OECD Tax Policy Reviews: Chile 2022

Executive summary

This report examines the level, composition and evolution of the tax burden in Chile. The Chilean Ministry of Finance appointed a tax commission in 2020 in part to evaluate the design of the tax system in Chile. As input to this work, the OECD was commissioned by the Ministry to undertake an independent analysis on the level, composition and evolution of the tax burden in Chile. The analysis includes an examination of tax shares and income levels in Chile, the tax structure in Chile, tax convergence and a tax share path for Chile in the future.

The report is based on pre-COVID-19 tax revenue data (i.e. up to 2019). The pandemic had a significant impact on economic activity and tax revenues, either directly through the drop in economic activity or indirectly through tax measures that were taken to support the economy. It was agreed that the analysis would be based on pre-crisis revenue data so that tax revenues, the tax structure and tax convergence would not be biased by the impact of the COVID-19 pandemic. As the report was written in 2020, the tax-to-GDP data for Colombia and Costa Rica, who recently joined the OECD in 2020, are not included in the analysis in this report.

Chile’s tax-to-GDP ratio is among the lowest found in the OECD, based on a range of different measures. Chile’s tax-to-GDP ratio and income levels are among the lowest found in the OECD despite convergence with the OECD average over the past 30 years. Chile’s tax-to-GDP ratio is lower than OECD countries when they had a similar income level to Chile (including Australia, Canada, Ireland and New Zealand). The ratio is also low when compared to the OECD average regardless of whether social security contributions (SSCs) are excluded or mandatory contributions to pension or health funds (that are managed by the private sector) are included.

Among OECD countries, Chile’s tax structure is one of the most divergent from the OECD average. However, when compulsory contributions to the private sector are included in the tax-to-GDP ratio, Chile narrows the tax-to-GDP gap with the OECD average. Tax revenues in Chile are concentrated in value-added tax (VAT) and corporate income tax (CIT) while higher income OECD countries depend more on revenues from the personal income tax (PIT) and SSCs. Chile’s current tax structure is also different to the tax structure in the OECD on average when GDP per capita in the OECD was closest to the current level in Chile (in the year 1978). While Chile’s tax structure has converged slowly towards the OECD average tax structure over time, it has done so more slowly than other OECD countries.

The tax structure gap between Chile and the OECD is driven by VAT and PIT. When contributions to the private sector are included in SSCs, the SSC share of tax revenues in Chile is not that dissimilar to the OECD average and the absolute tax structure gap between Chile and the OECD is found to be driven by VAT and PIT. In general, tax structure gaps may point to areas that could be further explored for possible tax reform. In the case of PIT for example, the tax burden on individuals is much lower in Chile driven by a narrow PIT base and low revenues from PIT, including capital income.

The analysis in this report shows that a rising tax-to-GDP ratio over time has been the historical trend in OECD countries on average, although some countries have followed a different path. Evidence from this report supports the notion that lower tax-to-GDP ratio countries like Chile have tended to catch-up slowly with higher tax-to-GDP ratio countries over time (referred to as β-convergence). This implies that Chile may follow the path of other low tax-to-GDP ratio countries.

If Chile followed a similar path to the OECD average from when the OECD had on average a similar level of economic development to Chile’s current level of GDP per capita, Chile’s tax-to-GDP would be set to rise between now and 2029, but the COVID-19 pandemic has made this outcome more uncertain. To take one example, Chile’s tax-to-GDP ratio is similar to Australia when Australia had a similar level of GDP per capita to Chile’s current level. However, tax-to-GDP ratio growth paths are anything but guaranteed as tax-to-GDP ratios change for many reasons including tax policy choices of governments. Moreover, there may be structural elements in an economy that require differing tax levels (expenditure levels, budget deficit, public debt, dependency ratios).

Once the recovery from the COVID-19 pandemic is firmly in place, there is scope for Chile to raise its low tax level and rebalance its tax structure. The post-crisis environment will provide an opportunity for countries to undertake a more fundamental reassessment of their tax and spending policies along with their overall fiscal framework. The analysis in this report finds that few countries have reached economic prosperity historically with a low tax-to-GDP ratio. Some of the favourable demographics in Chile, which helped facilitate a low tax-to-GDP ratio, may be changing. If Chile decides to raise tax revenue, it could do so through base broadening (e.g. limiting tax expenditures rather than tax rate increases and reducing tax evasion and avoidance) and rebalancing the tax mix (e.g. by increasing personal income tax revenues, including revenues from taxes on capital income).

Summary answers to key tax policy questions facing Chile are provided below, based on the analysis in this report. This research has been developed around a series of tax policy questions relevant to Chile across different tax topics. The table below provides a summary of short answers to these questions for Chile, based on the analysis and findings in this report. The summary table has been written for clarity in a non-technical and informal way. More in-depth analysis and caveats can be found in the relevant sections indicated.

Table 1. Summary findings

Non-technical summary answers to 17 tax policy questions in Chile, by tax topic

Tax Topic	Question	Finding
A. Tax-to-GDP ratio & GDP per capita	1. At what level does Chile raise taxes? (Section 2.3)	Chile's tax-to-GDP ratio is currently among the lowest in the OECD at 20.7% in 2019 (Figure 2.2).
	2. How has Chile’s GDP per capita performed relative to OECD countries? (Section 2.2)	Chile's GDP per capita income level remains relatively low, despite convergence with the OECD average over the past 30 years).
	3. When contributions to health and pension funds managed by the private sector are included, at what level does Chile raise taxes? (Section 3.4)	Chile’s tax-to-GDP ratio moves closer to the OECD average to 26.9% but remains relatively low among OECD countries (Figure 3.3)
	4. Do higher income OECD countries tend to raise relatively more tax revenues? (Section 2.3)	Tax-to-GDP ratios are weakly positively correlated with income levels in the OECD, but the result is driven by outliers and there is significant heterogeneity across countries (Figure 2.3).
B. Tax structures	5. How does Chile’s tax structure compare to other countries? (Section 3.1)	Chile’s tax structure differs significantly from the OECD average, it is more concentrated in VAT and CIT revenues as a share of total tax revenues and less so in PIT and SSC revenues (Figure 3.1).
	6. Is Chile’s tax structure becoming more or less similar to that of the OECD average? (Section 4.4)	Chile has converged with the average OECD tax structure, but more slowly than individual OECD countries have, on average, to the OECD average (Figure 4.3).
	7. At what level does Chile fund social benefits? (Section 3.2)	Chile’s funding level for social benefits is relatively low. Chile’s social security benefits are also financed atypically in that they are not mainly financed through SSCs, as is common in the OECD, but rather through contributions to the private sector (Figure 3.2).
	8. When compulsory contributions to the private sector are included, how does Chile’s tax structure compare to OECD countries? (Section 4.4)	Chile’s tax structure moves closer to the OECD average but remains among the least similar to OECD average tax structure (Figure 4.5).
	9. Which taxes drive the tax structure gap between Chile and the OECD average? (Section 4.6)	When contributions to the private sector are included in tax revenues (as are SSCs), Chile’s tax structure gap with the OECD is driven by VAT and PIT and to a lesser extent CIT (Figure 4.6).
	10. How do Chile’s tax rates compare to the OECD? (Section 3.5)	Tax rates on PIT, CIT and VAT in Chile and the OECD are broadly similar. This points to low tax revenues driven by a narrow tax base, particularly PIT (Table 3.2), including low tax revenues from capital income.
	11. Does the tax-to-GDP ratio grow over time in the OECD and by how much? (Section 4.1)	Tax-to-GDP ratios have tended to grow over time in the past at a rate of about 2 per cent per decade. However, tax-to-GDP in individual countries can fluctuate down and up for sustained periods (Figure 4.1).
C. Tax convergence	12. Do countries with a low tax-to-GDP ratio catch-up over time? (Section 4.2, 4.3)	Theoretical and empirical econometric evidence support the notion that low tax-to-GDP OECD countries catch-up over time (also known as tax ‘beta convergence’) (Figure 4.2) (Table 4.3) (1).
	13. Do lower income countries catch-up on tax-to-GDP ratio over time? (Section 4.7)	Countries with lower starting GDP per capita had faster subsequent tax-to-GDP on average, but this is not always the case (Figure 4.7).
	14. Does the evidence suggest that countries adopt policies that causes them to converge with the OECD average (tax-to-GDP ratio) over time? (Section 4.4)	The D-index suggests that the OECD may be a tax ‘convergence club’, which implies that lower tax-to-GDP countries like Chile may tend to converge with the OECD average over time (Figure 4.3).
D. A tax-to-GDP path for Chile	15. How does Chile’s tax-to-GDP ratio compare to countries when they had similar GDP per capita to Chile? (Section 5.1)	Chile’s tax-to-GDP ratio is low compared to when countries had similar levels of income (Figure 5.1). Chile’s tax-to-GDP ratio is somewhat similar to Australia when Australia had a similar level of GDP per capita (Table 5.1)
	16. How might the tax-to-GDP ratio develop over the next 10 years in Chile, if it followed average OECD historical trends? (Section 5.3)	Chile’s tax-to-GDP was set to rise by 2029 if it followed a similar path to the OECD average from when it had a similar level of economic development to Chile (Figure 5.3). However, the COVID-19 crisis will make this outcome much less likely.
	17. What role do demographics play in the extent to which the tax-to-GDP ratio can be raised? (Section 5.4)	Chile’s low dependency ratio may have supported a lower tax level in the past, but over the coming decades the old-age dependency will rise quickly (Table 2.1).

Note: This summary table has been written in a non-technical and informal way. Technical details are available in the relevant sections in this paper. (1) The beta convergence estimate is based on OECD countries only over the period 1965 to 2019.

Table 2. Key measures in Chile and the OECD

	Chile	OECD
Tax-to-GDP ratio measures
Tax-to-GDP ratio (2019)	20.7% (18.3% in 1990)	33.8% (32.5% in 1990)
Tax-to-GDP growth since 1995	2.4 pp	1.3 pp
Income & demographic measures
GDP per capita, USD	23,151 (12,253 in 1990)	42,953 (29,921 in 1990)
Old-age dependency ratio in 2025	23.6 (43.0 in 2050)	35.2 (53.2 in 2050)
Tax mix measures
VAT-to-revenue ratio	39.9%	20.4%
CIT-to-revenue ratio	23.4%	10.0%
PIT-to-revenue ratio	1.5%	8.1%
SSC-to-revenue ratio	1.5%	9.0%
Compulsory contributions to private sector	5.8%	0.9%
Selected tax rates
Top PIT rate	40.0%	42.8%
Standard VAT rate	19.0%	19.3%
CIT rate	25.0%	23.5%
Tax convergence
Sigma convergence (D-index*)	74.5 (79.5 in 1990)	34.5 (44.3 in 1990)
Sigma convergence (adjusted D-index*)	59.9 (69.8 in 1990)	33.3 (37.5 in 1990)
Other tax-to-GDP ratio measures
Tax-to-GDP ratio (excluding SSCs), 2018	19.6%	24.3%
Tax-to-GDP ratio (including compulsory contributions to the private sector)	26.9%	34.8%

Note: Information related to the data sources and calculations for the figures provided in this table are provided throughout this report.

*In the case of the D-index, the OECD average is calculated as the mean average of the sum of the absolute differences in all OECD countries, which provides an indicator of the extent to which tax structures are different or similar across countries in the OECD.

Source: OECD (2020), Revenue Statistics 2020, OECD Publishing, Paris, https://doi.org/10.1787/8625f8e5-en, OECD (2019), OECD Compendium of Productivity Indicators 2019, OECD Publishing, Paris, https://doi.org/10.1787/b2774f97-en.; OECD tax database statistics; United Nations, World Population Prospects – 2017 Revision; OECD calculations.