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Viewing cable 06BOGOTA6759, COLOMBIA'S COMPREHENSIVE TAX REFORM

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Reference ID Created Released Classification Origin
06BOGOTA6759 2006-07-26 20:09 2011-08-25 00:00 UNCLASSIFIED Embassy Bogota
VZCZCXYZ0004
RR RUEHWEB

DE RUEHBO #6759/01 2072009
ZNR UUUUU ZZH
R 262009Z JUL 06
FM AMEMBASSY BOGOTA
TO RUEHC/SECSTATE WASHDC 7379
INFO RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
UNCLAS BOGOTA 006759 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON ETRD EINV CO
SUBJECT: COLOMBIA'S COMPREHENSIVE TAX REFORM 
 
 
1. SUMMARY:  Taking advantage of President Uribe,s decisive 
electoral victory, the GOC presented its comprehensive tax 
reform bill to Congress on July 20.  The revenue neutral 
reform includes an overall reduction in the income tax 
(including reduced marginal rates), offset by a significant 
expansion of VAT coverage.  The administration proposes the 
gradual elimination of the tax on financial transactions and, 
is requesting authorization to make permanent a "war tax" on 
the wealthy to raise 2 trillion pesos (USD 800 million) for 
democratic security programs.  The vote in Congress will be 
the first test of the strength of the Uribe Congressional 
coalition; given his putative allies in the Cambio Radical 
party have already launched a competing comprehensive 
proposal.  End summary. 
 
---------- 
Income Tax 
---------- 
 
2.  Uribe,s proposal would reduce the highest effective rate 
on income from 38.5 percent (one of the highest in the 
region) to 33 percent in 2008, and 32 percent in 2009.  The 
first 34 million COP (approximately 13,000 USD) of an 
individual,s or company,s income (indexed to the minimum 
wage) would be exempt from income tax.  GOC plans to tax the 
next 13,000 USD to 47,999 USD at 15 percent, while all income 
of 48,000 USD or more will be subject to the highest rate. 
Income tax payments would be withheld from salary payments or 
due on a pay-as-you-go system (similar to the United States). 
 The overall effect of the reform would be a reduction in the 
income tax burden, especially for businesses that would 
benefit from the lower marginal rate.  The new payment regime 
should increase compliance rates. 
 
----------------- 
Business Stimulus 
----------------- 
 
3.  According to senior Finance officials, President Uribe 
directed the Ministry to include a package of incentives for 
capital investment in the tax reform proposal.  The most 
significant of these incentives would allow businesses to 
shield all profits redirected toward the purchase of capital 
goods.  Many experts have expressed concern this will place 
an undue burden on collection efforts, as businesses could 
adjust depreciation schedules on capital goods to maximize 
the benefits of this tax shelter, in effect reducing the 
overall marginal tax rate. 
 
------------ 
Expanded VAT 
------------ 
 
4.  Currently, Colombia,s VAT applies nine different rates 
ranging from 0 to 16 percent on approximately 53 percent of 
the GDP.  Uribe,s reform package would reduce the number of 
VAT categories from nine to three and apply the VAT to nearly 
seventy percent of GDP.  The general VAT, covering most 
goods, would increase from 16 percent to 17 percent, while a 
new rate of 12 percent would apply for items in the basic 
basket of goods.  The VAT on luxury items, including cars, 
perfumes and cellular phones would increase from 16 to 25 
percent.  Education, utilities, health, and rent would remain 
exempt from the VAT.  To meet constitutional obligations to 
protect the poor, the GOC plans to pay the lowest wage 
earners about 120 USD annually to compensate for the increase 
in VAT on basic necesities via Colombia,s welfare system 
(SISBEN). 
 
------------------------- 
Financial Transaction Tax 
------------------------- 
 
5.  Uribe,s proposal includes a gradual phase out of the 
financial transaction tax.  The tax has created a significant 
distortion of economic activity away from traditional 
banking, but is difficult to repeal because it is a reliable 
source of considerable income for the GOC.  In 2004, the 
financial transaction tax generated 2.2 trillion COP 
(estimated 916 million USD), while in 2005, the collection 
increased 7.3 percent to 2.4 trillion (estimated 1 billion 
USD), representing 5 percent of total revenue generated. 
Resistance to the complete elimination of this tax is 
hardening. Recent counter proposals suggest the number of 
accounts taxed could be cut in half or that the tax could be 
reduced, but not eliminated entirely. 
 
---------------- 
Dinosaur Hunting 
---------------- 
 
6.  The stamp tax, document tax, and numerous tax shelters 
 
protecting assets in pension funds and construction savings 
accounts (AFCs) would be eliminated under  Uribe,s proposed 
reform.  The stamp tax and document tax, two holdovers from 
colonial times, no longer generate revenue and are seen by 
most experts as a barrier to efficiency.  Pension fund - 
Construction Savings Accounts or AFCs, created in 1999 to 
stimulate the housing construction market also are 
eliminated.  According to Vice Minister of Finance Maria Ines 
Agudelo, these shelters are used by the wealthiest 10 percent 
of Colombians and cost the GOC close to COP 70 billion 
(approx. USD 29 million) in lost tax revenue.  Mauricio 
Cardenas, president of an influential economic think tank and 
author of part of the tax reform proposal, further explained 
that the exemption is a particularly important form of tax 
relief for those earning between USD 25,000 and 50,000 per 
year as the shelters effectively reduce marginal tax rate on 
this wage group from 38.5 percent to 30 percent. 
 
------------------------------ 
The Permanent One-time War Tax 
------------------------------ 
 
7.  On July 12, the President met with 40 Congressional 
representatives to lay out his request for an extension of 
the current net worth tax intended to raise two billion COP 
for democratic security programs - the third iteration of the 
wealth tax.  In 2003, President Uribe presented the wealth 
tax as a war tax to finance particular expenditures, much 
like this tax.  It was then extended in 2004 to 2006 as a 
simple wealth tax with a much wider base and smaller rate (.3 
percent on declared liquid net worth after specific 
deductions).  In the extension of the tax, Colombians and 
Colombian companies with a net worth in excess of 1.5 billion 
COP (approximately 600,000 USD) will be taxed at a rate of .4 
percent and will have two years to complete their payment to 
the GOC.  The GOC estimates it will collect two billion pesos 
(800 million USD) from nearly 11,000 contributors under the 
proposal.  The GOC surprised many experts by proposing to 
Congress that this tax be made annual, during the 
presentation of the tax reform package on July 20. 
 
-------------------- 
Next Step - Congress 
-------------------- 
 
8. Initial congressional reaction to the tax reform have 
generally been positive, but the Cambio Radical party 
(generally Uribe-supporting but headed by a Senator with 
presidential asperations for 2010) presented a competing 
version, indicating early in the process he will seek a 
compromise on key elements with the other of the "Uribe 
block" parties.  Cambio Radical's plan is a less significant 
reform, but it is also revenue neutral.  It proposes a slight 
cut in the income tax, retention of various tax shelters, and 
the immediate elimination of the tax on financial 
transactions. 
 
------- 
Comment 
------- 
 
9. Strong economic growth, a negotiated free trade agreement 
with the United States and Uribe's decisive electoral victory 
have created an environment where comprehensive tax reform is 
a strong possibility.  It is unclear, however, how Congress 
will react to the Uribe proposal.  On a daily basis, new 
press reports discuss one element or another of the reform to 
be scaled back or reconsidered.  The elimination of the 
financial transaction tax and increases in coverage of the 
VAT have generated the most public discussion.  There is much 
public handwringing that the increased VAT coverage will make 
the system more regressive.  The motives of Cambio Radical in 
preparing a competing, less sweeping, reform are unclear, but 
may have much to do with the presidential ambitions of its 
leader, German Vargas Lleras.  Colombia's professional middle 
class will bear a majority of the burden under the proposed 
reform.  Facing a significant increase in VAT charges and the 
elimination of popular tax shelters, the potential exists for 
a vocal middle class push back that could affect the outcome 
of Uribe's reform efforts.  End Comment. 
WOOD