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The role of capital taxation on the business cycle: the case of Chile, 1960–2019

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Abstract

How relevant could capital income tax be as a growth engine? We analyse the Chilean experience that since the mid-80s has shown significant increase in its growth rate, outperforming most Latin American countries in the same period. This paper analyses the contribution of capital stock to the Chilean business cycle from 1960 to 2019. We do so by constructing a dynamic general equilibrium model in which firms accumulate capital and capital income taxation occurs at both firm and individual levels. In line with previous studies, we find that productivity shocks were an important driver of growth but unlike them, we find that capital income taxation policies also played an important role in explaining the Chilean miracle. The large adjustments in capital stock that Chile experienced are in line with the reasoning that interest rates in small open economies like Chile respond less to increases in capital taxation, and therefore do not diminish the impact of tax reforms.

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Sources: World Economic Outlook, 2019, IMF

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Notes

  1. Using a capital income share equal to 0.4, as in Corbo and Gonzalez (2014) and Coeymans (1999) among others.

  2. We model the trend by means of a quadratic time model.

  3. The objectives and principles of the reform are summarized in a document by the former Minister (Cauas 1974).

  4. However, a transition period was contemplated in the new legal text. In 1976 and 1977, the tax rate was 20% and 18%, respectively.

  5. Law Decree No 1604, December 1976.

  6. Until March 1974, the top marginal rate of the second category tax was 65%. With the approval of Law Decree \(\hbox {N}^\circ 367\), the top marginal rate rose to 80% on a temporary basis until December 31 of 1974. With the enactment of law Decree No. 824 (1st January, 1975), the maximum rate was set at 60%. In 1981, maximum rate was set at 58%. This structure was modified only temporarily between March and December 1982, with the sole purpose of increasing tax revenue.

  7. It should be noted that exceptionally, and only for 1989, the corporate tax was applied on the basis of received income . As from 1990, with the Law No. 18,985, the corporate tax returned to a regime were accrued profits were the taxable base.

  8. In 2010, the government raised temporarily the corporate tax to 20%. However, the corporate tax was established at 20% permanently in 2012. Further, in 2014 with the approval of Law No. 20.780, the corporate tax was increased to 27% within a period of four years.

  9. The tax reforms of 2012 and 2014 also contain changes in personal taxes.

  10. The personal income tax is the tax levied on personal earnings including labour and capital income. In Chile, it corresponds to the “Impuesto Global Complementario” (IGC) which taxes the entire personal income base. This is the only progressive tax in Chile. Other taxes are generally flat rates. We use the highest marginal rate of the IGC to construct the time series for the personal income tax. These are available from the tax code—which had obviously changed many times since 1960.

  11. Our specification of the country interest rate premium makes the interest rate a function of the level of debt as opposed to the level of debt relative to trend output. Therefore, to make the comparison possible, the value of \(\psi\) of 1.3 used by García-Cicco et al. (2010) must be divided by the level of steady-state output in that model, which equals 1.4865.

  12. Models with imperfect enforcement of international loan contracts a la Eaton and Gersovitz (1981), predict that country premium increases with the level of external indebtedness. In a similar way, models in which international borrowing is limited by collateral constraints imply a shadow interest premium that is increasing in the level of net external debt.

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Authors and Affiliations

  1. Facultad de Derecho, Pontificia Universidad Católica de Chile and Centro Latinoamericano de Políticas Económicas y Sociales (Clapes-UC), Santiago, Chile

    Rodrigo A. Cerda

  2. Centro Latinoamericano de Políticas Económicas y Sociales (Clapes-UC), Santiago, Chile

    José Tomás Valente

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  1. Rodrigo A. Cerda
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  2. José Tomás Valente
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Correspondence to Rodrigo A. Cerda.

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We received helpful comments from participants at the 3rd EH-Clio Lab Annual Conference (Santiago,Chile) and two anonymous referees. Any remaining mistake is our own.

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Cerda, R.A., Valente, J.T. The role of capital taxation on the business cycle: the case of Chile, 1960–2019. Econ Change Restruct 55, 83–108 (2022). https://doi.org/10.1007/s10644-020-09308-2

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