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Colombia's indirect taxation system: slowly moving in the right direction

Colombia has undergone multiple tax reforms over the past 20 years. These frequent alterations to the tax code have engendered a plethora of differential treatments and specific sector rates within the country’s VAT system. As a result, the goal of economic equality has been greatly diluted. Until December 2012, the legislation on the system of indirect taxation in Colombia was the obvious target of lobbying powers. These groups jockeyed for the special tax treatment of their particular sectors, all but losing the fundamental objectives of what a fiscal policy on indirect taxation should mean. Indirect taxation has increasingly become the most powerful tool for tax collection among world economies, collecting on average nearly 20% of the total tax revenue. Its simple collection process makes it an appealing first choice tax to which governments like to direct their efforts. Although from the standpoint of revenue VAT is worth its weight in gold, this weight becomes an issue when politics come into play. Moreover, the distributional effects of high rates of VAT appear to pose a heavier confiscatory burden on the consumption of low-income households. However, when doing a partial equilibrium analysis, the apparent negative effects of having a VAT on all goods and services sold in an economy (goods and services for which there has been a measureable chain of value added) highlight the weakness of the negative argument of a generalised tax when confronted with (a) a large underground economy and (b) the price advantage for final products when a producer is shown to be able to deduct all of the cost of the VAT incurred in production. Quite apart from these weaknesses, the mere thought of taxing the basic basket of goods (even at a preferential rate) is a political non-starter in Congress and even in the highest spheres of government causes a negative reaction; nobody wants to be responsible for taking the historic step of taxing value chains in a rather basic production economy. A deeper analysis of these two implications should be considered in order to develop a better consensus as to how VAT taxation should be addressed. Bearing this in mind, the challenges of indirect taxation in Colombia have two different dimensions: first, the challenge of fighting under-invoicing and hence under-compliance with tax laws; and second, the challenge of finding mechanisms to compensate the low-income section of the population for the tax cost they have to incur when consuming and spending