Three Essays in Public Finance in Developing Countries

Abstract

The three chapters presented in this dissertation focus on fiscal issues affecting developing countries. Low tax revenue collection, weak enforcement capabilities, high levels of tax evasion, inefficient tax system design, and reactive handling of contingent liabilities –such as natural disasters–, are characteristics commonly observed in countries across the developing world. In the analyses presented here, I study some of these issues and seek to contribute to their understanding through new empirical evidence.

Chapter 1: Minimum taxes are attractive to governments because under such regimes evasion incentives are expected to be lower than under profit taxation. Until recently, this type of policies was considered suboptimal from a social welfare perspective. The present analysis focuses on the Guatemalan corporate income tax regime faced by firms registered in Regimen Optativo. The empirical evidence shown in this chapter suggests strong firm responses to the minimum tax and to its exemption rule, most of which seem in accordance with evasion behavior. Upper-bounds for average reported profits are estimated to be as low as 42% of actual firms’ profits, implying an evasion rate of 58% in the absence of the minimum tax scheme. These results are consistent with the view that minimum taxes can be an effective mechanism to lower tax evasion in environments with limited enforcement capabilities.

Chapter 2: This chapter analyses the fiscal impact of extreme weather events. While the literature analyzing the economic incidence of natural disasters has mainly focused on their macroeconomic consequences, the fiscal dimension of this problem remains relatively neglected. Due to their adverse effect on the economy, extreme weather events tend to reduce government revenues and increase public expenditure, creating a negative pressure on the budget balance. According to the results shown in this chapter, the occurrence of at least one extreme weather event is associated with an increase in the budget deficit between 0.4% and 0.9% of GDP. This impact comes primarily from an immediate reduction in government revenues, as a percentage of GDP, with some evidence pointing out to a lagged effect on public expenditure two years after the event. The analysis also shows that the fiscal effect is larger for low-income and lower-middle income countries but is not significant for high-income and upper-middle income countries.

Chapter 3: This chapter explores the consequences of having two co-existing corporate income tax regimes within a domestic tax system. This scenario is interesting because, in such environments, a simple theoretical model predicts an optimal strategy involving tax arbitrage through income shifting across regimes. The empirical exercise focuses on the case of Guatemala, where firms choose between a regime that taxes profits –Regimen Optativo–, and a regime that taxes turnover –Regimen General–. Following a difference-in-difference approach, where treatment and control groups are defined by whether firms belong to a tax arbitrage network or not, the results show differential behavior between the two groups. Firms that do not belong to a tax arbitrage network faced a decrease of around one percentage point more than the treatment group in the probability of registering in Regimen General after the reform. Despite their consistency with the theoretical predictions, it is acknowledged that these results should only be interpreted as indirect evidence of profit shifting and the existence of tax arbitrage networks in Guatemala.