Congress Approves Controversial Tax Reform to Shore Up Budget and Replace Depleted Oil Revenue

Just two days before Christmas, Colombia’s Congress approved a controversial tax reform that will raise the national sales tax, among other revenue-generating increases, in order to replace lost oil income for the state that has disappeared since 2014 when the price of crude plummeted.

While the public was widely opposed to a measure that will raise the value-added tax (VAT) from 16% to 19% on many items, the overhaul is expected to raise an additional $2 billion USD (6.2 trillion Colombian pesos) for the government in 2017 and lower the risk that credit agencies will downgrade Colombia’s sovereign rating.

Photo: Finance Minister Mauricio Cardenas says the overhaul “is a difficult measure that will require a large sacrifice of all Colombians — but it is necessary.” (Credit: World Economic Forum)

Fitch Ratings and Standard & Poor’s both put the nation on negative outlook this year and Fitch dropped the country’s long-term local currency (LTLC) issuer default rating (IDR) and its long-term senior unsecured local currency bonds to BBB from BBB+ — just two notches above junk status.

Finance Minister Mauricio Cardenas, just after submitting the plan to Congress in October, highlighted the importance of preserving Colombia’s investment-grade rating and how much that factored into the administration’s push to pass the reform this year. “Colombia has a BBB rating,” he told Bloomberg in an English-language interview on U.S. television. “I think this is something we’re going to preserve. And we’re going to introduce all the decisions that are necessary to keep our BBB rating.”

Private Sector Burden

In addition to raising sales tax — known as IVA locally — the so-called “reforma tributaria” will reduce the overall tax burden for companies. Due to the number of Colombians who work in the informal economy on top of widespread evasion, the private sector currently pays an abnormally high percentage of the total taxes collected by officials in Bogotá.

The new provisions, which come into force on January 1, will lower the overall tax rate for companies from 43% now to 33% by 2019. “We don’t need all the revenues at once,” Cardenas told Bloomberg. “This is something that would need to be something that is eased in, introduced in terms of revenues during the next few years to comply with our fiscal rule — and our fiscal rule is quite strict.”

New protocols to detect and punish tax evaders are also included in the reform, something that the government has trumpeted in recent months to counterbalance the widespread opposition to the tax raise. Those found guilty of evading taxes can now face up to nine years in prison.

Spending Political Capital

President Juan Manual Santos’ peace accord with the Revolutionary Armed Forces of Colombia (FARC) guerrilla group passed Congress earlier this month. But the original agreement was rejected by a popular referendum in October — by just over 50,000 votes out of some 13 million cast — and the amended deal still faces ongoing opposition from rival legislators who boycotted the ratification vote in Congress.

Though the president has controlling support within the Congress, doubt had swirled earlier this fall as to whether the administration would still have enough political capital left to also hammer through an unpopular tax code overhaul following the unexpected complications getting peace approved.

After the approval, Cardenas lauded Congress members for making the right call. “These decisions aren’t easy,” he told the press. “They are unpopular on the first reading. But behind that is the greater interest of the nation.”

Popular Disapproval

Nelson Fabian Rubio, a taxi driver in Bogotá, was clear about why he voted against Santos’ peace in the nation’s October 2 referendum: it would affect his wallet. He admits being uncomfortable with the relative impunity for FARC guerrillas who committed heinous crimes when he voted “No.” But his decision was rooted in fear that his meager salary would be cut even more.

Living in a country where inflation hit a 16-year high and economic growth is slowing, he is struggling to get by. The extra costs needed to fund post-conflict social programs — along with a feared tax hike — mean that he sees the accord as wrong for his family and wrong for Colombia.

Whether such fears are real or perceived, they drove some to reject the deal. Nelson, a Bogotá-born 33-year-old with two kids, has never really known the war. Even Pablo Escobar’s terrorist bombing campaigns on the capital in the early 1990s occurred when he was just a kid.

Instead, Nelson, and millions like him, worry more about rent, groceries, car maintenance, and medical bills than the contents of the rejected peace agreement. He doesn’t trust the government to spend revenue wisely and he certainly had no interest in seeing more of his paycheck going to federal coffers.

Too Little, Too Late?

Some have been skeptical that the proposed reforms would go far enough to stave off more negative action from the ratings agencies. Sergio Clavijo, head of the Bogotá-based economic think tank ANIF, told Finance Colombia earlier this fall that this move should have come years ago. He questions whether it will bring in revenue quickly enough to appease the international investment community.

“Too late,” said Clavijo. His organization advised the government to make the VAT changes in 2012. “They didn’t hear us,” he said. “And now they are in shambles.”

Even with more incoming revenue, he was still wondering in October if this would make Fitch, Standard & Poor’s, and Moody’s hold off from further downgrades. “It’s going to be very hard actually to avoid at least the reduction of one of the two notches that holds us above the investment grade,” said Clavijo. “Very likely, I reckon that, in a year time, once markets realize that the expected additional tax revenue is coming too late and too little, one notch will be gone.”

The Big Sacrifice

The government had to make some concessions in order to get the measure approved. One major change from the initial proposal was killing the planned tax on sugary drinks. This measure does not appear in the final reform and that loss will lower the amount of revenue raised by the government, including funds that were earmarked for health initiatives.

Despite changes like this, the administration knows that most Colombians remain upset. The majority of voters were against the peace deal yet still had a very similar, if re-worked, agreement imposed upon them. And now here comes a tax overhaul that even fewer citizens support — at the end of an economically challenging year beset by heavy inflation and high food prices.

Cardenas believes it was essential, however. He says the government needed to act to set itself up for the long term, swallowing a tough pill now in order to ensure the massive economic growth and security improvements of the past decade are not squandered by the oil-price plunge.

“Raising VAT to 19% is a decision that requires a lot of effort,” Cardenas told BluRadio. “I am the first to recognize that it is a difficult measure that will require a large sacrifice of all Colombians — but it is necessary.”