LatinFinance - May/June 2015 - 28

holes may be optimistic. "It is very difficult
to guess if they are right or not. If tax reform
is not likely to generate more than 1% by
2017 and perhaps 2-point-something in
2018, it is less of an impact on the economy
than a reform that generates tax revenue
of 3%."
Investment may suffer
The collection of 3% of GDP "is a huge
reform by any standards", says Marcos
Buscaglia, head of Latin America economics at Bank of America-Merrill Lynch Global
Research. "It increases uncertainty. And
what happens with uncertainty is that
businesses postpone investment and hiring
decisions. You don't need to have a stance
on whether the reforms are good or bad to
make this argument."
Buscaglia has no doubt the tax reforms
will slow economic growth because of their
impact on investment. The previous system
incentivized firms to retain profits and not
issue dividends, which helped Chile to have
the highest savings ratio in the region. "The
reform was partially changed so it is an
improvement over the original reform," he
says. "But at the end of the day, the system
will increase corporate taxes and will not
help investment."
Still, Alex Wolf, emerging markets economist at Standard Life Investments, says
overall the reforms appear "very positive"
for long-run growth prospects, but adds:
"The only downsides are short-term risks
to investment and consumer sentiment
and difficulties with actual execution of the
fiscal reforms."
José De Gregorio, professor of economics
at the University of Chile in Santiago and
until 2011 governor of the Chilean Central
Bank, was more optimistic about the tax
measures.
"Recent political problems have been
linked to the fact that there has been a lot
of tax fraud. These reforms will bring more
fiscal discipline by the government but also
from the private sector because tax authorities will be much more careful about detecting evasion. More than ever, there is an
opportunity to increase fiscal revenues."
Aside from clamping down on tax evasion, the remaining government revenues
will come from a mix of higher corporate
tax rates, a change to the way share dividends are taxed, and a host of consumer
and excise levies. The headline measure
is an increase in the flat corporate tax rate
from 20% to 25%.
Morgenstern laments the way the tax re-

28 L ATINFINA NCE.COM - May/June 2015

EDWARD GLOSSOP
CAPITAL ECONOMICS

"BACHELET HAS BEEN
PROACTIVE IN
PUSHING THROUGH
HER AGENDA.
UNFORTUNATELY IT IS
DIFFICULT TO GAUGE
WITH ANY ACCURACY
HOW SUCCESSFUL
REFORMS WILL BE
OVER THIS HORIZON"

forms were discussed at the outset with not
much debate from business representatives
or tax experts. "That created a moment
of uncertainty which had some impact on
GDP," he says. "But it is very difficult to measure because you were having other shocks
at the same time, such as the decline in copper prices and mining investment."
Wolf at Standard Life says most forecasters still project a revenue shortfall of about
1.5% of GDP over 2015 fiscal targets. "Even
with reforms, the government will likely
have to hike taxes further, lower spending,
or tolerate a higher depreciation of the currency," he says.
On the positive side, the tax reforms are
unlikely to affect the ability of Chilean corporates to access the capital markets. Morgenstern says the chief danger had come
from ambiguities that have dissipated over
the last year. With the removal of uncertainty, he says, lenders view Chile to be in better
shape than the rest of Latin America. "That
is also true in terms of the macro environment and the rule of law," he says.
The government is making some efforts to increase the traditionally low level
of foreign investment in capital markets
in Chile by loosening the domination of
buy-and-hold pension funds and opening
investment up to European funds. "Cost of
capital is fairly low in Chile compared with
other countries and the system is okay in

that regard," says Morgenstern.
Education boost
The big issue will be how the reforms deliver impacts on the ground. Some analysts
prefer to look at the medium-term scenario.
"My opinion is that the implementation
has been pretty fast," says Edward Glossop,
emerging markets economist at Capital
Economics. "Especially compared to other
presidents in Latin America, Bachelet has
been proactive in pushing through her
agenda. Unfortunately it is difficult to gauge
with any accuracy how successful reforms
will be over this horizon."
Two-thirds of the tax revenues are scheduled to pay for investment in education and
improving social inclusion while the remaining one percentage point will be used
to close the structural fiscal deficit.
"We have a lot of challenges in terms
of improving education for all. We need
greater human capital for an economy that
can deliver growth," De Gregorio says.
The two-pronged education strategy
focuses on schools and universities. After
eight months of intense debate, the lower
house of Congress in January approved the
first part of the reform, which eliminates
profits at state-subsidized schools and ends
selective entrance practices.
The second tranche boosts teachers' pay
and conditions. It also brings public schools
currently financed by townships under
national jurisdiction, and makes university
education free.
Bachelet won power in part due to a
wave of support for the university reforms
by students who held angry protests calling
for former dictator Alberto Pinochet's fee
regime to be abolished.
Productivity problem
Morgenstern says this emphasis on universities could distract from a focus on
elementary education that would make a
greater long-term contribution to economic
growth.
"The problem of implementation is not
easy," he says. "Any study on where to put
money to improve human capital says you
should stress elementary education. But
of course older students are more vocal in
their demands than elementary students."
Glossop, who calls the education reforms "impressive", says the only drawback
is that results will take a while to filter to
the economy. "We are unlikely to see any
meaningful benefits in the near future."
Buscaglia echoes that caveat: "Even if ed-

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