Fiscal policy in the time of COVID-19: a new social pact for Latin America

By Pablo Ferreri, Public Accountant and former Vice Minister of Economy and Finance of Uruguay

This blog is part of a series on tackling COVID-19 in developing countries. Visit the OECD dedicated page to access the OECD’s data, analysis and recommendations on the health, economic, financial and societal impacts of COVID-19 worldwide.

We could say that ultimately the role of government remains unchanged overtime: to achieve ever higher levels of development with the understanding that true development means achieving sustained economic growth while generating greater equity and social cohesion. This must be done through more and better exercise of civil rights and in an environmentally sustainable manner. But in achieving this ultimate goal, challenges change according to realities that governments must face.

Challenges that Latin America faced fifteen years ago, when it enjoyed high levels of growth and a commodity boom in an increasingly open world, are quite different to those that have been brought about by economic slowdown, lower international prices and new isolationist tendencies.

As Alicia Bárcena[1] asked about the region in 2016 and still relevant today: “from the fiscal point of view, the central question would be: how can the region promote economic and social advances in a context of deceleration and high international volatility like the current one? The central aspect to answer this question is the construction of national agreements around various areas of development, with a single normative ethical principle and ultimate goal: equal rights of individuals”.

To address this question, we must first address the pre-existing structural challenges that the pandemic is intensifying today, as well as the social and cultural changes it has brought about. In other words, the future of work, improving social security, the provision of public goods, the boundaries between state and market, natural resource governance and environmental sustainability, were all issues that needed addressing before the outbreak.

Many of these issues take on a new dimension in light of the crisis which is generating immediate impacts and long-term change, such as the shift to remote working and its possible implications for social security. This crisis has made clear on one hand that societies lean on the state and the public goods and services it provides in difficult times, and on the other that the market cannot face such challenges alone. And while many countries have temporarily abandoned public debt restrictions, this path is not sustainable in the long term.  

It is therefore necessary to ensure the solvency and sustainability of public accounts, which requires more decisive fiscal action, especially in our region which with few exceptions, has a significantly low tax burden. However, more decisive fiscal action is first and foremost a matter of political will; fiscal policy is the most “political” of public policies because it concerns the interests of society as a whole. Moreover, we face these issues as a continent marked by high concentration of wealth and inequality and significant social and political instability in several countries, where major interest groups are accustomed to exerting pressure on governments.

In this economic and social context, fiscal policy must play a much more active role in combating inequality. Not only must it contribute to economic stability, it must also contribute to equitable and sustainable development. Only societies that have continued to grow over long periods of time have been able to sustainably improve social cohesion and ensure equitable living conditions. And in turn, only societies that succeed in sharing the fruits of progress with all their members, are able to sustain growth over long periods of time. Additionally, better quality democracy and more freedom and exercise of civil rights are also prerequisites for increasing prosperity and equal opportunities for all.

The most important conceptual change will be to put economic policy at the service of social impact, to improve employment, poverty and social exclusion indicators, and reduce the unfair distribution of income and wealth. In short, economic policy should seek to improve people’s quality of life, particularly among those most in need. But this is not just about solidarity, it is also a strategy for development, social justice and growth. This kind of strategy would most certainly be met with resistance and debate, as we have heard time and again that raising taxes on the rich and helping the poor would damage economic growth. There is no logical reason however to believe that comforting the comforted and afflicting the afflicted is good for economic growth, when in fact a more just economy would inevitably be a more prosperous one.

Facing these challenges will require significant changes to several Latin American countries’ tax systems, given the continent’s low tax burden compared to its level of development, its regressive tax systems and the significant share of indirect taxes in total tax revenues. In other words, in Latin America we tend to collect both little and badly. Increasing the tax burden through tax and fiscal systems reforms will be indispensable to address the various medium to long term challenges that most Latin American countries face. But how and from whom we collect matter too. Moreover, these reforms must come hand in hand with public policies that uphold the quality and efficiency of public spending, especially on social protection. Structural reforms that improve how fiscal resources are collected and where they are invested will be key to reducing inequality in the region. In short, public policies must go beyond expanding coverage to reduce poverty, they should also seek to address inequalities by ensuring the quality of coverage.

[1] Prologue of “Sustentabilidad Fiscal y Reformas Tributarias en América Latina” –  Alberto Arenas for CEPAL – 2016