Uruguay’s progressive tax reform : why didn’t it fail?

Andrés Rius Universidad de la

RepúblicaUruguay

December 11, 2012

The presentation

• Introduction: the reform• “The battle for the middle class”• The weaknesses of “the rich”• Implications

The presentation

• Introduction: the reform• “The battle for the middle class”• The weaknesses of “the rich”• Implications

The reform in a nutshell

• Eliminated distortionary and low productivity taxes, and ad hoc special regimes

• Consolidated indirect taxes into VAT, reduced rates; kept exemptions, and taxes on specific consumptions

• Substituted schedular taxes with single, broad-based PIT (IRPF), with dual taxation on income

• Unified taxes on corporate profits

A progressive reform, in line with the P.E. and institutionalist

literatures• No fiscal crisis but awareness of “social

debt” from 2001-02 crisis (pull from expend. side)

• Administrative capacity: acceptable and improving

• First administration of a left-of-center coalition, with absolute majority in Parliament

• Reform launched right after election, with the economy growing fast

More “winners” than “losers”

The presentation

• Introduction: the reform• “The battle for the middle class”• The weaknesses of “the rich”• Implications

The battle

• Reformers, “supporters” and opposition believed the middle class was going to be or feel hurt

• Confirmed by polls: majority of public opinion was against the new PIT

• …yet, all professional estimates showed a large majority (more than 80% in some) were going to win or stay the same

The government couldn’t win

1. Voters can’t compute net outcome of complex reform, have reasons to be skeptical of interested parties, and few will seek advice to find out who’s right

2. Faced with resulting uncertainty, they look for signals, may favor status quo

3. Opinions/attitudes of peers and those known to be richer/poorer frame the voters reasoning about what to expect

The government couldn’t win

4. Politicians assume that being on the side of the “middle class” is a winning strategy (and reformers struggled to remain on that side)

5. …but everyone thinks (s)he is “middle class”…

We’re all middle class

Source: Cruces, Pérez-Truglia, Tetaz (2011) “Biased perceptions of income distribution…”, IZA DP No. 5699, May

The presentation

• Introduction: the reform• “The battle for the middle class”• The weaknesses of “the rich”• Implications

Behavior of “the rich” in context

Behavior of “the rich” in context

Values, ideas

Political strength

The issue

• The “rich” (proxied by top 10%) felt correctly that they were going to lose

• Why didn’t they develop more decisive and effective opposition? (the nature of “compliance”: ¿convictions or weakness?)

A weak economic elite

• ideologically and organizationally divided

• sparse personal linkages with the political elite

The party system

• Institutionalized: Limits the influence campaign money can buy

• Catch-all: augments the cost for politicians of playing “the voice of the injured” (a privileged minority)

The presentation

• Introduction: the reform• “The battle for the middle class”• The weaknesses of “the rich”• Implications

Implications (1): cognitive constraints & biases

• Progressive reforms can succeed despite public opinion

• If everyone feels is “middle class”, the battle can’t be won A progressive agenda will always bring about negative outcome for sectors that are richer than MC but don’t feel that way

Implications (2): cognitive constraints & biases

• Perception biases create a “pincer effect”: the rich feel unfairly taxed “as if they were rich”, the poor (less informed) can be mobilized to deffend “the middle class”

• If government gets fixated with winning it (bounded rationality of policymakers) may get distracted from key tasks,

• But battle has to be fought, with information (biased but not impervious)

Implications (3): “…but it wasn’t lost”

• Challenges were limited and handled through the institutions

• The government was re-elected with almost the same share of the vote

• No anti-reform movement so far• Informing voters, worked• Growth probably helped• … it must be fought, but don’t expect to

win it

Implications (4): learning from the weak rich

• Ideologically united: debate vertical and horizontal equity, expose “unfair” special treatments (within elites and upper-middle classes), use “consulta pública”

• Organizationally united: set up parallel tables for “productive policies” (e.g., tax incentives for investment promotion)

Implications (5): learning from the weak rich

• Socially cohesive, inter-married and exclusively schooled elites: the hardest to tackle? Cause of LA’s democracy without redistribution? Use “modernity” demonstration effects?

• Weakly institutional & class-based parties: set up a catch-all coalition for progressive tax reform, get support of visible achievers