Fitch: Tax Reform Key to Tackle Colombia's Fiscal Pressures

NEW YORK--(BUSINESS WIRE)-- The proposed tax plan shows the Colombian government's commitment to addressing the sovereign's loss of oil revenues, rebuilding the tax base, and supporting the economy's formalization and investment recovery, Fitch Ratings says. However, in the aftermath of the recent rejection of the historic peace deal, the final outcome of the proposal remains subject to dilution risks.

The Santos administration's structural tax reform proposal generally follows the recommendations that a panel of experts submitted to the government at year-end 2015. The proposal would consolidate and lower the income tax rate from a previously expected 42% in 2017 to 34% for 2017, 33% for 2018 and 32% in subsequent years. It would raise the value added tax rate to 19% from 16% and maintain current exemptions for food staples and other essentials. It would also introduce a tax on dividends, simplify taxes for small businesses, and lower the threshold for the payment of personal income tax.

The proposal would also preserve the financial transaction tax, but phase out the wealth tax. It would introduce a tax on sugary drinks and increase taxes on tobacco. Finally, the proposal would also toughen penalties on tax evasion, including jail time for offenders.

The government estimates the tax plan would raise revenues by 0.8% of GDP in 2017 and that margin of increase would rise to 2.7% through 2022. The government also expects to gain an additional 0.6% of GDP in revenues from economic growth and, beginning in 2020, an expansion in economic formalization. The central government's deficit is forecast to increase to 3.9% of GDP in 2016, up from 2.3% in 2013 and above the estimated 'BBB' median of 3%. As Colombia lost oil revenues equivalent to 3.4% of GDP between 2013 and 2016, this tax revenue would be important to the country's fiscal consolidation.

Amid rising interest rate costs, the government has adjusted to the revenue decline of recent years by reducing capital spending and containing current spending. In our view, successful achievement of fiscal targets and improvement in government debt dynamics will be dependent on continued fiscal restraint and growth performance.

In spite of the reduced timeframe, Fitch expects the reform to be approved by the end of the year -- although risks for dilution remain. The ongoing peace talks and negotiations, perceptions regarding the government's level of political capital and early positioning for the 2018 electoral campaign could influence the discussion and outcome of the proposal.

On July 22, Fitch revised Colombia's Rating Outlook to Negative reflecting its large current account deficit, rising external indebtedness and a higher and increasing government debt burden relative to its rating peers. Colombia's Long-Term Foreign-Currency Issuer Default Rating of 'BBB' balances the country's flexible and credible policy framework, improved external buffers and a record of macroeconomic and financial stability against high commodity dependence, limited fiscal flexibility, and the structural constraints of low per-capita GDP and weak governance indicators.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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