Colombia's finance minister tackles inequality head on

Reforming Colombia’s tax system is key to keeping the country on a growth path, according to new finance minister Mauricio Cardenas. Mr Cardenas, who has recently moved from leading the country's energy and mining ministry to replace Juan Carlos Echeverry, who stepped down for personal reasons last September, highlights the damage that an inappropriate taxation policy can perpetuate in fast-growing countries, and the challenges in changing such rules.

In particular, Mr Cardenas is proud of having lowered employers’ burden on payroll tax and increased tax on wealthy individuals. Reforms have been based on the ministry’s ultimate objective – to reduce inequality. Because of this, Mr Cardenas believes that Colombia’s new rules are likely to be imitated by others in Latin America. 

Leading the way

“We have developed a number of reforms in Colombia over the past three years that are aimed at [reducing] inequality and strengthening our fiscal framework, but there is one reform that was approved in December that I think has an international interest. It’s the type of reform that [observers] from rating agencies to multilateral banks are telling us other countries should undertake as well,” says Mr Cardenas.

“In Latin America there has been, throughout the years, a bias in favour high payroll tax, taxation on employers and low income taxation. The impact of that has been lots of informality in the labour market because employing people is too expensive, and at the same time low taxes for rich people. [This is] a structure that does not help the objective of reducing inequality.”

The government wanted to reduce such harmful and unwanted consequences. “We decided to deal directly with those two issues: cutting payroll taxes and [increasing] personal income taxation,” says Mr Cardenas. “We cut payroll taxes from 29.5% to 16%. Personal income taxation for higher income individuals went from an average effective rate of 5% to a minimum of 20%. We introduced the concept of the minimum income tax. [High-income individuals] can use all the benefits they want but they have to pay at least 20%.” A high-income individual in Colombia is someone who earns more than $5000 a month, or $60,000 a year. The new upper rate for such taxpayers is 33%. Thanks to the new rules’ final goal of reducing inequality, “Mexico is following [our reform],” says Mr Cardenas.

External forces

But Colombia’s government has been dealing with more than just home-grown issues. As with other emerging-market currencies, until recently, the value of the peso against the US dollar was particularly high. This had been hurting Colombia’s manufacturing and agricultural sectors, according to Mr Cardenas. To help the situation, the country had enacted a number of measures, from classic central bank intervention and debt management, to new rules on pension funds to encourage larger exposure to foreign currency assets.

Recently, the country’s efforts had been amplified by a stronger dollar. “All things combined, plus the reactions of the market to policy change expectations in the US, resulted in a weaker currency in Colombia, which is welcome,” says Mr Cardenas. “We definitely think our currency was overvalued at the beginning of this year; we talked about a 10% overvaluation. It has [now] depreciated by 9%; that overvaluation has been corrected. We don’t have an exchange target, but we’re happy [with this rate] because we’re very mindful of the impact that a strong currency had on our manufacturing and our agricultural sector.”

Mr Cardenas believes the international effects of national monetary policies ought to be taken into consideration in the future given the overwhelming impact that some decisions can have on the world, and particularly on emerging economies. Colombia’s government had voiced such concerns in the past.

“Any changes in monetary policy in today’s world, especially in the US and Europe, are going to have an impact on us. We were very concerned at one point with the impact of QE3 [the US’s third round of quantitative easing],” he says. “[The government] asked for more information and coordination, ideally. Of course coordination is difficult. But there has to be more discussion and more consideration of impacts on other countries.”