Colombia’s Constitutional Court Invalidation Of Tax Reform Package Unlikely To Have Significant Macroeconomic Impact

Colombia’s Constitutional Court invalidated several articles of the President Ivan Duque’s “Ley de Financiamiento” fiscal reform law that was approved at the end of 2018 declaring them unenforceable. This means that the government has until January 1 2020 to return to the previous taxation regime, or to pass replacement legislation that can take effect in the last two months of this year.

The law includes a cut in corporate tax rates, investment incentives, and anti-tax evasion measures. When the Constitutional Court invalidated the measure on procedural grounds, the stock market did not react negatively, and ratings agencies did not foresee a significant impact.

“At the time the tax reform passed, we stated that our models suggested a positive effect on GDP, through the accumulation of private capital due to the reduction of the corporate tax burden. However, we also warned that the tax uncertainty that prevails in our country would lessen the effective impact of the increase in investment on growth. In that sense, we maintained our projection of GDP variation for 2019 at 3.2%,” said Bancolombia in a statement.

Colombia’s largest bank added: “One of Colombia’s greatest strengths for international investors and risk rating agencies is the commitment of the authorities to an orderly management of the economy, and to make decisions aligned with preserving the sovereign credit status. Thus, it is foreseeable that at this juncture market agents would provide the Government a time window for actions to be taken in order to resolve the situation arising from this ruling. We do not expect a permanent negative effect on risk premiums or the level of the Colombian Peso.”

According to Fitch Ratings, “The Financing Law has been revenue positive this year and should help to contribute to the government meeting its 2019 2.4% of GDP fiscal deficit target. We previously highlighted that meeting the target without one-off asset sales would be a positive development. However, the corporate tax rate cuts and investment incentives that are due to begin in 2020 would have also led to significant revenue losses beginning that year and we maintain that the law would not have been significant for addressing the structural deficit in line with achieving the 1% of GDP target set out in the country’s Fiscal Rule. However, the law included tax administration measures that would help reduce tax evasion and improve efficiencies, but this was difficult to quantify in terms of revenue impact.”

The Constitutional Court has ruled frequently on fiscal and economic matters in the past and this latest decision raises questions about judicial security and risks to economic policymaking from in general, opined Fitch. However, as the decision itself does not fundamentally alter Colombia’s fiscal, economic growth or debt trajectory, or policy credibility, it is not likely to have a significant effect on the country’s credit profile.

Fitch revised Colombia’s rating outlook to Negative earlier this year to reflect risks to fiscal consolidation, the direction of government debt, increasing external imbalances and weakening fiscal policy credibility. Despite an economic recovery, the country faces challenging fiscal deficit targets that have been revised several times in the past several years and a rising debt/GDP ratio. A widening current account deficit, estimated to exceed 4% of GDP in 2019-20, also points to increasing external risks.