded to include some services. The rate at which changes are introduced should be dependent on the effectiveness of income tax reforms and the introduction of the system of retention. 48. Petroleum Taxation. Chapter VI of this report deals specifically with the problems of petroleun taxation. This is a difficult and complex field of taxation and the suggestions outlined in this Chapter (VI) merely point in the direction in which improvements can be made. The main factor that must be kept in mind here is the limited ability of Colombia, given its position as a high cost producer, to tax petroleum at rates other than those dictated by the oligopolistic nature of the world's market structure, Expenditure Policy 49. The chief concern of the mission here is the deterioration of current expenditures. The difference between capital and current expendi- tures is at best arbitrary and to focus all effort on increasing capital expenditures does not necessarily lead to faster economic growth. There are many current expenditures that can also have a positive impact upon growth as, for example, expenditures on education. A certain degree of waste and inefficiency is endemic to all large bureaucracies and Colombia appears to be better off than most countries of Latin America in this respect. The more negative aspect of this is its affect on the efficiency of public administration. Low salary levels in relation to the private sector particularly in the upper administrative brackets cannot but have a detrimental impact. A modern economy cannot depend upon the existence of a  - 19 - dedicated upper class to provide the managerial and professlonal skills required to run its public administration. A serious gap in public policy exists here. Local Governments 50. Local governments are in need of reform if they are to be expected to carry out many of their past responsibilities. Their present tax systems cannot provide the necessary revenues and their administra- tive structure is too poor to adequately manage the expenditures even if they had the revenues. To change the structure of local governments is necessarily a long-term project, but some thought should be given currently to measures that would alleviate some of the more immediate problems. The need for revenues is pressing and the mission suggests that improvements in property tax administratiorn be used to provide the resources (see pages 82&- Perhaps the easiest system would be to link property values to a general price index and thus avoid the problems associated with property valuation. A more effective tariff structure for public utilities is needed. There is also a serious information gap with respect to local governments. Information comes in too slowly and is too incomplete to allow the effect- ive incorporation of this important sector into the general planning of the public sector. The Decentralized Agencies '51. No attempt has been made (in Chapter IV) to provide a compre- hensive analysis of all public: agencies, but rather the focus has been one of the relationship of the agencies to the rest of the public sector. Here, as is the case with 10CEL1 governments, the problem is one of an information gap. Too little is known by the center regarding the current activities of these institutions. The mission strongly recommends the continuation of the questionnaire technique developed in the Planning Office in 1965 on a regular basis. Social Security Institutions 52. Chapter V contains a detailed analysis of the social security system, the main conclusion of which is that the system is inadequately financed and thus may constitute a major drain upon public revenues in the near future.  - 20 - Aaendix Chapter I 53. The purpose of this appendix is to outline the methods used and the assumptions behind the projections contained in tables I-6 and I-7. These projections are basically illustrative in character and attempt to show the impact of certain policy measures upon the income and the expendi- tures of the public sector0 The estimates for 1967 are, barring any marked shifts in policy, a reasonable approximation of what can be expected to take place during the year; the estimates for 1968 and beyond are necessarily of a more tentative nature. 54. Behind all of the estimates are the assumptions made as to changes in the price level, real income, and the exchange rate. The Government's goal of a 6 percent increase rer annum in national income is accepted as a basis for the projections, that is, this is the goal towards which policy is directed. This may be a scmewhat ambiticus target, particularly for 1967, but it is nevertheless useful to work out the implications of this rate of growth. A second aim of the Government, to reduce the rate of in- flation, is also built into the projections. The rate at which to decrease the rate of price increases in an optimum manner is an unrimotn variable of the economic system and largely a matter of judgement. The following price changes are what the mission regards as a feasible patterng 1967 10.0% 1968 8.0% 1969 6.5% 1970 5.0% There is nothing inherently preferable in this rate of decrease over arny other,but given the 13 percent rise in prices during 1966,it does not appear unrealistic. To assume no increases in prices during this period would be unrealistic in view of past changes in prices and the adverse im- pact of such a policy on t1ie lievel of real income. 55. The assumptions made with regard to changes in the exchange rate are necessarily more complex, It is assumed that the new exchange system will result in rates of exchange that will reflect both the rising domestic price levels and the competitive position of Colombian exports. (For the specific assumptions see Annex II, Miain Report.) It should be stressed that these estimates are part of the illustrative nature of the projection exercise and merely reflec-t the mission's informed guesses as the magnitude of exchange rate movements given the assumptions regarding prices, exports and imports. (See Main Report, General Note to Statistical Annexes). ventral Government Revenues 56. The Income Tax. The past performance of income tax collections nas not been good and seems to indicate that this tax has an income  - 21 - elasticity of less than one.1/ The Government has expressed its intentions to improve this record and as an initial assumption a basic incomne elasti- city of one has been assumed. The rate structure of the income tax system would indicate that the elasticity should be much higher than this, thus a marked improvement in the system (as for example along the lines suggested on pages 17-18) should increase this elasticity. Given an elasticity of one, the one year lag in collections means that this year's collections will be based on last year's changes in income. During 1966 real income grew by 4.7 percent and prices increased by 13.1 percent, thus collections in 1967 should be 18.4 percent higher than in 1966. Collections in 1966 were Ps. 2292 million on a cash basis of which an estimated Ps. 150 million was attributable to the 10 percent surcharge in effect during this year. The basis of the projections is thus Ps. 2142 million. Table IA-1: CALCULATION OF INCOME TAX COLLECTIONS (in millions of pesos) 1967-1970 1956 1967 1968 1969 1970 1971 a. Price increase 11,3.1 110.0 108.0 106.5 105.0 - bo Real increase 10)4.7 106.0 106.0 1C6.0 106.0 106.0 c. Change in money income (a x b) 113.4 116.6 114.5 112.9 112.3 106.0 d. Collections based on elasticity of 1 and 1 year lag 2142 2536 2904 3279 3650 3869 e. Retentions 110 492 1095 2321 f. M4inus taces paid - 110 492 1095 g. Tax collected (d+e-f) -264 3286 38t 2 U-876 h. Net impact of Retentionas (e-f) 110 382 603 1226 Source: Se)e text. 57. Incorporated into the projections are several assumptions regarding the system of retentions iltroduced in 1967. The retentions for 1967 are less than that given by the tac base (which should yield approximately Ps. 200 million) for the reasonis given on page 29. The Government has expressed its intentions of placing the income tax system on a current pay- ment basis within a period of 5 years (by 1972), and in order to reach this goal it was assumed that the percentage of the tax liability retained doubled over that of the previous year. Thus in 1968 the tax liability is Ps. 3279 million, 15 percent of which is to be paid in 1968 (Ps. 492 million) ILJ This is possible given the lags in collection and an acceleration in - the rate of inflation.  - 22 - minus the amounts already retained for 1968 (Ps. 110 million). In 1969 retentions would amount to 30 p?ercent of that yearts tax liabilities in 1970, 60 percent, and in 1971, 100 percent. The Government has rot com- mitted itself to any particular rate of increase, thus the percentages used here are purely illustrative but do indicate the approximate orders of magnitude of the increases necessary to meet both the five-year goal and the need of the public sector for additional resources. The resulting net impact (line h) does not appear to represent an unreasonable additional tax burden. 58. Customs Duties. Taxes on imports were estimated by using the average tax rate (non-auto) for the latter part of 1966, 24.68 percent,/ and applying this to estimated imports (see laein Report, balance of payments) with appropriate deductions for exempt imports. Table IA-2: CAIJULATION OF CUSTOMS DUTIES (in millions of pesos & dollars) 1967 1968 1969 1970 a. Imports F.O.B. (US$) 658.4 719.7 792.2 873.2 b. Plus Freight & Insurance (Us$) 37X2 40o5 44I6 49e2 c. Imports CIF (US$) 695e4 76.32 *80J5 922- dr Minus Project Loans (Usp) 228.0 236.3 308.5 279.3 e. Taxable Imports (Pesos)a 7319 8014 9515 12161 f. 70% of taxable imports (Fesos)V/ 5123 5610 6661 8513 g. Tax Collected (Pesos)S/ 1264)/ 1385 1644 2101 a/ Converted at the exchange rates specified in Annex II, Main Report. b/ 30 percent of imports (the average for 1966) are tax exempt, generally because they are public sector imports. c/ 24.68 percent of line f. d/ In the consolidated revenue table, Table I-7, the Government estimate of Ps. 1266 million was used for 1967. Source: Import data and project loans, balance of payments sectic-n of the Main Report. 59. The Coffee Tax. The coffee tax was estimated by applying an average rate to the estimated coffee surrender to the Central Bank. 1/ Assumes that autos will have a negligible impact on Governrmlent revenues - see Chapter II.  - 23 - Table IA-3: CAL"ULATION OF THE COFFEE TAX (in millions of pesos and dollars) 1967 1968 1969 1970 a. Coffee Exports (US$) 323.9 331.7 33907 b. IMinus external expenditures of Coffee Federation (US$) 24.0 24-0 24.0 c. Exchange surrender (a-b) 222a/ 299.9 307.7 31. 7 d. Average Tax Rabt. (minus 4% to finance Coffee Fund)-' 21656 18.87 17.50 17.5o e. Tax in US dollars 47.9 56.6 53.8 55.2 f. Tax in pesos c 750 957 969 1044 g. Minus administrative expenses of BOR (Pesos) 120 130 130 130 h. Central Government Collections (Pesos) 630 8M27 839 913 a/ Banco de la Reptblica estiTaate for 3 quarters of 1967. b/ Assumes tax is reduced from initial 26 percent by one quarter of a percent per month through 1968. c/ ConvwJerted at rates specified in Annex II, Main Report. Source: Banco de la Repub:Lica and export projections of Main Report. 60. Sales Tax. This tax was estimated at having an income elasticity of one and projected on the basis of the incorme and price increases dis- cussed in paragraph 53, Ps. 800 million, the budget estimate for 1967 was used as the base. 6:L. Stamp Taxes. Most of the stamp taxes were estimated at growing at the same rate as price and income increases with adjustments made for stamp taxes on automobiles and international passages. Table IA-4: CALCULATION OF STAMTP TAX REVENUES (in millions of pesos) 1966 1967 1968 1969 1970 a. Assumed rate of growth 14 116.6 l...5 112.9 111.3 b. Basic Tax 231 269 308 348 337 c. Automobiles b/ - 54 54 54 54 d. Passages C/ - 40 43 46 48 e. Total Collections 231 3 63 707 9 4 i/ See paragraphs 53-55. b/ Assumed constant at Banco de la Republica estirmate for 1967. c/ Assumed to grow at the same rate as price increases. Source: Table I-7, Banco de l>- Republica, and text.  - 24 - 62. Gasoline and Fuel Texes. Tax collections were assumed to grox at the same rate as average gasoline consumption from 1960 to 1965, 4.2 percent per year. 63. Petroleum Revenues. The revenue projections are based on esti- mated production. 1967 anLd 1568 are projected at the 1966 level, Ps. 5 million. Revenues for 1969 are increased by 71 percent, the same rate of increase projected for export.-, and 1970 by 19 percent. 64. Others. All items except estate and gift taxes were assumed to grow at the same rate as income and prices. Estate and gift taxes were assumed to grow at the same rate as prices. Central Govcrrnment Expenditure s 65. All current expenditures except interest were assumed to grow at the same rate as the combiLed effect of prices and income. An addi- tional 5 percent in these items was assumed for 1968-70 for the reasons outlined in paragraphs 27-29 of this chapter. Interest payments were assumed constant because little of the projected increase in the external debt is directly serviced by the central government. Investment and Its Financing 66. Resources. The current account surplus of the central government was obtained by estimating both income and expenditures as outlined above, For the remaining part of the public sector such direct estimates are not possible due to the inadeqjuate quality of the data. Instead the current account surplus of the agencies and the local government was assumed to grow at the same rate as income and prices. This does not appear vnreasonabl: in view of past performance. 67. Investment. As no detailed public investment program has been prepared for all the public sector, the level of public investment was in- directly estimated by projecting the level of investment necessary to main- tain a 6 percent rate of growth. See Annex I, Main Report, for details of the investment calculations. 68. Financing. Net external credit was estimated from the list of suggested externally financed projects plus the disbursements on existing projects as contained in the Mlain Report (Chapter III ). Amortization was estimated by assuming that 18.9 million dollars of projected amorti- zation of the total external debt was payable by the private sector.  - 25 - Table IA-i RSTTIMATED NET EXTERNAL FPIANCING (in millions of dollars and pesos) 1967 1968 1969 1970 a. Gross Disbursements (us$) 97.2 134.8 i95.o 181.6 b. Amortization (US$) 51.4 55.2 55.7 62.8 c. Net External Credit (U'$) 1m5. 79-6 139.3 TlI7 d. Net External Credit (Pesos) '717 1346 2508 2246 Source: Main Report, Statistical Annex II. 69. Internal credit was assumed to expand at the same rate as prices and income. This in effect assumqed the continuation of recent policy where internal credit has been in the form of INCORA bonds and forced bond purchases. The Deficit and the Export Subsidy 70. The deficit or surpluis is shown (Table I-6) both including and excluding the export subsidy ofI Article 166 of Decree Law 444 of 1967. 'Tis subsidy was estimated by taking 15 percent of the projected minor exports and lagging the results by one year.  - 26 - II: THE CENTTRAL GOVERNMENT A. The Revenue System 71. The revenue system in Colombia has been characterized by a relatively high dependence on income and wealth taxes, a characteristic uncommon in Latin America. This, however, is changing rapidly as the income tax system has proved inadequate in meeting the expanding revenue needs of the Government. Table II-1: THE COMPOSITION oF CENTRAL GOVMINMENT REVENUES (in million of pesos & percentages) 1.962 1964 1966 Ps % Ps % Ps PS- 1. Taxes on income & property 1.215 57.5 1.954 50.8 2.373 39.1 2. Taxes on foreign trade 569 26.9 1.310 34.1 2.272 37.5 a. Customs ( 569) (26.9) ( 626) (16.3) (1.910) (31.6) b. Exchange differential ( - ( - ) ( 684) (17.8) ( 360) ( 5.9) 3. Taxes on Domestic consumption 133 6.3 351 9.1 1.176 19.b l. Other 197 9.3 232 6. o 2b0 a_.0 Total 2.11 100.0 3.847 100.0 6.06l1- 100.0 a/ Preliminary data Source: Table I-7 with division between taxes based on that in IMF Report SM/67/30 p. 115. 72. In 1962 income taxes accounted for 57.5 percent of total current account revenues declining to 39 percent in 1966. This decline is ex- pected to continue in the future as greater reliance is placed upon the various indirect taxes. Income and Other Direct Taxes 73. The Colombian income tax system is a complicated mixture of a  - 27 - number of taxes jnd surcharges levied both on natural persons and business organizations. - Table II-2: INCO]E & OTHER DIRECT TAXES (in million of pesos) 1962 1963 19614 1965 1966 1. General Income Tax 1047 1258 1759 1888 2. Extraordinary sur- charges - 223 331 215 3. Absentee tax 1 - - - 14. 3% Electric & Steel Tax 38 55 78 87 5. 1% Surcharge - - - - 6. Tax on Lottery Prizes 3 5 6 8 7. 6% Housing Tax 26 29 143 148 Sub Total (1-7) 1115 1570 2217 2246 2275 8. Property Tax 12 15 15 17 9. Gifts & Death Taxes 714 99 99 107 Sub Total (8&9) 88 114 1114 124 125 Total Direct Taxes (1-9) 1203 16814 2331 2370 2400 Total in 1962 pesos 1203 1353 1619 1513 1304 % growfth in real terms 0.0 12.5 19.7 - 6.5 - 13.8 a/ Mission estimates Source: Inforrne Financiero, annual, Contraloria General. This data is collected on a different basis than that contained in Table I-7 where the source is the Treasury. The data contained in this table is based on col:Lections attributable to the budget year and does not represent cash flows on a calendar year basis. This detail is not availab:Le on a cash basis. l/ A more detailed description and analysis of the income tax system is contained in the OAS/IDB study Fiscal Survey of Colombia, John Hopkins, 1965, Chapters 3 to 5.  - 28 - 74. The income tax in Cclombia has not been a success and unless reforms are undertaken it will continue to decline in its importance as a source of revenue. The basic problems are both of a structural and administrative nature. Steps have been taken to improve a still weak administration but these steps have been minim.al and because of a s-tructurally weak tax system even these minimal steps have yielded dis- appointing results. 75. Perhaps the greatest problem associated with the income taxes has been the inability of these taxes to insulate Government revenues from the effects of rising price levels. This arises out of the fact that pay- ments are made from one to two years after the income has been earned. The process of declaring income at the end of the tax year with payments to be made in the following year invites enforcement difficulties in an inflationary environment. Measures have been taken to offset the tax loss inherent in this lag and for the tax year 1967 a step in the direction towards a system of retention at the source has been introduced (Decree 2933 of 1966). 76. The System of Retention. The new system of retentions l/ requires all persons and business to withhold specified amounts of salary wage and dividend payments according to a given schedule of monthly pay- ments. These retentions are to be applied to the tax liabilities of the year in progress. The following table illustrates the impact of these payments: Table II-3: EFFECT OF RETENTIONS AT THE, SOURCE ON TAXPAYER LIABILITIES (in Ps. and percentages) Family Single person Retention as Retention as Annual Tax Tax percentage Taxb/ Tax Re- percentage IncomC/ Liabilitya/ Retained of liability Liability tamed of liability In.-_ Libiit_ y .t_.n_e. 27,000 730 - 0.0 1,475 135 9.2 33,000 1360 165 12.1 2,296 231 10.1 39,000 2170 195 9.0 3,290 390 11.9 LU8,ooo 3720 384 10.3 5,205 720 13.8 60,000 6420 600 9.3 8,127 1200 1i.8 69,000 8920 897 10.0 10,807 1725 16.0 78,000 11700 1170 10.0 13,580 2340 17.2 50,000 15520 11300 11.6 17,101 3150 18.1 1022,000 19500 2550 13.1 21,356 1080 19.1 120,000 25720 3600 1h.0 27,575 4500 16.3 lL4,000 34120 5040 14.8 35,737 7200 20.1 156,000 38320 6240 16.3 39,859 7800 19.6 200,000 54120 8000 11.8 55,380 10000 18.1 500,000 170220 19600 11.5 169,220 25000 14.8 '1/ A similar measure was introduced in 1962 (Decree 1651 of 1961) but was withdrawn after three months in operation because of political opposition Urid the lack of any adrainistra;ive machinery.  - 29 - a! Assumes average famiJ.y personal deductons or Ps.10,000 cf. OAS/IDB Fiscal Survey ibid., p.22 2. Does not inc'ude steel and electric development tax of 3 percent. b/ Assumes a basic personal deduiction of Ps.2500 and 2 percent of gross income for other deductions (medical, etc.) c/ Annual income implicit in monthly rate schedule of decree establishing retention system. Source: Decree 2933 of 1966 and Law 81 of 1960 (Basic income tax law). The system does not provicle for an accurmulation of payrents from various sources. IWhen more than 75 percent of income is earned from other than wages, salaries and dividends, an additional 5 percent of the tax liability for 1966 (liquidated in 1967) must be paid. The decree also permits the Minister of Finance to vary the rate of retention for each tax year. The above table is based on the rates established for 1967. 77. The system is an in.tial step and in view of the limited ad- ministrative preparations the small scale w7ill permit some time to make the necessary changes that will be dictated by experience. There are, however, a number of inequities in the system that should be altered as experience is gained. The upper limit of 4 percent on monthly retentions after an annual income of Ps.256,000 (5 percent for individuals) is a regressive feature as is the roncumulation clause of the decree. The revenue yield of this measure should be approximately 10 percent of income tax from individual collections as the majority of the tax is paid by tax- payers in the under Ps.l00,000 bracket and 5 percent on corporate and business taxes. Assuming the personal income tax to be 50 percent of total collections, the retention system should increase revenuies by approxi- mately Ps.200 million in 1967.1/ This, however, is an optimistic estimate and does not take into account the administrative difficuilties that will have to be overcome. A more realistic estimate would be for yields of about half this amount, that is, Ps.100 million. Structure of the Income and Conplementary Taxes 78. Taxes on Individuals. The main tax on individuals in the mixture of income and net wealth taxes is the progressive income tax, based on a wide definition of income that can be interpreted to encompass both capital gains and imputed income. The rate structure is approximately that shown in the following table. 1/ Assume a 10 percent increase in prices and a 6 percent increase in real income during 1967 giving a total tax liability of Ps.2700 million.  - 30 - Table II-L: AMOUNT PAID BY HEAD OF FAMILY FOR PERSONAL INCOME TAX (in US$ except where noted) Gross Income Tax Tax as % of Marginal US$ Pesos a! Paid - Gross Income Tax Rate (%) 1,000 16,200 5 0.5 3 2,000 32,400 80 14.0 12 3,000 488,600 237 7.9 20 4,000 6b,800 176 11.9 28 5,000 81,000 762 15.2 32 6,000 97,200 972 16.2 33 7,000 113,W00 14LL 20.6 35 8,000 129,600 1795 22.1 35 9,000 115,800 2145 23.8 35 10,000 162,000 2496 25.0 36 1]5,000 2Lt3,000 14317 28.8 37 20(,000 3214,000 6215 31.1 39 50,000 810,000 18532 37.1 L3 100,000 1,620,000 41736 41.7 49 1'50,000 2,1430,000 66865 14.6 51 a/ U.S. Dollars conv9rted to pesos at the rate of 16.20 pesos equals one US dollar. b/ Assumes average deductions of Ps.10,000 (see note a/ Table II-3). Source: Based on income tax law (Law 81 of 1960). The above table condenses the rate structure contained in the income tax law which contains marginal rates ranging from 05 percent to 51 percent in 66 brackets. The first division of Table II-4 alone contains six brackets of tax law, that is, for taxable incomes up to US$380 there are six divisions. For the next thousand dollars of taxable income there are twelve separate brackets. The number of divisions would appear to be ex- cessive and unduly complicate the calculation of the tax. 79. The structure of the tax when related to the distribution of taxpayers and taxable income indicates some of the reasons why the income taxes in general have failed to provide the Government with a source of  - 31 - revenues that has expanded along with the economy. A sample!/ of taxpayers taken in 1962 indicates that 96 5 percent of individual income taxpayers are in the first tax bracket of the table where average rates on taxable income range between 0.5 and 1.3 percent. These taxpayers account for about 25 percent of revenues collected.2/ In the next bracket of the table are 2.7 percent of the taxpayers accounting for 39 percent of the revenue yielded. The remaining 0.8 percent of the taxpayers account for 36 percent of indi- viduals' income tax revenues. 80. This combination of a large number of taxpayers in the low income brackets of the tax schedule euid the low rates at which this income is taxed creates serious administrative problems. It means that a large percentage of the resources of the tax office are devoted simply to filing and process- ing the returns of taxpayers whose taxes barely cover the cost of collection. This process is accelerated as increases in the price level bring more and more persons into the reach of the income tax. The liquidation procedures of this tax also add to the amount of administrative resources devoted to this low yield group; the taxpayer submits his estimate of income to the tax office ihich then computes the tax liability forwarding the bill to the taxpayer. If the taxpayer were to estimate his own tax liability sub- mitting payment at the same time only checking on the part of the tax office for obvious errors would be necessary. 81. The existence of a Large group of low income taxpayers is furthered by the elaborate and complicated system of deductions in order to arrive at taxable income. Increases in the price level have successfully limited the impact of the personal exemptions - Ps.2,500 for the individuals, Ps.2,500 for spouse and Ps.l,000 for other dependents - but there still remains a multitude of allowable deductions which on grounds of equity are of dubious value and unnecessarily complicate the structure of the income tax. A partial list of such deductions is as follows: 1/ The taxpayers of this sample accounted for 86.6 percent of the revenue yield of the income tax. Since 1962 the price level has almost doubled which shoul(d mean that taxpayers have moved up the rate scale, that is, that the percentage of taxpayers in the second bracket and above should be much higher than indicated by the 1962 sample and thus lead to higher collections in real terms. This, however, does not seem to )aave occurred indicating either this shift has not occurred (due, for example, to the income redistribution effects of the inflation) or the presence of serious administrative and enforcement problems. 2/ Not all of this revenue caa be attributed to the personal income tax as shown in the table as this revenue includes the net wealth tax, the steel and electric development tax, and additional sur- charges and minor levies. The net wealth tax should have no appre- ciable effects on collectiDns in the lower brackets of taxable income.  - 32 - (1) education expend:Ltures (2) rental housing (3) payment to professionals (4) real property taxes (5) transportation a:Llowances (6) interest on personal loans (7) contributions to social security and pension plans (8) service bonuses (9) interest on gove-rnment obligations (10) payments in lieu of vacations (11) severence pay and (12) emoluments earnedl by the religious of the Catholic Church. 82. On top of this compl-Lcated structure must be added the various related income taxes and surcharges. The most important of these for indi- viduals (personas naturales) is the net wealth tax. This is a tax on rights over property in Colombia that are capable of earning income. This includes both real property (mortgages and chattel liens) and intangible property such as stock shares of corporations. A basic exemption of Ps.20,000 is applied in the case where net wiealth does not exceed Ps.200,000. There is also an extensive list of special exemptions which include, for example, investments in Colombian airlines. Net wealth is then taxed at progressive rates ranging from 0.1 percent on the first Ps.20,000 to 1.5 percent on amounts overPs.800,000. Records are no longer kept in a form that allows the proportion of the incorme and complementary taxes attributable to the net wealth tax to be separated out but in 1960 the net wealth tax accounted for 27 percent of total income tax collections (includes both business and indi- viduals). The net wealth -tax thus forms an important part of the income tax structure in Colombia. The difficulties encountered in re-evaluating property under inflationary conditions would help to explain the income inelasticity that seems to be a feature of the income tax. 83. In addition to the income and net wealth taxes individuals are also subject to the steel and electric development tax, a livestock tax, and in some years a general surcharge on income tax liabilities.!/ The 3 percent steel tax is levied on taxable income which is defined in a slightly different fashion than the general income tax. Income tax payments are, for example, deductible. In the past,half of this tax was payable by purchasing Paz del Rio (the steel company) shares but in 1966 this was changed to a cash payment which was earmarked haLf for power development and half for social security funds. The livestock tax is really a tax which is levied on a form of wealth and is therefore related to the net wealth tax. The rate is one percent on livestock that exceed Psl5,000 in value and is payable in cash or by purchase of shares in the Livestock Bank and Livestock Fund. 1/ There is also an excess profits tax, but for all practical purposes it is applied to business organlizations rather than to individuals. See page 34.  - 33 - 84. The inadequacies of tax revenues has forced the Government in the period from 1963 to 1966 to levy a general surchargel/ on tax liability liquidated in these years. These liabiiities included tlhe incomne and net wealth tax of both individuals and corporations with various minor exemptions and adjustments, The rates ivere 20 percent in 1963 and 1964, 15 percent in 1965, and 10 percent in 1966.2/ These surcharges were payable at the same time as the general income taxes. 85. The single most distinguished feature of the Colombian personal income tax is its complexity. It consists of a number of separate levies each with its own set of deductions, exemptions and exceptions. Such com- plexity cannot but make enforcement and compliance difficult and must in large part account for the failure of the income tax to provide a dynamic basis for the expansion of public services within the framework of a serious effort at economic develoPment, The mission suggests that the Government undertake a major overhaul of its system of personal income taxes dith a view towards simplifying its basic structure. Until this is done, the efforts that have been undertaken and that are being undertaken to improve administration will continue to meet with disappointing results. 86. The Taxation of Business Income. The complexities of the personal income taxes are also reflected in the income taxes levied on the various forms of business crganization. Of the total income taxes collected (Table II-2 ) approximately 50 percent3/ comes from business organizations, (personas juridicas). Business organizations are taxed in difforent ways depending on their form of organization. These organizations, for tax purposes, fall irto three categories: 87. (a) Coroorations. 3orporation (sociedades anonimas) and limited stock partnersh- %soc-.edades en comandita por acciones) pay a tax on net income (as defined by the tax law) as follows: Up to Ps .100,000