© 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 27 26 25 24 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. The boundaries, colors, denominations, links/footnotes and other information shown in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The citation of works authored by others does not mean the World Bank endorses the views expressed by those authors or the content of their works. Nothing herein shall constitute or be construed or considered to be a limitation upon or waiver of the privileges and immunities of The World Bank, all of which are specifically reserved. Rights and Permissions This work is available under the Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) http://creativecommons.org/licenses/by/3.0/ igo. Under the Creative Commons Attribution license, you are free to copy, distribute, transmit, and adapt this work, including for commercial purposes, under the following conditions: Attribution—Please cite the work as follows: Maloney, William, Jorge Andres Zambrano, Guillermo Vuletin, Guillermo Beylis, and Pablo Garriga. 2024. Taxing Wealth for Equity and Growth. Latin America and the Caribbean Economic Review (October 2024). World Bank, Washington, DC. doi: 10.1596/978-1-4648-2182-0. License: Creative Commons Attribution CC BY 3.0 IGO Translations—If you create a translation of this work, please add the following disclaimer along with the attribution: This translation was not created by The World Bank and should not be considered an official World Bank translation. The World Bank shall not be liable for any content or error in this translation. Adaptations—If you create an adaptation of this work, please add the following disclaimer along with the attribution: This is an adaptation of an original work by The World Bank. Views and opinions expressed in the adaptation are the sole responsibility of the author or authors of the adaptation and are not endorsed by The World Bank. Third-party content—The World Bank does not necessarily own each component of the content contained within the work. The World Bank therefore does not warrant that the use of any third-party-owned individual component or part contained in the work will not infringe on the rights of those third parties. The risk of claims resulting from such infringement rests solely with you. If you wish to re-use a component of the work, it is your responsibility to determine whether permission is needed for that re-use and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. ISBN (electronic): 978-1-4648-2182-0 DOI: 10.1596/978-1-4648-2182-0 Cover design: Maria José Ascoli Edition: Nancy Morrison Taxing Wealth for Equity and Growth Acknowledgements II Latin America and the Caribbean Economic Review October 2024 Acknowledgements Latin America and the Caribbean Economic Review October 2024 III Acknowledgements This report is a product of the Chief Economist Office for Latin America and the Caribbean at the World Bank. The preparation of the report was led by William Maloney (Chief Economist), Guillermo Raul Beylis (Senior Economist), Pablo Garriga (Economist), Guillermo Vuletin (Senior Economist), and Andres Zambrano (Senior Economist). Excellent research and editorial assistance were dispensed by Pilar Ruiz Orrico (Research Analyst), José Andrée Camarena Fonseca (Research Analyst), Maria José Uribe (Consultant), Fausto Andres Suaza Duarte (Consultant), Ivana Benzaquen (Consultant), Fernando Castaño (Consultant), Matias Ciaschi (Consultant), Guillermo Falcone (Consultant), Jessica Bracco (Consultant), Isidro Guardarucci (Consultant), and Jacqueline Larrabure (Senior Program Assistant). Other contributions were provided by Nathalie Gonzalez- Prieto (Economist), Marcela Meléndez Arjona (Deputy Chief Economist), Daniel Riera-Crichton (Bates College) and Lucila Venturi (Harvard University). Special contributions were provided by: Erik von Uexkull (Senior Economist, ELCMU), Yira Mascaro (Practice Manager, ELCFN), Federico Alfonso Diaz Kalan (Financial Sector Specialist, ELCFN), Faruk Miguel Liriano (Financial Sector Specialist, ELCFN), Nicolo Fraccaroli (Economist, ELCFN), Guillermo Fernandez Zubia (Consultant, ELCFN), Dean A. Cira (Program Leader, SLCDR), Paula Restrepo Cadavid (Lead Urban Specialist, ILCUR), Ivonne Astrid Moreno Horta (Senior Land Administration Specialist, ILCUR), Alvaro Federico Barra (Land Administration Specialist, ILCUR), and Cornelius Fleischhaker (Senior Economist, ELCMU). Substantive inputs were offered by the regional teams: Poverty and Equity: Carlos Rodriguez Castelan (Practice Manager, ELCPV), Hugo Ñopo (Senior Economist, ELCPV), Hernan Winkler (Senior Economist, ELCPV), Diana Marcela Sanchez Castro (Research Analyst, ELCPV), and Karen Yiseth Barreto Herrera (Consultant, ELCPV). Human Development: Jaime Saavedra (Regional Director, HLCDR), Will Wiseman (Practice Manager, HLCSP), Tania Dmytraczenko (Practice Manager, HLCHN), Josefina Posadas (Lead Economist, HLCSP), Julie Ruel Bergeron (Senior Health Specialist, HLCHN), and Santiago de la Cadena Becerra (Human Development Economist, HLCSP). Digital Development: Yolanda Martinez Mansilla (Practice Manager, DLCDD) and Diana Parra Silva (Senior Public Sector Specialist, DLCDD). Finance, Competitiveness and Innovation: Arlan Zandro Ilagan Brucal (Economist, ETIIC), Mauricio Alejandro Pinzon Latorre (Consultant, ETIIC), and Eduardo Antonio Jimenez Sandoval (Consultant, ETIIC). Country-specific macroeconomic estimates and write-ups were produced by country economists in the Macroeconomics, Trade, and Investment Global Practice, under the leadership of Barbara Cunha (Lead Economist and Acting Practice Manager, ELCMU) and the coordination of Elena Fernández Ortiz and Adriane Landwehr. Contributors included Daniel Barco, Rafael Barroso, Paola Brens, Luigi Butron, Natalia Campora, Bledi Celiku, Fabiano Colbano, Antonio Cusato, Anton Dobronogov, Aygul Evdokimova, Julian Folgar, Sebastian Franco, Fernando Giuliano, Christian Gonzalez, Bernard Haven, Fernando Im, Evans Jadotte, Melise Jaud, Santiago Justel, Andres Lajer, Woori Lee, Rafael Ornelas, Esteban Orozco, Fausto Patiño, Raphael Pinto Fernandes, Maryan Porras, Daniel Reyes, Natasha Rovo, Gabriela Schmidt, Heron Teixeira, Vasileios Acknowledgements IV Latin America and the Caribbean Economic Review October 2024 Tsiropoulos, Hulya Ulku, Constanza Vergara, Pui Shen Yoong, and Gabriel Zaourak (all ELCMU). Additional collaborators include Elena Resk (CASAE), Andrew Burns (EMFMD), Shireen Mahdi (ELCDR), Rafael Munoz (ELCDR), Ana Maria Aviles (ELCDR), Mark Thomas (LCC1C), Michel Kerf (LCC2C), Peter Siegenthaler (LCCCO), and Cristina Panasco (LCC7C). Valuable regional insights were also shared by Augusto de la Torre (Columbia University). Communications and Dissemination support was provided by Ana Elisa Luna Barros (Manager, ECRLC), Ruth Idalina Gonzalez Llamas (Senior External Affairs Officer, ECRLC), Analia Martinez (Online Communications Officer, ECRLC), Yuri Szabo Yamashita (External Affairs Officer, ECRLC), Belkis Delcid Diaz (Program Assistant, ECRLC), Carlos Alberto Cortes Galavis (Consultant, ECRLC), Francisco Seminario (Consultant, ECRLC), and Leandro Juan Hernandez (Consultant, ECRLC). Nancy Morrison (Consultant, LCRCE) provided editorial support, Leonardo Padovani (Consultant, LCRCE) and Martin Gianelli (Consultant, LCRCE) translated the document, and Maria Jose Ascoli (StudioM) contributed on design. The cutoff date for this report was October 2, 2024. Contents Acknowledgements Latin Latin America the Caribbean America and and the Caribbean Economic Economic Review Review October 2024 October 2024 V Contents Acknowledgements III Overview Taxing Wealth for Equity and Growth 1 Growth Outlook of the Region 6 Chapter 1 The State of the LAC Region 7 Growth Will Improve, but Long-term Prospects Remain Low 8 Inflation is Receding, but is Not Completely Under Control 13 Fiscal Pressures Are Crowding Out Investment 16 The Banking Sector Is Stable, with Some Signs of Stress 19 Nearshoring Watch: Is LAC Missing the Boat? 26 FDI is Not Dramatically Increasing in the Region 26 LAC is Displacing Chinese Exports, but Again, on a Small Scale 30 Labor Markets and Social Conditions 34 Labor Market Mirrors Disappointing Growth Performance 34 Poverty and Inequality 40 Conclusion 48 References 49 Contents VI Latin America and the Caribbean Economic Review October 2024 Chapter 2 Taxing Wealth for Equity and Growth 52 Why Tax Wealth? 53 The Renewed Global Focus on Wealth Taxes 55 Which Wealth to Tax? 55 A Tale of Two Models: Wealth Taxation in Advanced Economies 56 Wealth Tax Revenues 57 Administrative Challenges of Wealth Taxes: Chasing the Elusive Liquid Asset 60 Plugging the Wealth Loophole: Can the World Act Together? 60 Targeting the Tangible: Real Estate as a Potential Anchor for Wealth Taxes in LAC 62 Why Is It that Real Estate Reigns Supreme as a Form of Wealth in LAC? 69 The Property Tax Paradox in LAC 69 Anatomy of the Real Estate Tax in LAC: A Patchwork of Systems with a Serious Valuation Problem 72 Reliance on Presumptive Taxes 74 Using New Technologies for Better Valuation 80 How Property Taxes Can Help Reduce Vertical Fiscal Imbalance 83 Public Spending Decentralization and Vertical Imbalance 83 The Potential of Subnational Real Estate Taxes 85 How Rural Land Tax Can Help with Environmental Protection 86 The Billion Dollar Question: Is Taxing the Ultra-Wealthy the Solution to LAC’s Fiscal Shortfalls? 89 Global Billionaire Spotting 90 Latin America’s Modest Billionaires 93 Is Taxing Billionaires the Silver Bullet for LAC’s Fiscal Problems? 93 Conclusion 94 References 95 Contents Latin America and the Caribbean Economic Review October 2024 VII Graphics Figure 1.1 Growth Will Improve in LAC, but the Region Continues to Underperform 8 Figure 1.2 Consumption Remains Strong, but Investment is Faltering 9 Figure 1.3 Balance of Payments Continues Adjusting to Historical Norms 10 Figure 1.4 LAC Countries Face External Uncertainty 11 Figure 1.5 Business and Consumer Confidence Are Growing 12 Figure 1.6 Headline and Core Inflation Continue to Slowly Fall Toward Central Banks’ Inflation Targets 13 Figure 1.7 Energy and Food Prices Remain High since Peaking in 2022 14 Figure 1.8 Inflation Expectations Are Anchored 15 Figure 1.9 Monetary Policy Has Loosened 15 Figure 1.10 The LAC Region is Progressively Improving Its Primary Fiscal Balance, but Interest Payments Are Increasing 17 Figure 1.11 Debt Has Been Steadily Increasing Since 2010 17 Figure 1.12 Real Yields of Sovereign Bonds Have Sharply Increased 18 Figure 1.13 While Credit Growth Remains Sluggish in the Largest LAC Economies, It Has Picked Up in the Smaller Ones 19 Figure B1.1.1 Droughts Increase the Nonperformance of Agricultural Loans in Paraguay 24 Figure B1.1.2 Stress Tests Reveal Different Physical Risks and Transition Risks across Selected Countries 25 Figure 1.14 FDI Flows to LAC Have Not Recovered Previous Peaks 27 Figure 1.15 Brazil Has Driven Recent Movements in FDI and There is Little Evidence of Nearshoring in the Region 27 Figure 1.16 Other Regions Have Fared Better than LAC in Terms of the Capital Expenditure of FDI Greenfield Announcements 28 Figure 1.17 Capital Expenditure of FDI Greenfield Announcements to LAC-6 Countries Has Been Limited 29 Figure 1.18 FDI Inflows to the Smaller Countries of Costa Rica and the Dominican Republic Are Strong 29 Figure 1.19 China’s Losses Translated to LAC’s Gains 31 Figure 1.20 Mexico Is the Primary Beneficiary of China’s Export Losses to the United States 32 Figure 1.21 Central American Countries and Haiti Also Have Benefitted from Substituting Chinese Exports 33 Figure 1.22 Employment Rates Have Mostly Recovered, but Challenges Persist 34 Figure 1.23 Real Labor Incomes Have Not Fully Recovered 35 Figure B1.2.1 Minimum Wages Have Increased Steeply in Some LAC Countries 36 Figure B1.2.2 Minimum Wages that Increase with Firm Size Can Distort Employment Decisions 37 Contents VIII Latin America and the Caribbean Economic Review October 2024 Figure B1.2.3 High Relative Minimum Wages Are Irrelevant to Many Workers 38 Figure 1.24 The LAC Poverty Rate Has Fallen below 2019 Levels, Driven by Brazil and Mexico 41 Figure 1.25 Small Gains Have Been Achieved in Income Inequality in LAC, but Challenges Persist 41 Figure B1.3.1 The Heterogeneity in Food Insecurity is High across LAC 42 Figure B1.3.2 LAC Is the Region with the Highest Average Cost of a Healthy Diet 43 Figure B1.3.3 Progress Has Been Made in Reducing Child Stunting in LAC, but Rising Obesity Is a Concern 44 Figure B1.3.4 The Trends in Overweight Children and Adult Obesity in LAC are Worrisome 45 Figure B1.3.5 Rising Obesity Will Lead to Major Economic Costs 46 Figure 2.1 Statutory Corporate Tax Rates in LAC Countries Are Higher than in Other Groups of Countries 54 Figure 2.2 LAC Has a Relatively Unfriendly Business Environment 54 Figure 2.3 Wealth Taxes Vary Greatly by Region and Country 58 Figure 2.4 Property is the Greatest Type of Wealth in LAC 63 Figure 2.5 Real Estate Accounts for a Very Large Share of Household Wealth of the Top Earners in LAC 64 Figure 2.6 Real Estate Is Important as a Source of Wealth across All Income Percentiles in LAC 65 Figure 2.7 As Countries Develop, their Wealth Composition Shifts from Real Estate to a More Diversified Portfolio 68 Figure 2.8 While Most Wealth in LAC is Held as Real Estate, Property Taxes Yield Very Little Revenue 70 Figure 2.9 LAC Countries Tend to Collect Too Little Real Estate Tax Given the Prominence of Real Estate Wealth 71 Figure 2.10 There is Significant Potential for Growth in Property Tax Revenue in LAC 72 Figure 2.11 Property Tax Rates in LAC Countries Are Within the Range of US States 73 Figure 2.12 Fiscal Valuations Are Very Low on Properties in Buenos Aires 74 Figure B2.3.1 An Analysis of Properties in Buenos Aires Found No Direct Impacts of Higher Real Estate Taxes on Rental Prices 79 Figure 2.13 LAC Countries Vary in the Degree They Devolve Public Expenditures to Subnational Governments 84 Figure 2.14 The Vertical Fiscal Imbalance Is Larger in LAC Countries than in Advanced Economies 84 Contents Latin America and the Caribbean Economic Review October 2024 IX Figure 2.15 The Number of Billionaires Has Surged, but There Are Relatively Few Billionaires in the World 91 Figure 2.16 Billionaires are Concentrated in a Few Countries in LAC 92 Figure 2.17 LAC Has Relatively Few Billionaires Given its Population 92 Figure 2.18 Billionaires in Other Regions Are Much Wealthier than Billionaires in LAC 93 Figure 2.19 A Wealth Tax on Billionaires in LAC Would Yield Little Revenue, and Less Revenue than in Other Regions 94 Tables Table 1.1 Banking Systems in LAC Continue to be Well Capitalized, though Liquidity is Getting Tighter in Several Countries 21 Table 1.2 Some NPLs Segments Have Been Showing Signs of Stress 22 Table B2.2.1 The Nature of Property Valuation is Very Complex in LAC Countries 75 Maps Map 2.1 LAC Has Relatively Few Billionaires in Absolute Numbers 91 Boxes Box 1.1 Helping Assess and Monitor Climate and Environmental Risks Facing the Financial Sector in Latin America and the Caribbean 23 Box 1.2 The Limits of Increasing Minimum Wages in Latin America and the Caribbean 35 Box 1.3 Food Insecurity and the Economic Costs of Unhealthy Diets in Latin America and the Caribbean 42 Box 2.1 The Great French Wealth Tax Shuffle 61 Box 2.2 Unpacking the Presumptive Tax 75 Box 2.3 Do Higher Property Taxes Raise Rents: Evidence from Buenos Aires 78 Box 2.4 Property Registry Success Stories: Lessons from Bogotá and Barranquilla 81 Box 2.5 Brazil’s Land Tax: A Tool for Conservation 87 Box 2.6 Why Might Argentine Entrepreneurs Move to Uruguay? A Deep Dive into Differential Taxes on Wealth 90 Overview Taxing Wealth for Equity and Growth Overview: Taxing Wealth for Equity and Growth 2 Latin America and the Caribbean Economic Review October 2024 L atin America and the Caribbean (LAC) is close to winning the battle on inflation and turning the corner on the macroeconomic dislocations wrought by the pandemic. Monetary authorities in the region have managed the multiyear challenge at least as well as their counterparts in the advanced economies, yet another sign of competent macroeconomic management. Interest rates, both in the region and now in the United States, have been falling, relieving stress on households and banking sectors and offering some prospect of more vigorous economic activity. Challenges remain, however, to redress fiscal imbalances and reduce debt, recover lost earnings power, and regain the advances in reducing poverty of the previous decade. Nor is there any prospect for substantially higher growth, which would help address those challenges. Investment, both public and private, remains depressed, and data suggest that the region is potentially missing the boat on “nearshoring” or “friendshoring,” the practice of bringing offshore operations to close or friendly countries. Both challenges point to a substantial agenda of growth-related reforms that have been put off for decades in infrastructure, education, regulation, competition, and tax policy which success in managing the post pandemic macroeconomic disequilibria provides an opportunity to now address. In the short run, the stubbornness of poverty and inequality is leading some governments to recur to take more direct measures, such as raising minimum wages as a means to support the poor—with both positive and potentially negative consequences if not pursued with caution. Concerns have also surfaced about one particular dimension of poverty—food insecurity and the cost of unhealthy diets. Chapter 1 of this report lays out the recent social and macroeconomic evolution of the region and the near- term challenges it faces, particularly in the realm of growth and balancing the fiscal accounts. Chapter 2 explores a third emerging agenda: the use of wealth taxes to generate fiscal space, while advancing equity and growth—including, the proposed taxes on billionaires discussed at the G20. Chapter 1. Turning the Corner on Pandemic Disruptions: Time to Address Longer Term Challenges The region is close to vanquishing inflation, the second major macro challenge arising from the pandemic after the initial recessions. Among the large countries, Brazil and Peru are likely to achieve their inflation targets in 2024, with other major economies following soon after. Inflationary expectations remain anchored, and monetary authorities have begun to reduce interest rates; both nominal and real rates have begun to fall. That said, in the last mile, elements of inflation remain stubborn, with fuel and food prices still above their long-term trends and policy rate reductions need to proceed with deliberation. On the financial front, lower rates will reduce stress on households and firms that has given rise to sharp increases in nonperforming loans. The debt service shock is taking place against a backdrop of an almost doubling of consumer credit as a percentage of GDP in many countries over the past 20 years. These risks must continue to be monitored, although to date, banks appear to be well provisioned and international markets remain sanguine. A box in chapter 1 examines how the World Bank has helped LAC countries on assessing and monitoring climate and environmental risks on the financial sector. For the short term, international headwinds are moderately positive. The US Federal Reserve’s September decrease in interest rates of 0.5 percent with further decreases expected by the end year signals increased confidence in achieving a soft landing—eliminating inflation without inducing a recession—and gives local authorities more freedom to lower rates without the danger of significant capital outflows. Growth in the Group of Seven (G-7) nations is expected to remain moderate this year. China, LAC’s largest trading partner, Overview: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 3 continues with sluggish and increasingly unpredictable behavior as authorities reconsider their growth model. This clearly spills over to softened commodity prices. Together, growth in LAC is forecasted to reach 1.9 percent in 2024, but with substantial variation across countries. Both business and consumer confidence are rising. On the fiscal front, government spending remains elevated, but some relief is to be expected with falling interest rates. Transitory transfers to vulnerable individuals and businesses during the COVID-19 pandemic are continuing to recede—albeit incompletely, while in many countries, other spending has not fallen or has increased. Overall, progress on debt reduction remains limited: the debt-to-GDP ratio increased in 2024 to 62.8 percent and remains above the 2019 level of 59.1 percent. The region still needs to generate more fiscal space through gains in efficiency, spending reductions, and increased tax revenues. Some reduction in current account imbalances has occurred, though mostly due to a stagnation in investment. This low public and private capital accumulation, combined with low productivity gains over the longer term, bodes ill for long-term growth. Further, despite the enthusiasm for nearshoring, foreign direct investment (FDI) remains below levels of 13 years ago in real terms. The sharp increase in 2022 was followed by more modest inflows in 2023 and greenfield investment announcements are more vigorous to other parts of the world. While some countries, such as Costa Rica and the Dominican Republic, are embracing the opportunities to integrate in rapidly restructuring global value chains, most governments do not have FDI on their growth agenda. The April 2023 edition of the Latin America and Caribbean Economic Review (LACER) discussed how, despite the fact that wages are now competitive with those in China and other destinations, other structural factors in LAC—such the cost of capital, the weak education level of the workforce, poor energy and infrastructure policy, and social instability—all reduce the attractiveness of the region as a friendshoring destination. Compounding this is the fact that corporate taxes are among the highest in the world, with rates in Colombia and Brazil among the highest. Put bluntly, if a company leaving China had a choice between going to Viet Nam—with education scores above the average of the member countries of the Organisation for Economic Co-operation and Development (OECD), low levels of violence, attentive government agencies, and corporate taxes of 20 percent—or come to LAC, where big challenges remain in all those areas and corporate taxes in some potential destinations are 25 percent to 35 percent, the company may choose to find its new partners in Asia. Addressing these structural concerns is urgent. Progress on poverty and inequality remains slow. In 2024, monetary poverty is expected to decrease marginally to 24.7 percent of LAC’s population (based on an upper-middle-income poverty line of $6.85 per day in 2017 PPP terms), while inequality is expected to remain high by World Bank standards, with a Gini coefficient of 49.9 percent. A box in chapter 1 examines a persistent challenge and form of nonmonetary poverty in LAC: food insecurity and the costs of unhealthy diets. Wage growth remains sluggish, reflecting the low growth rates. This has led some countries, such as Bolivia, Costa Rica, Dominican Republic, Ecuador, and Mexico, to engineer significant rises in minimum wages. As the box in chapter 1 on the topic shows, in Mexico, lifting minimum wages from very low rates appears to have had an overall positive impact on key social indicators. However, regional experience suggests that once the minimum wage reaches higher levels, further rises place burdens on firms of all sizes that can deter job creation, induce unemployment and informality, and even increase poverty. Further, many social benefits are indexed to the minimum wage, putting stress on government budgets and complicating fiscal adjustment. The labor market is not infinitely resilient, and governments need to proceed with caution. Overview: Taxing Wealth for Equity and Growth 4 Latin America and the Caribbean Economic Review October 2024 Continued inequality, high taxes on productive investment that limit growth, and continued lack of fiscal space have raised taxing wealth as a possible means of addressing all three issues. This is the subject of chapter 2. Chapter 2. Why Tax Wealth? Wealth taxes have moved to center stage in the global agenda, particularly during Brazil’s Presidency of the Group of Twenty (G-20), where such taxes are seen as a tool to reduce inequality, raise resources to fight global warming, and improve global governance. They also have the potential to raise growth, shifting the tax burden from productive investment—as noted, LAC’s taxes on firms are among the highest in the world— toward assets with likely less negative impact on economic dynamism. While greater reliance on wealth taxes has potential to address these goals, experience from the advanced economies suggests challenges in administration and sometimes unintended consequences depending on what type of wealth tax is considered. Financial assets—stocks, bonds, and cash—are easy to move and hide, and tracking them requires major global coordination around tax havens which, while also necessary in the fight against illicit monetary flows, is likely to remain elusive over the short term. On the other hand, property, such as real estate, is generally less mobile and easier to valuate. It is also less linked to the productive process than financial assets, making taxes on property less distortive for growth-inducing processes such as innovation and job creation. In fact, taxing unused land differentially can lead to higher productivity. Moreover, property taxes can be a valuable tool for empowering subnational governments and reducing their reliance on central government transfers. Hence, to maximize the effectiveness of wealth taxes, countries need to consider the type of asset to focus on, and invest in the corresponding robust administrative systems to ensure compliance. Most importantly, the wealth tax needs to be considered as one element of a broader tax reform geared to both improve equity and stimulate growth. Wealth Tax Revenues The concept of wealth taxation, which involves taxing an individual’s net worth, has been implemented differently across advanced economies. North America has largely relied on property taxes and estate taxes, while Europe has adopted broader net wealth taxes, although in recent years, some of these taxes have been narrowed in scope or repealed. For example, France has recently shifted toward a real estate wealth tax targeting high-value properties. The LAC region has relatively low amounts of wealth tax collection, collecting 2.7 percent of revenues compared to North America at 12.8 percent or Western and Central Europe at 4.3 percent—although there is significant variation among LAC countries. LAC Has a Property Tax Paradox Surprisingly, LAC countries typically collect only 2 percent of tax revenue from property taxes—below the global average—despite the fact that 80 percent of wealth in the region is held in in real estate, even among the top 10 percent of earners, and that, administratively, property is easier to track than financial assets. While, globally, the share of wealth held as property decreases with level of development, reflecting deepening financial markets and increasing financial literacy, the share of wealth tied to property is especially high in LAC, reflecting a strong cultural preference for homeownership and perhaps a preference for a tangible hedge against recurring bouts of inflation. The potential contribution of a properly administered wealth tax on property is estimated to be as high as 3 percent of GDP (Ahmad, Brosio, and Jiménez 2019). Overview: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 5 The root of the property tax paradox in LAC lies not in the tax rates themselves, but in outdated and inaccurate property valuations that are sometimes less than 10 percent of market valuations. This leads to undervaluation, lower tax bills for landowners, and possible regressivity. Presumptive taxes, based on proxies like size, location, and property type, are often used to generate revenue, but they can also be inaccurate and inequitable. To address these challenges, LAC governments need to enhance their fiscal valuation systems, employing new digital platforms and modernizing cadasters to improve property mapping, data collection, and data sharing. A study in Buenos Aires suggests that increasing property tax payments through higher valuations does not significantly increase rents, making this approach both effective and neutral on renters. Moreover, experience from Bogotá and Barranquilla, Colombia shows the potential leverage property taxation as a powerful tool for generating revenue, promoting transparency, and driving sustainable urban development through effective cadastral management and modernization. Property Taxes Can Help Reduce Vertical Fiscal Imbalance Throughout the region, local governments bear significant spending responsibilities but possess limited revenue-raising capabilities. The dependency on transfers from higher levels can create moral hazard and rent-seeking behavior and reduces local control over spending priorities. Subnational real estate taxes offer a promising solution to this challenge. While these taxes hold significant potential benefits, it is essential to address certain challenges. Rural Land Taxes Can Help Support Environmental Protection Rural land taxation can also be a powerful tool for environmental stewardship and sustainable land use. By penalizing inefficiently used land, it can incentivize landowners to adopt more productive and environmentally friendly practices. A well-designed rural land tax can disincentivize land hoarding, promote sustainable land use, generate revenue for environmental programs, and prevent land acquisition for speculative purposes. This can help mitigate deforestation, preserve biodiversity, and improve soil health. The Billion Dollar Question: Is Taxing the Ultra-Wealthy the Solution to LAC’s Fiscal Shortfalls? The tax on billionaires proposed by President Lula da Silva and French President Macron could very likely generate the hoped-for $US250 billion globally to be used to combat climate change and would contribute to equity. However, despite the importance of those with the greatest ability to pay shouldering their share of the burden, such a tax would be unlikely to contribute significantly to LAC’s fiscal shortfalls because the region has relatively few billionaires as a share of population (0.1 billionaires per million inhabitants compared to 2.1 in North America); they are not as wealthy as in advanced economies (the wealth of the top 10 billionaires in LAC combined barely surpasses the wealth of the richest man in the United States); and they are extremely mobile, meaning they can easily evade by moving. Back-of-the-envelope calculations suggest that possible revenues would amount to 0.1 percent of GDP assuming no mobility for LAC. As with income tax, it will probably be necessary to expand the base of the wealth tax to significantly increase revenues. In sum, reforming LAC’s tax systems with an eye toward greater reliance on property taxes could increase equity, promote growth and generate fiscal space. The benefits will not be automatic, however. Investments need to be made in administrative capacity, and proper valuation is necessary to ensure progressivity. Overview: Taxing Wealth for Equity and Growth 6 Latin America and the Caribbean Economic Review October 2024 Growth Outlook for the Region Real GDP Growth Rates 2021 2022 2023 2024e 2025f 2026f Argentina 10.4 5.3 -1.6 -3.5 5.0 4.7 Barbados -1.2 13.5 4.4 3.9 2.8 2.3 Belize 17.9 8.7 4.7 4.3 1.2 0.5 Bolivia 6.1 3.6 3.1 1.4 1.5 1.5 Brazil 4.8 3.0 2.9 2.8 2.2 2.3 Chile 11.3 2.1 0.2 2.5 2.2 2.2 Colombia 10.8 7.3 0.6 1.5 3.0 2.9 Costa Rica 7.9 4.6 5.1 4.0 3.5 3.4 Dominica 6.9 5.6 4.7 4.6 4.2 3.2 Dominican Republic 12.3 4.9 2.4 5.1 4.7 5.0 Ecuador 9.8 6.2 2.4 0.3 1.6 2.2 El Salvador 11.9 2.8 3.5 2.9 2.7 2.5 Grenada 4.7 7.3 4.7 3.2 4.7 4.4 Guatemala 8.0 4.2 3.5 3.7 4.0 4.0 Guyana 20.1 63.3 33.8 43.0 12.3 15.7 Haiti -1.8 -1.7 -1.9 -4.2 0.5 1.5 Honduras 12.6 4.1 3.6 3.5 3.4 3.7 Jamaica 4.6 5.2 2.6 0.8 2.2 1.6 Mexico 6.0 3.7 3.2 1.7 1.5 1.6 Nicaragua 10.3 3.8 4.6 3.6 3.5 3.6 Panama 15.8 10.8 7.3 2.4 3.0 4.0 Paraguay 4.0 0.2 4.7 3.9 3.6 3.6 Peru 13.4 2.7 -0.6 3.1 2.5 2.5 St. Lucia 11.6 20.4 2.2 3.4 2.6 2.3 St. Vincent and the Grenadines 0.8 7.2 6.0 5.0 3.5 2.9 Suriname -2.4 2.4 2.5 2.9 3.0 3.1 Trinidad and Tobago -1.0 1.5 1.3 2.2 2.3 0.9 Uruguay 5.6 4.7 0.4 3.2 2.6 2.6 Source: World Bank staff calculations. Note: The cut-off date for the data is October 2, 2024. “e” stands for estimate; “f” for forecast. Overview: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 7 Chapter 1 The State of the LAC Region Chapter 1: The State of the LAC Region 8 Latin America and the Caribbean Economic Review October 2024 L atin America and the Caribbean (LAC) continues in the last mile to reduce inflation, and shows improved prospects for growth, potentially facilitated by falling local and global interest rates. This said, growth will be below global and historical levels and continue to be driven by consumption demand without the investment needed to sustain future gains in productivity. Although most countries have made progress in correcting external imbalances, and have recovered lost employment and earnings, the legacy of debt from the COVID-19 pandemic and still-high servicing costs continue to impede efforts to generate fiscal space for further public spending and investment. Poverty and inequality continue to fall slowly, albeit unevenly, complicated by continued low projected growth rates. Further, nonmonetary measures of poverty such as food insecurity are sticky, while obesity is rising. Despite the current challenges, the receding of immediate conjunctural emergencies, such as inflation and previously recession, now permit the region to focus on the new opportunities that are emerging that require timely strategizing to take advantage of. The US-China trade realignment over the past five years has presented the opportunity to attract nearshoring investment and fill new export niches, which, to date, LAC has been slow to exploit. While some countries, such as Costa Rica, have grabbed parts of emerging value chains, foreign direct investment (FDI) to the region remains below levels of 2010 and announced greenfield investments are growing more in other regions, suggesting the need for reforms to improve LAC’s attractiveness. Growth Will Improve, but Long-term Prospects Remain Low Growth in LAC is expected to recover in 2025 from reduced rates in 2024. As highlighted in the April 2024 edition of the Latin America and Caribbean Economic Review (LACER),1 the tightness of monetary and fiscal policies to control post-pandemic inflation, and a deep adjustment-related recession in Argentina, reduced expected growth in LAC for 2024. However, monetary relaxation and declining interest rates following progress in decreasing inflation have led to an upgrade in the growth forecast for 2024 from 1.6 percent (six months ago) to 1.9 percent, and to an increase in the expected growth in 2025 to prepandemic levels of 2.6 percent (figure 1.1). Figure 1.1 Growth Will Improve in LAC, but the Region Continues to Underperform Percent change in GDP 9 8 7 6 5 4 3 2 1 0 East Asia Europe and Latin America Middle East South Asia Sub-Saharan and Pacific Central Asia and the Caribbean and North Africa Africa 2010-14 2015-19 2023 2024e 2025f Sources: World Bank Macro-Poverty Outlook (Annual Meetings 2024). Note: The values are based on projections (as of October 2, 2024). e = estimate; f = forecast; GDP = gross domestic product. 1 World Bank (2024a). Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 9 Growth has been propelled largely by consumption in most countries, while investment, dampened by high interest rates, remains weak in Argentina, Chile, Colombia, and Peru (figure 1.2, panels a and b). An exception is Mexico, which has increased its level of private investment, by taking advantage of opportunities for nearshoring and friendshoring, and public investment, especially on infrastructure projects (figure 1.2, panel c). Figure 1.2 Consumption Remains Strong, but Investment is Faltering a. Private consumption (seasonally adjusted) Index, 2019:Q2=100 125 120 115 110 105 100 95 90 Argentina Brazil Chile Colombia Mexico Peru 2022:Q2 2023:Q2 2024:Q2 b. Public consumption (seasonally adjusted) Index, 2019:Q2=100 125 120 115 110 105 100 95 Argentina Brazil Chile Colombia Mexico Peru 2022:Q2 2023:Q2 2024:Q2 c. Gross fixed capital formation (seasonally adjusted) Index, 2019:Q2=100 135 130 125 120 115 110 105 100 95 90 85 Argentina Brazil Chile Colombia Mexico Peru 2022:Q2 2023:Q2 2024:Q2 Chapter 1: The State of the LAC Region 10 Latin America and the Caribbean Economic Review October 2024 d. Exports and imports of goods and services Percent of GDP 50 40 30 20 10 0 -10 -20 -30 -40 -50 2022:Q2 2023:Q2 2024:Q2 2022:Q2 2023:Q2 2024:Q2 2022:Q2 2023:Q2 2024:Q2 2022:Q2 2023:Q2 2024:Q2 2022:Q2 2023:Q2 2024:Q2 2022:Q2 2023:Q2 2024:Q2 Argentina Brazil Chile Colombia Mexico Peru Exports Imports Exports - Imports Sources: World Bank staff calculations based on national sources (retrieved from Haver Analytics). Most countries have made progress in correcting external imbalances, reducing trade deficits, or maintaining a sustainable equilibrium (figure 1.2, panel d), partly by making fiscal adjustments, but also due to the fall in investment (figure 1.3). Figure 1.3 Balance of Payments Continues Adjusting to Historical Norms Current account balance as percent of GDP 4 2 0 -2 -4 -6 -8 -10 -12 -14 Argentina Brazil Chile Colombia Mexico Peru 2022:Q2 2023:Q2 2024:Q2 Source: Haver Analytics. Mixed external headwinds are moderating the region’s projections. On the positive side, the lower-than- expected August 2024 inflation and employment reports, and continued well-anchored inflation expectations, led the US Federal Reserve and other central banks to relax their previous hawkish stance, releasing pressure on regional capital outflows and allowing a relaxation of domestic interest rates (figure 1.4, panel a). That said, growth in advanced countries is projected to be modest, despite a recent pickup in prospects in the European Union (figure 1.4, panel b). On the other hand, China’s forecasts are both low and increasingly uncertain (figure 1.4, panel c). Commodity prices are expected to remain relatively high, but volatile (figure 1.4, panel d). Trade fragmentation, internal conflict and geopolitical tensions raise concerns about the region’s opportunity to take advantage of them. Elections in several countries have added uncertainty around regional integration, and the political Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 11 crisis in the Bolivarian Republic of Venezuela could lead to a second migration wave to a region that has experienced difficulties absorbing the previous shock in their economies. Extreme weather events related to climate change present a further downward risk to growth prospects. However, countries prepared to export green energy commodities are facing a strong demand, which could serve as an important source for growth. Figure 1.4 LAC Countries Face External Uncertainty a. Fed Funds rate and real yield on 10-year US Treasury Note b. G-7 growth Percent Percent 6 6 5 5 4 4 3 3 2 2 1 1 0 0 2024f 2025f 2026f 2019:Q1 2019 :Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022:Q1 2022:Q2 2022:Q3 2022:Q4 2023:Q1 2023:Q2 2023:Q3 2023:Q4 2024:Q1 2024f 2025f 2026f 2022:Q1 2022:Q2 2022:Q3 2022:Q4 2023:Q1 2023:Q2 2023:Q3 2023:Q4 2024:Q1 Fed Funds Rate Real Yield on 10 year U.S. Treausry T-note c. China growth d. Commodity prices Percent Index, 2016 = 100 7 240 6 220 200 5 180 4 160 3 140 2 120 1 100 0 80 2024f 2025f 2026f 2024f 2025f 2026f 2022:Q1 2022:Q2 2022:Q3 2022:Q4 2023:Q1 2023:Q2 2023:Q3 2023:Q4 2024:Q1 2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022:Q1 2022:Q2 2022:Q3 2022:Q4 2023:Q1 2023:Q2 2023:Q3 2023:Q4 2024:Q1 Sources: For panel a, Organisation for Economic Co-operation and Development (OECD) Quarterly GDP (indicator) (doi: 10.1787/b86d1fc8-en) and International Monetary Fund (IMF) World Economic Outlook (WEO) database (https://www.imf.org/en/Publications/WEO/weo-database/2024/April; for panel b, Haver Analytics and IMF WEO database; for panel c, US Federal Reserve Economic Data (FRED), Federal Reserve Bank of St. Louis; for panel d, World Bank Commodity Prices (Pink Sheets) (https://www.worldbank.org/en/research/commodity-markets) and IMF WEO database. Note: f = forecast; G-7 = Group of Seven. Business confidence in the region has recovered (figure 1.5, panel a), while consumer confidence remains below its historical level (figure 1.5, panel b). The increase in confidence in Costa Rica and Mexico is associated with increased investment, while the converse is the case in Brazil and Colombia. Chapter 1: The State of the LAC Region 12 Latin America and the Caribbean Economic Review October 2024 Figure 1.5 Business and Consumer Confidence Are Growing a. Business confidence index Index, 100 = Historical mean 106 104 102 100 98 96 94 92 Feb 18 Apr 18 Jun 18 Aug 18 Oct 18 Dec 18 Feb 19 Apr 19 Jun 19 Aug 19 Oct 19 Dec 19 Feb 20 Apr 20 Jun 20 Aug 20 Oct 20 Dec 20 Feb 21 Apr 21 Jun 21 Aug 21 Oct 21 Dec 21 Feb 22 Apr 22 Jun 22 Aug 22 Oct 22 Dec 22 Feb 23 Apr 23 Jun 23 Aug 23 Oct 23 Dec 23 Feb 24 Apr 24 Jun 24 Aug 24 Brazil Chile Colombia Costa Rica Mexico OECD - Total b. Consumer confidence index Index, 100 = Historical mean Percent 105 103 101 99 97 95 93 Feb 18 Apr 18 Jun 18 Aug 18 Oct 18 Dec 18 Feb 19 Apr 19 Jun 19 Aug 19 Oct 19 Dec 19 Feb 20 Apr 20 Jun 20 Aug 20 Oct 20 Dec 20 Feb 21 Apr 21 Jun 21 Aug 21 Oct 21 Dec 21 Feb 22 Apr 22 Jun 22 Aug 22 Oct 22 Dec 22 Feb 23 Apr 23 Jun 23 Aug 23 Oct 23 Dec 23 Feb 24 Apr 24 Jun 24 Aug 24 Brazil Chile Colombia Costa Rica Mexico OECD - Total Sources: OECD Business Confidence Index (BCI) (indicator) (doi: 10.1787/3092dc4f-en); OECD (Consumer Confidence Index (CCI) (indicator) (doi: 10.1787/46434d78-en). Note: The countries included in this figure are limited to those for which the OECD provides data specific to the Latin America and the Caribbean region. OECD = Organisation for Economic Co-operation and Development. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 13 Inflation is Receding, but is Not Completely Under Control After a period of global progress in fighting inflation engineered by early and committed increases in interest rates, the last mile to reaching central banks targets is proving challenging (figure 1.6, panel a). While core inflation, the most persistent component of inflation, continues to converge to the target (figure 1.6, panel b), food and energy prices are still elevated relative to their prepandemic trend (figure 1.7), making headline inflation resistant. The ongoing war in Ukraine, compounded by El Niño droughts that have affected vast parts of South America continue to put upward pressure on food prices that may be exacerbated by worsening geopolitical tensions or a possible La Niña. Energy prices remain elevated due to increased transport costs arising from tensions in the Middle East. Most of the large LAC countries will meet inflation targets in 2024, with other major economies expected in 2025. All major central banks have reduced their monetary rates since their peak in 2023 and with expectations appearing anchored (figure 1.8), they are projected to reduce them further during the third quarter of 2024, following the cuts by the US Federal Reserve (figure 1.9, panel a). However, further cuts in nominal interest rates must be cautious and keyed to achieving the last mile of inflation reduction. Brazil recently raised their rates after overly optimistic decreases earlier. Real interest rates are expected to be higher than in 2021 (figure 1.9, panel b) and remain contractionary. Figure 1.6 Headline and Core Inflation Continue to Slowly Fall Toward Central Banks’ Inflation Targets a. Annual headline inflation Percent change, year-on-year Percent 16 14 12 10 8 6 4 2 0 Apr 18 Jun 18 Aug 18 Oct 18 Dec 18 Feb 19 Apr 19 Jun 19 Aug 19 Oct 19 Dec 19 Feb 20 Apr 20 Jun 20 Aug 20 Oct 20 Dec 20 Feb 21 Apr 21 Jun 21 Aug 21 Oct 21 Dec 21 Feb 22 Apr 22 Jun 22 Aug 22 Oct 22 Dec 22 Feb 23 Apr 23 Jun 23 Aug 23 Oct 23 Dec 23 Feb 24 Apr 24 Jun 24 Aug 24 Brazil Chile Colombia Mexico Peru LAC (median) Chapter 1: The State of the LAC Region 14 Latin America and the Caribbean Economic Review October 2024 b. Annual core inflation Percent change, year-on-year Percent 14 12 10 8 6 4 2 0 Apr 18 Jun 18 Aug 18 Oct 18 Dec 18 Feb 19 Apr 19 Jun 19 Aug 19 Oct 19 Dec 19 Feb 20 Apr 20 Jun 20 Aug 20 Oct 20 Dec 20 Feb 21 Apr 21 Jun 21 Aug 21 Oct 21 Dec 21 Feb 22 Apr 22 Jun 22 Aug 22 Oct 22 Dec 22 Feb 23 Apr 23 Jun 23 Aug 23 Oct 23 Dec 23 Feb 24 Apr 24 Jun 24 Aug 24 Brazil Chile Colombia Mexico Peru LAC (median) Source: World Bank Macro-Poverty Outlook (Annual Meetings 2024). Note: LAC = Latin America and the Caribbean; LAC (median) includes Brazil, Chile, Colombia, Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Paraguay, Peru, Trinidad and Tobago. Figure 1.7 Energy and Food Prices Remain High since Peaking in 2022 Energy Price Index, 2010=100 Food Price Index, 2014-16=100 180 180 160 160 140 140 120 100 120 80 100 60 80 40 60 20 0 40 Feb 16 May 16 Aug 16 Nov 16 Feb 17 May 17 Aug 17 Nov 17 Feb 18 May 18 Aug 18 Nov 18 Feb 19 May 19 Aug 19 Nov 19 Feb 20 May 20 Aug 20 Nov 20 Feb 21 May 21 Aug 21 Nov 21 Feb 22 May 22 Aug 22 Nov 22 Feb 23 May 23 Aug 23 Nov 23 Feb 24 May 24 Aug 24 Energy Price Index World Bank Average Energy Price Index 2016-19 Food Price Index FAO (rigth scale) Average Food Price Index 2016-19 (rigth scale) Sources: World Bank Energy Price Index (https://www.worldbank.org/en/research/commodity-markets); Food and Agriculture Organization (FAO) Food Price Index (https://www.fao.org/worldfoodsituation/foodpricesindex/en/). Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 15 Figure 1.8 Inflation Expectations Are Anchored Inflation forecasts and central bank targets Percent, year-on-year 6 5 4 3 2 1 0 Brazil Chile Colombia Mexico Peru Inflation target range Long-term forecast Forecast for December 2024 Forecast for December 2025 Target Source: Consensus Economics. Note: The survey date was September 2024 for the December 2024 and December 2025 forecasts, and July 2024 for the long-term forecasts. Figure 1.9 Monetary Policy Has Loosened a. Monetary rates (percent) Percent 16 14 12 10 8 6 4 2 0 Jan 21 Feb 21 Mar 21 Apr 21 May 21 Jun 21 Jul 21 Aug 21 Sep 21 Oct 21 Nov 21 Dec 21 Jan 22 Feb 22 Mar 22 Apr 22 May 22 Jun 22 Jul 22 Aug 22 Sep 22 Oct 22 Nov 22 Dec 22 Jan 23 Feb 23 Mar 23 Apr 23 May 23 Jun 23 Jul 23 Aug 23 Sep 23 Oct 23 Nov 23 Dec 23 Jan 24 Feb 24 Mar 24 Apr 24 May 24 Jun 24 Jul 24 Aug 24 Sep 24 In 3 months In 12 months Brazil Chile Colombia Mexico Peru Fed Chapter 1: The State of the LAC Region 16 Latin America and the Caribbean Economic Review October 2024 b. Real policy rates (percent) Percent 10 8 6 4 2 0 -2 -4 Jan 21 Feb 21 Mar 21 Apr 21 May 21 Jun 21 Jul 21 Aug 21 Sep 21 Oct 21 Nov 21 Dec 21 Jan 22 Feb 22 Mar 22 Apr 22 May 22 Jun 22 Jul 22 Aug 22 Sep 22 Oct 22 Nov 22 Dec 22 Jan 23 Feb 23 Mar 23 Apr 23 May 23 Jun 23 Jul 23 Aug 23 Sep 23 Oct 23 Nov 23 Dec 23 Jan 24 Feb 24 Mar 24 Apr 24 May 24 Jun 24 Jul 24 Aug 24 Sep 24 Brazil Chile Colombia Mexico Peru Fed Sources: World Bank Macro-Poverty Outlook (Annual Meetings 2024).; Consensus Economics; central bank databases. Note: Fed = US Federal Reserve. Fiscal Pressures Are Crowding Out Investment Fiscal imbalances are gradually being addressed (figure 1.10). The pandemic era increases in transfers to the vulnerable have proved sticky but are declining. Most countries have resorted to tax reforms to generate more revenue, often increasing the burden on the private sector and hurting private investment and consumption. As discussed in chapter 2, corporate taxes in LAC substantially exceed the average for the Organisation for Economic Co-operation (OECD) and Asia. As argued in the April 2023 LACER, The Promise of Integration,2 and chapter 2, these high corporate taxes offset the region’s relative attractiveness in wage costs as a destination for nearshoring and domestic investment critical for growth. 2 World Bank (2023). Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 17 Figure 1.10 The LAC Region is Progressively Improving Its Primary Fiscal Balance, but Interest Payments Are Increasing Percent of GDP 7 5 3 1 -1 -3 -5 -7 2021 2022 2023 2024e 2021 2022 2023 2024e 2021 2022 2023 2024e 2021 2022 2023 2024e 2021 2022 2023 2024e 2021 2022 2023 2024e 2021 2022 2023 2024e 2021 2022 2023 2024e 2021 2022 2023 2024e Argentina Brazil Chile Colombia Mexico Peru South America Central America Caribbean Primary Fiscal Balance Interest Payments Source: World Bank Macro-Poverty Outlook (Annual Meetings 2024). Note: The values are based on projections (as of October 2, 2024). e = estimate. GDP = gross domestic product. Debt remains high, with interest rates and debt service exacerbated by the globally high interest rates. The trend in rising debt began in the 2010s, long before the exigencies of the pandemic (figure 1.11), and has raised concerns about the sustainability of the debt burden. This has contributed to a rise in sovereign interest rates since 2022 (figure 1.12) and adds urgency to the fiscal consolidation agenda. A notable exception is the Caribbean, which has maintained primary surpluses over time, preventing further increases in interest payments. Most notable is Jamaica’s success in generating social consensus around the need to reduce debt over the past decade. Figure 1.11 Debt Has Been Steadily Increasing Since 2010 Percent of GDP 160 140 120 100 80 60 40 20 0 Argentina Brazil Chile Colombia Mexico Peru Jamaica South Central Caribbean America America 2010 2019 2024e Source: World Bank Macro-Poverty Outlook (Annual Meetings 2024). Note: The values are based on projections (as of October 2, 2024). e = estimate. GDP = gross domestic product. Chapter 1: The State of the LAC Region 18 Latin America and the Caribbean Economic Review October 2024 Figure 1.12 Real Yields of Sovereign Bonds Have Sharply Increased Percent 6 4 2 0 -2 -4 -6 -8 Jan-18 Aug-18 Mar-19 Oct-19 May-20 Dec-20 Jul-21 Feb-22 Sep-22 Apr-23 Nov-23 Jun-24 LAC US dollar-denominated LAC local currency-denominated US Treasury Sources: Bloomberg; Haver Analytics; US Federal Reserve Economic Data (FRED). Note: Nominal bond yields were converted to real yields by adjusting for inflation. For bonds denominated in local currency, each country’s inflation data were used. For dollar-denominated bonds, US inflation data were applied. The LAC sample reflects the median values for Brazil, Chile, Colombia, Mexico, and Peru. LAC = Latin America and the Caribbean; US = United States. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 19 The Banking Sector Is Stable, with Some Signs of Stress In recent years, the largest economies in the region have experienced weak credit growth (figure 1.13, panel a). Excluding Argentina, only Brazil has been able to recover prepandemic rates of about 5 percent. All major economies, except Argentina, showed mild improvement in the first quarter of 2024. In contrast, smaller economies have seen faster credit growth, particularly in recent quarters. Dominican Republic, Honduras, and Paraguay are notable examples, with rates between 9 percent and 17 percent at the beginning of 2024 (figure 1.13, panel b). Figure 1.13 While Credit Growth Remains Sluggish in the Largest LAC Economies, It Has Picked Up in the Smaller Ones a. Larger economies Real credit growth Percent change, year-on-year 25 20 15 10 5 0 -5 -10 -15 -20 -25 -30 2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022:Q1 2022:Q2 2022:Q3 2022:Q4 2023:Q1 2023:Q2 2023:Q3 2023:Q4 2024:Q1 Argentina Brazil Chile Colombia Mexico Peru Chapter 1: The State of the LAC Region 20 Latin America and the Caribbean Economic Review October 2024 b. Smaller economies 20 15 10 5 0 -5 -10 2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022:Q1 2022:Q2 2022:Q3 2022:Q4 2023:Q1 2023:Q2 2023:Q3 2023:Q4 2024:Q1 Costa Rica Dominican Republic Ecuador Guatemala Honduras Jamaica Panama Paraguay El Salvador Uruguay Source: International Financial Statistics (IFS) (International Monetary Fund, IMF). The high interest rates of the last two years have placed stress on the budgets of consumers and small firms, leading to a rise in nonperforming loans (NPLs). Capital buffers remain robust in most of LAC. Only Honduras, Bolivia, and—marginally— Ecuador exhibit regulatory capital ratios below 15 percent of risk-weighted assets (RWA). Still, banks in most countries comfortably exceed minimum requirements. Some Caribbean countries do need special oversight on the capitalization of banks, especially when loan loss provisioning remains at 60 percent of the NPLs on balance sheet; and its development banks and credit unions may also face challenges in terms of solvency. Liquidity risk has increased in LAC, predominantly in the LAC-6 countries (Argentina, Brazil, Chile, Colombia, Mexico, Peru), as the ratios of liquid assets to short-term liabilities flag a systemic vulnerability, especially for those with limited market access, such as Bolivia and Ecuador. Colombia and Paraguay are especially prone to liquidity risk, as they combine a low coverage ratio of short-term assets versus liabilities with a relatively high loans-to-deposits ratio. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 21 Table 1.1 Banking Systems in LAC Continue to be Well Capitalized, though Liquidity is Getting Tighter in Several Countries Solvency Liquidity Regulatory Reg. Tier1 Private Credit Liquid Asset to Liquid Asset to Country Capital to Capital to to Dep. Total Assets ST Liabilities RWA (percent) RWA (percent) Ratio (percent) (percent) (percent) LC1 18.7 16.6 136.4 24.3 74.9 Colombia 18.0 15.3 200.6 17.6 35.0 Mexico 19.5 17.8 72.2 31.0 114.9 LC2 16.4 12.6 111.8 28.0 45.4 Costa Rica 18.6 16.2 146.4 32.9 68.5 Dominican Rep. 17.6 14.9 El Salvador 15.6 11.9 96.0 17.7 26.0 Guatemala 16.8 10.8 80.2 38.9 29.9 Honduras 13.7 8.5 113.4 26.6 36.0 Nicaragua 17.3 10.1 84.7 41.9 83.9 Panama 15.1 15.9 149.9 9.7 28.3 LC3 16.2 12.6 47.6 52.5 Antigua 25.3 18.9 45.9 52.0 Dominica 18.0 12.7 49.3 57.0 Grenada 14.9 11.0 50.3 56.3 Jamaica 13.7 St. Kitts and 11.1 7.3 48.5 54.3 Nevis St. Lucia 14.2 12.3 50.0 52.5 St. Vincent and 16.4 13.7 41.9 42.9 the Grenadines LC5 17.6 15.6 105.4 14.0 232.3 Brazil 17.6 15.6 105.4 14.0 232.3 LC6 15.3 12.8 112.5 17.6 37.1 Bolivia 13.7 11.8 100.4 17.5 46.2 Chile 16.2 12.1 141.8 14.3 Ecuador 15.0 14.0 106.0 15.2 30.1 Peru 16.3 13.1 101.9 23.3 35.1 LC7 24.8 22.7 142.5 27.7 62.8 Argentina 39.5 39.0 201.4 47.2 86.2 Paraguay 18.0 13.2 164.4 8.3 20.8 Uruguay 17.0 16.0 61.8 81.4 Thresholds 13.0 - 15.0 11.0 - 13.0 110.0 - 130.0 18.0 - 25.0 35.0 - 50.0 Sources: International Financial Statistics (IFS) and Financial Soundness Indicators (FSI) (International Monetary Fund, IMF). Note: Data are as of the first quarter of 2024 or latest available. Red = high risk; yellow = medium risk; green = low risk. RWA = risk-weighted assets; ST = short-term. LC1 to LC7 refer to different Country Management Units (CMUs) in the Latin America and Caribbean region, with each CMU representing a group of countries. The specific groupings are as follows: LC1 (Mexico, Colombia, Venezuela), LC2 (Central America, Dominican Republic), LC3 (Caribbean Islands, Belize, Suriname, Guyana), LC5 (Brazil), LC6 (Bolivia, Chile, Ecuador, Peru), and LC7 (Argentina, Paraguay, Uruguay). Chapter 1: The State of the LAC Region 22 Latin America and the Caribbean Economic Review October 2024 Credit quality continues to gradually decline in most LAC countries, typically led by worse consumer credit. However, conservative provisioning requirements continue to provide room to accommodate losses. While levels of loan portfolio quality are acceptable in most LAC countries, system-wide NPL ratios have deteriorated in Colombia, Panama, Ecuador, and Peru. Financial supervisors continue to expect a mitigation of credit deterioration, as the easing of monetary conditions by central banks would provide relief to more vulnerable borrowers as the earlier consumer borrowing boom has halted. Table 1.2 Some NPLs Segments Have Been Showing Signs of Stress Asset Quality NPLs to total Gross Loans Real NPLs Growth Country (percent) (percent change year-on-year) LC1 2.0 -0.3 Colombia 5.2 22.4 Mexico 2.0 -0.3 LC2 2.5 11.5 Costa Rica 2.1 14.6 Dominican Rep. 1.3 0.8 El Salvador 1.8 0.9 Guatemala 2.9 53.7 Honduras 2.3 -5.3 Nicaragua 1.5 10.8 Panama 5.7 4.8 LC3 9.4 Antigua 6.0 Dominica 12.3 Grenada 3.2 Jamaica 2.8 St. Kitts and Nevis 19.1 St. Lucia 11.9 St. Vincent and the Grenadines 7.4 LC5 3.3 1.7 Brazil 3.3 1.7 LC6 3.5 5.9 Bolivia 2.7 33.1 Chile 2.3 -19.3 Ecuador 4.7 5.8 Peru 4.3 4.1 LC7 2.3 -6.7 Argentina 1.8 -51.0 Paraguay 3.3 8.8 Uruguay 1.7 22.2 Thresholds 2.5 - 4.0 15.0 - 20.0 Sources: International Financial Statistics (IFS) and Financial Soundness Indicators (FSI) (International Monetary Fund, IMF). Note: Data are as of the first quarter of 2024 or latest available. Red = high risk; yellow = medium risk; green = low risk. The NPL (nonperforming loan) ratio represents the proportion of loans that are not meeting their scheduled payments out of the total loan portfolio. Loans are considered nonperforming if the borrower is 90 days past due. The Stressed NPL ratio is a broader indicator; its numerator includes not only nonperforming loans but also loans that have been restructured, refinanced, or renewed, with the denominator remaining as total loans. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 23 Box 1.1 Helping Assess and Monitor Climate and Environmental Risks Facing the Financial Sector in Latin America and the Caribbean Climate-related and environmental risks are increasingly recognized as material sources of financial risk,a based on concerns about the sustainability of economic activity and the stability of the financial systems. These risks affect the financial system through two main channels: physical risks and transition risks. Physical risks emanate from nature-related and climatic events that lead to financial losses. Transition risks are related to the economic adjustment costs during the transition toward a greener, carbon-neutral economy. Climate risk assessments are an important instrument to inform the development of a prudential approach for financial institutions. They can help identify and monitor systemic risk in the financial sector related to climate hazards, and encourage steps to preserve and promote financial stability, as well as to support the transition toward a more sustainable, low-carbon economy. Against this backdrop, the Basel Committee on Banking Supervision is analyzing the introduction of a disclosure framework for climate-related financial risks through Pillar 3 of the Basel supervisory framework.b Climate risk assessments are particularly relevant for the Latin America and Caribbean (LAC) region due to its vulnerability and biodiversity. The LAC region is the second most disaster- prone region globally, as natural disasters have become more frequent and destructive, and the frequency and impact of floods and storms have recently increased.c Moreover, LAC is one of the most biodiverse regions in the world; hence, preservation of its natural capital is pivotal. Although it covers only 16 percent of the earth’s land surface, the region is home to 50 percent of the world’s known biodiversity, 25 percent of all forests, and 30 percent of all freshwaters.d LAC hosts about 60 percent of the world’s terrestrial life and diverse marine and freshwater species.e Despite the growing need for climate risk assessments, many countries in LAC struggle with challenges such as limited awareness, insufficient capacity, or a lack of necessary data and methodologies. To overcome these challenges, the World Bank’s Finance, Competitiveness and Innovation Global Practice for Latin America and the Caribbean (FCI LAC) has supported more than 11 LAC countries in the assessment of climate-related and environmental financial risks. The climate risk assessments conducted by FCI LAC have helped financial supervisors in LAC better identify the risks that climate hazards pose to their financial sectors and improve their monitoring of such risks. A World Bank study that analyzed climate-related risks for the financial sector in LAC found that large-scale climate disasters increase bank nonperforming loans (NPLs) by up to 1.4 percentage points in affected subnational areas in LAC.f Another study identified the exposure of Paraguay’s banks to floods and droughts, as well as the impact of these natural hazards on lending. It found that both droughts and floods impair the quantity and quality of credit to the agricultural sector (figure B1.1.1), with differences among crop types. In Honduras, a similar exercise conducted by FCI LAC found that a future 1-in-100-year hurricane could reduce system-wide capital ratios by up to 3.2 percentage points by 2050. In addition, it showed that Chapter 1: The State of the LAC Region 24 Latin America and the Caribbean Economic Review October 2024 climate change could increase the expected annual damages from river floods in Honduras by 13 percent by 2050, highlighting how climate change can magnify these risks in the near future.g Finally, there is a nascent stream of work on nature-related risks, which include increased understanding of risks to biodiversity. Following a pioneering effort by De Nederlandsche Bank, FCI LAC conducted an assessment of this type in Brazil, the first one carried out in a developing and megadiverse country. Results showed that the collapse of ecosystem services has the potential to increase Brazilian banks’ nonperforming loans by 9 percentage points.h Figure B1.1.1 Droughts Increase the Nonperformance of Agricultural Loans in Paraguay The volume of nonperforming ...but credit goes up, too... …and NPL and stressed NPL ratios loans increases significantly increase by less than NPL volume. three months to one year after a drought... a. Volume of nonperforming loans b. Total outstanding loan volume c. Nonperforming loan ratio Percent Percent Percent 40 40 40 20 20 20 0 0 0 -20 -20 -20 3 months 6 months 9 months 12 months 3 months 6 months 9 months 12 months 3 months 6 months 9 months 12 months Month of Month of Month of drought drought drought Stressed NPL NPL Statistically significant (90 percent CI) Not significant Sources: World Bank calculations with data from Central Bank of Paraguay, 2016–22. Note: Only loans in the Agriculture–Crops Sector (excluding livestock, services and forestry) are shown. The shaded area shows the 90 percent confidence interval (CI) for nonperforming loans (NPLs) and stressed NPL ratios. Drought events are based on the Standardized Precipitation- Evapotranspiration Index (SPEI), for a 12-month accumulation period. The NPL ratio represents the proportion of loans that are not meeting their scheduled payments out of the total loan portfolio. Loans are considered nonperforming if the borrower is 90 days past due. The Stressed NPL ratio is a broader indicator; its numerator includes not only nonperforming loans but also loans that have been restructured, refinanced, or renewed, with the denominator remaining as total loans. Climate stress tests carried out by central banks and supervisors in LAC suggest that systemic financial risks are generally manageable, though different countries and banks vary in their capabilities. Historical data indicate that severe climate and environmental disasters have Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 25 resulted in higher nonperforming loan ratios, with effects lasting up to three years after the disaster. This trend is consistent across various World Bank regions and income levels, especially in low-income countries.i As climate change intensifies, these historical patterns may shift, highlighting the importance of proactive climate stress testing. An analysis of banking sector results from stress tests on physical risks and transition risks in various developing countries shows that while systemic impacts appear manageable and post-shock solvency ratios remain above Basel accords’ standards, there is significant disparity in vulnerability among individual banks (figure B1.1.2). For instance, in a severe flood scenario, Colombian banks displayed a wide range of vulnerability, with some more than ten times more vulnerable than others. Figure B1.1.2 Stress Tests Reveal Different Physical Risks and Transition Risks across Selected Countries a. Physical Risks b. Transition Risks CAR CET 1 CAR CET 1 20 16 20 16 18 14 14 18 12 12 16 16 10 10 14 14 8 8 12 12 6 6 10 4 10 4 Mexico Dominican Colombia Philippines Morroco South Honduras Colombia Korea Netherlands (Extreme Republic (Severe (Typhoon, (Drougth, Africa (1-in-100 (Delayed (1.5oC (confidence shock) season, (Cat. 4 flood, 1-in-500 RCP 8.5) (Drought) year 50 percent) Scenario) RCP 8.5) hurricane) RCP 8.5) years) hurricane) LAC EAP MENA SSA LAC LAC EAP ECA Pre-shock CAR Pre-shock CET 1 Pre-shock CAR Pre-shock CET 1 Post-shock CAR Post-shock CET 1 Post-shock CAR Post-shock CET 1 Sources: For Colombia, Reinders et al. 2021; for the Dominican Republic, Central Bank of the Dominican Republic 2022; for the Republic of Korea, Bank of Korea 2021; for South Africa, South African Reserve Bank 2021; Hallegatte, Jooste, and McIssac 2022; Vermeulen et al. 2018; World Bank estimates. Note: CAR stands for Capital Adequacy Ratio. It measures the adequate amount (usually defined by regulators) of capital (shareholder money) a bank needs to hold, as a percentage of its risk-weighted assets. CET1-ratio stands for Common Equity Tier 1 capital ratio. It measures the ratio between high-quality regulatory capital and risk-weighted assets. The CET1-ratio is the main metric used to assess the capital adequacy of banks. RCP stands for Representative Concentration Pathway. It quantifies future greenhouse gas concentrations and the additional energy taken up by the Earth system (the radiative for forcing) due to increases in climate change pollution. RCP 8.5 represents the worst-case scenario with a continued rise of greenhouse gas emissions throughout the twenty-first century. “Delayed percent” is defined as the scenario in which policies are introduced only from 2026 and there is a high target (51 percent greenhouse gas emission reduction in 2030). EAP = East Asia and Pacific; ECA = Europe and Central Asia; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa; SSA = Sub-Saharan Africa. The assessment of climate and environmental risks can guide a more effective approach to integrating these risks into supervisory practices. Effective integration requires the boards of supervisory authorities and central banks to be fully committed and to include these risk considerations within their mandates. Each distinct component within the supervisory framework may necessitate its own specific plan, tailored to the local supervisory and institutional context. Authorities are faced with the Chapter 1: The State of the LAC Region 26 Latin America and the Caribbean Economic Review October 2024 challenge of formulating strategies to incorporate climate-related and environmental risks into their supervisory frameworks, establish internal organizational and governance structures, and allocate the necessary resources to manage these risks effectively. FCI LAC has supported supervisory authorities in countries such as Colombia and Honduras to develop green finance roadmaps, contributed to embedding the new national green taxonomy into financial regulation in Dominican Republic, and has worked with Brazil—a pioneer in the topic—to assess the impact of capital requirements based on exposure to environmental risks on bank lending to the corporate sector and how these effects transmit to real economic activity and greenhouse gas emissions. Notes a. See, for example, Ma, Caldecott, and Volz (2020), published by the Network of Central Banks and Supervisors for Greening the Financial System, a network consisting of 141 members institutions and 21 observers, including the World Bank. b. Pillar 3 of the Basel framework seeks to promote market discipline through regulatory disclosure requirements (Bank for International Settlements). See BIS (2023). c. UN (2015, 2020). d. Wellenstein and Connors (2022). e. World Economic Forum (2023). f. Calice and Miguel (2021). g. World Bank (2022). h. Calice, Diaz Kalan and Miguel (2021). i. Nie, Regelink and Wang (2023) and World Bank (2024). Nearshoring Watch: Is LAC Missing the Boat? Continued and potentially higher tariffs on Chinese imports, increasing geopolitical tensions, and the recognition during the COVID-19 pandemic of the fragility of supply chains has led the United States to strive for derisking its trade by encouraging nearshoring, or friendshoring. US Secretary of the Treasury Janet Yellen has stressed how this could be a major driver of growth in LAC (U.S. Department of the Treasury 2023). Indeed, some countries, like Costa Rica, have succeeded in securing important links in the semiconductors and medical machinery supply chains. Further, the green transition positions the region well for manufacturing, given that it has the greenest electricity grids in the world (World Bank 2022). FDI is Not Dramatically Increasing in the Region However, there is relatively little evidence of redirected flows of FDI to the region or increased exports as a result. While realized FDI flows fell sharply in Asia and the Pacific in 2013, they also fell slightly in LAC, where levels remain 25 percent below those of 2011 (figure 1.14). Further, the large jump in 2022 was almost entirely due to investments in Brazilian resource sectors, while flows to nearshoring destination Mexico have remained essentially unchanged over the last decade (figure 1.15). Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 27 Figure 1.14 FDI Flows to LAC Have Not Recovered Previous Peaks US$, billions, at constant 2015 prices 250 200 150 100 50 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa Sources: World Bank staff using data from the United Nations Conference on Trade and Development (UNCTAD) and GDP data from the World Bank Macro Poverty Outlook (Annual Meetings, 2023). Note: Converted to real terms with consumer price index (CPI) from the U.S. Bureau of Labor Statistics; countries included are from the World Bank Macro Poverty Outlook list of countries. FDI = foreign direct investment. Figure 1.15 Brazil Has Driven Recent Movements in FDI and There is Little Evidence of Nearshoring in the Region Inward FDI Flows US$, billions, at constant 2015 prices 120 100 80 60 40 20 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Argentina Brazil Chile Colombia Mexico Peru Sources: World Bank staff using data from the United Nations Conference on Trade and Development (UNCTAD) and GDP data from the World Bank Macro Poverty Outlook (Annual Meetings, 2023). Note: Converted to real terms with consumer price index (CPI) from the U.S. Bureau of Labor Statistics. FDI = foreign direct investment. Chapter 1: The State of the LAC Region 28 Latin America and the Caribbean Economic Review October 2024 Nor do announcements of new greenfield investments suggest a major shift from Asia to LAC. Levels in the East Asia and Pacific (EAP) region have fallen somewhat since peaking in 2018, but levels in LAC remain at or below those of 2010–13. Measured as a share of total greenfield investment, LAC has seen only a slight uptick compared to the gains in South Asia and Sub-Saharan Africa, and at 10 percent remains below the 2013 peak of 18 percent (figure 1.16). Figure 1.16 Other Regions Have Fared Better than LAC in Terms of the Capital Expenditure of FDI Greenfield Announcements US$, billions, at constant 2015 prices 350 300 250 200 150 100 50 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 East Asia and Pacific Europe and Central Asia Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa Source: World Bank staff calculations based on fDi Markets. Note: Converted to real terms with consumer price index (CPI) from the U.S. Bureau of Labor Statistics. FDI = foreign direct investment. In the larger countries in the region, new greenfield investments have also not increased with respect to previous years (figure 1.17). The important exceptions to the rule are Costa Rica and the Dominican Republic (figure 1.18). The latter received $US1.4 billion from Intel and is growing the semi-conductor and medical devices sectors. Both countries’ experiences suggest that nearshoring flows can increase; they just are not happening in the larger countries in the region. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 29 Figure 1.17 Capital Expenditure of FDI Greenfield Announcements to LAC-6 Countries Has Been Limited US$, billions, at constant 2015 prices 50 45 40 35 30 25 20 15 10 5 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Argentina Brazil Chile Colombia Mexico Peru Source: World Bank staff calculations based on fDi Markets. Note: Converted to real terms with consumer price index (CPI) from the U.S. Bureau of Labor Statistics. FDI = foreign direct investment; LAC = Latin America and the Caribbean. Figure 1.18 FDI Inflows to the Smaller Countries of Costa Rica and the Dominican Republic Are Strong US$, billions, at constant 2015 prices 4.0 70 3.5 60 3.0 50 2.5 40 2.0 30 1.5 20 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Costa Rica Dominican Republic Central America (right axis) Source: World Bank staff calculations using data from the United Nations Conference on Trade and Development (UNCTAD). Note: FDI = foreign direct investment. Chapter 1: The State of the LAC Region 30 Latin America and the Caribbean Economic Review October 2024 Indeed, the low realized FDI flows and greenfield announcements contrast strikingly with reports from the ground and in the international press of high demand for industrial park real estate. This might indicate that FDI records do not tell the whole story, or that some of the demand for real estate may be speculative, as some banks have suggested, or that the new activity is still not of the scale to register in the aggregate statistics. New announced greenfield investment in Mexico has quadrupled over the last two years, but is still a small fraction of total projects.3 LAC is Displacing Chinese Exports, but Again, on a Small Scale In 2023, US imports from China were roughly at the same level as in 2015–16, but significant changes occurred at the product level. This was the outcome of a turbulent period, beginning with a decline in imports in 2019 following the introduction of new US tariffs on Chinese imports, a recovery during the following years, and another decline in 2022–23. These shifts were reflected in 7,832 products4 experiencing real losses in US imports from China totaling US$128 billion and 5,103 products experiencing gains totaling US$122 billion. The largest losses mainly occurred in the machinery and electrical sector, followed by textiles, footwear, base metals, and transport equipment (figure 1.19, panel a). During same period, LAC countries significantly increased their real exports to the United States, with more than the half of these gains occurring in sectors where China had experienced the most losses. Total exports from LAC to the United States increased by US$183 billion on net, with gains for products in which LAC countries were able to increase their exports to the United States amounting to US$245 billion, and losses in contracting products totaling US$61 billion. Gains from the machinery and electrical sector alone accounted for more than one-third of the increase, with additional substantial growth in base metal, transport equipment, and textiles. However, most of this growth happened during the immediate aftermath of the US-China trade conflict, with real export growth slowing after 2020 (figure 1.19, panel b). 3 According to the Financial Times, announced Chinese greenfield projects in Mexico went from 10 to 40 as exporters seek to avoid higher tariffs on goods from China, but Mexico has averaged around 600 projects a year over the last 10 years, so this amounts to 5 percent of the total (Telling et al. 2024). 4 As defined by the 10-digit United States Harmonized Tariff Schedule (US HTS) classification. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 31 Figure 1.19 China’s Losses Translated to LAC’s Gains Change in real exports to the United States since 2015–16 US$, billions, at constant prices a. China 200 150 100 50 0 -50 -100 -150 2017 2018 2019 2020 2021 2022 2023 Gains machinery and electrical Losses machinery and electrical Total change (real) Gains textiles Losses textiles Gains footwear and headgear Losses footwear and headgear Gains base metals Losses base metal Gains transport equipment Losses transport equipment Gains all others Losses all others b. LAC 250 200 150 100 50 0 -50 -100 2017 2018 2019 2020 2021 2022 2023 Gains machinery and electrical Losses machinery and electrical Total change (real) Gains textiles Losses textiles Gains footwear and headgear Losses footwear and headgear Gains base metals Losses base metal Gains transport equipment Losses transport equipment Gains all others Losses all others Source: World Bank staff calculations based on data from the United States International Trade Commission (USITC). Note: To assess real trade dynamics of China and LAC with the United States, the analysis looks at HTS 10-digit US imports. The focus is on products with consistent HTS tariff line definitions between 2015 and 2016, plus a few that can be manually adjusted for consistency. In this way, the analysis accounts for approximately 85 percent of US imports from China in value terms. Real exports are calculated as Qi,t,c * UVi, c, where Q is US import quantity of product i from country c in year t and UVi,c is the weighted average unit value of imports of product i from country c covering the entire period (2015–23). The constant prices are calculated as the weighted average price for each exporting country across the entire observation period (2015–23). HTS = Harmonized Tariff Schedule of the United States. Chapter 1: The State of the LAC Region 32 Latin America and the Caribbean Economic Review October 2024 While LAC’s exports to the United States expanded in sectors for which China’s contracted, substitution at the product level was more limited, and occurred mostly in 2019. To evaluate this substitution, nearshoring was calculated using a quantity terms (NSQ) indicator, which quantifies a country’s export growth resulting from replacing Chinese products in the US market. LAC’s combined NSQ peaked in 2022 and then stagnated in 2023. LAC countries may have captured about one-third of China’s lost exports to the United States. Most of NSQ growth occurred in 2019, following the onset of the US-China trade conflict, but China’s more recent US export losses in 2023 did not boost LAC trade further. On a country level, Mexico stands out as the primary beneficiary, accounting for 84 percent of LAC’s total NSQ in 2023, followed by Brazil (5 percent), Colombia and Peru (1 percent each) (figure 1.20). Nevertheless, Mexico’s accumulated increase in exports over six years as a result of displacing China is a mere 4.7 percent of the total to the United States in 2023. Figure 1.20 Mexico Is the Primary Beneficiary of China’s Export Losses to the United States Net substitution quantity (NSQ) US$, billions, at constant prices 40 35 30 25 20 15 10 5 0 2017 2018 2019 2020 2021 2022 2023 Mexico Brazil Colombia Peru Other LAC countries Source: World Bank calculations based on data from the United States International Trade Commission (USITC). Note: Net substitution quality (NSQ) is the minimum of a LAC country’s export gain and China’s export loss in the US market, or zero if the LAC country does not gain or China does not lose. This is calculated in quantity terms (for example, a Chinese toaster for a Mexican toaster, rather than US$20 worth of Chinese toasters for the same amount of Mexican toasters), and valued at the country’s average export unit value over the entire period for exports to the United States: NSQi,c=MAX(0,MIN (dXQi,c;dXQi,China*(-1))* UVi,c where dXQi,c stands for the quantity change in a country’s exports to the United States, i denotes the product, c the country, and UVi,c the unit value of a country’s exports to the United States. The constant prices are calculated as the weighted average price for each exporting country across the entire observation period (2015–23). LAC = Latin America and the Caribbean. In relative terms, some Central American countries and Haiti also benefited from substituting Chinese exports over the last decade. For Nicaragua, substitution primarily occurred in the machinery, electrical, and textile sectors, resulting in a gain equivalent to 2.7 percent of the country’s GDP in 2023, 55 percent in one product, insulated ignition wiring sets for cars. Mexico’s gains were concentrated in machinery and transport equipment, and amounted to 1.7 percent of GDP. Costa Rica, Dominican Republic, El Salvador, Guatemala, Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 33 Haiti, and Honduras experienced more modest gains, ranging from 0.3 percent to 0.5 percent of GDP. The largest percent increases were in machinery, electrical, and plastics account in Costa Rica, and machinery, electrical, and textiles in Dominican Republic and El Salvador. The textile sector was the most important for Guatemala and Haiti, while machinery, electrical, and vegetable products was for Honduras (figure 1.21). Figure 1.21 Central American Countries and Haiti Also Have Benefitted from Substituting Chinese Exports Net substitution quantity (NSQ) Percent of GDP 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Ecuador El Salvador Dominica Uruguay Argentina St. Vincent and Grenadines Grenada Panama Belize Barbados Bolivia Bahamas Brazil Paraguay Jamaica St. Lucia Chile Colombia Peru Suriname Guyana Dominican Rep. Guatemala Costa Rica Honduras Haiti Mexico Nicaragua Machinery and electrical Footwear Textiles Base metals Transpot equipment Other sectors Source: World Bank calculations using World Bank World Development Indicators for GDP data. Note: NSQ is the minimum of a LAC country’s export gain and China’s export loss in the US market, or zero if the LAC country does not gain or China does not lose. This is calculated in quantity terms (for example, a Chinese toaster for a Mexican toaster, rather than US$20 worth of Chinese toasters for the same amount of Mexican toasters), and valued at the country’s average export unit value over the entire period for exports to the United States: NSQi,c=MAX(0,MIN(dXQi,c;dXQi,China*(-1))*UVi,c where dXQi,c stands for the quantity change in a country’s exports to the United States, i denotes the product, c the country, and UVi,c the unit value of a country’s exports to the United States. The constant prices are calculated as the weighted average price for each exporting country across the entire observation period (2015–23). GDP values are in current 2023 US dollars. GDP = gross domestic product. The relatively small displacement of Chinese imports to the United States by Latin American firms, combined with the lackluster FDI data, suggest that, to date, nearshoring remains an ongoing mission. Further, with few exceptions, articulated government strategies do not take advantage of these opportunities— and they need to do so. As noted in the April 2023 LACER, The Promise of Integration,5 LAC’s evolving wage and geographical advantages are offset by high domestic financing costs, low worker skill levels, and high levels of violence, all exacerbated by some of the highest corporate tax rates in the world. Chapter 2 of this report discusses how the region might reduce this penalty on domestic and foreign investment by shifting to wealth taxes, especially property taxes. 5 World Bank (2023). Chapter 1: The State of the LAC Region 34 Latin America and the Caribbean Economic Review October 2024 Labor Markets and Social Conditions Labor Market Mirrors Disappointing Growth Performance The disappointing growth performance of the region translates into underwhelming labor market outcomes. As noted in the April 2024 LACER,6 employment levels in the region have mostly recovered from the pandemic shock (figure 1.22), although there are signs in some countries that the global slowdown and unfavorable external conditions are starting to constrain employment growth in the region. Figure 1.22 Employment Rates Have Mostly Recovered, but Challenges Persist Employment-to-population ratio by country Index, 2019:Q1 = 100 110 100 90 80 70 60 2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022:Q1 2022:Q2 2022:Q3 2022:Q4 2023:Q1 2023:Q2 2023:Q3 2023:Q4 2024:Q1 2024:Q2 Argentina Brazil Chile Colombia Costa Rica Ecuador Mexico Paraguay Peru United States Source: ILO (International Labour Organization) Modelled Estimates Database, ILOSTAT [database] (https://ilostat.ilo.org/data/). Note: The employment-to-population ratio is total employment divided by working-age population. As discussed in previous editions of LACER, labor markets in the region primarily adjusted through prices— with real labor incomes and wages declining significantly with respect to 2019—which helped prevent sharp shifts in employment levels. Wages and labor incomes continue to remain depressed relative to prepandemic levels, except in Mexico and Costa Rica (figure 1.23). Mexico’s policy of increasing the minimum wage from the previously low level appears to have had some positive effects on earnings, and reducing poverty. Yet, the economic literature and the region’s experience 6 World Bank (2024a). Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 35 clearly suggests that there are limits to this strategy. The initial positive effects in Mexico may be related to the fact that minimum wages started off at very low levels relative to median or average wages, and further increases may have important employment trade-offs to consider. The dynamics for minimum wages are discussed in box 1.2. Figure 1.23 Real Labor Incomes Have Not Fully Recovered Percentage change of real individual labor income and real wage from 2019 to 2023 Mexico Costa Rica Brazil Dominican Republic Ecuador Panama Peru Argentina -15 -10 -5 0 5 Percent Real individual labor income Real wage Source: World Bank Poverty and Equity Global Practice based on the Socio-Economic Database for Latin America and the Caribbean (SEDLAC) [Center for Distributive, Labor and Social Studies (CEDLAS) and World Bank]. Note: Colored bars display the percentage change of average real individual labor income (wage income plus self-employment income) from 2019 to 2023. Triangles track the variation in the average real wage in main activity. The levels upon which the variations are calculated are measured in 2017 purchasing power parity (PPP) dollars. For Argentina, data have only urban coverage. For Brazil, the 2022 value is used for 2023. For Mexico, the 2018 value is used for 2019 and the 2022 value for 2023. For Argentina, Dominican Republic, and Peru, 2023 values are preliminary. PPP = purchasing power parity. Box 1.2 The Limits of Increasing Minimum Wages in Latin America and the Caribbean Minimum wages, as a fraction of average wages, in the Latin America and the Caribbean (LAC) region tend to be high when compared with the advanced economies of the OECD. Furthermore, over the last decade several countries in the region have increased their minimum wages significantly (figure B1.2.1). What does this mean for workers in the region? As the region continues to struggle with high inequality, continues to make slow progress against poverty and still has labor market characterized by high informality, are increases in the minimum wage an effective tool to enhance welfare in the region? Chapter 1: The State of the LAC Region 36 Latin America and the Caribbean Economic Review October 2024 Figure B1.2.1 Minimum Wages Have Increased Steeply in Some LAC Countries Minimum wages relative to mean wages Percent 110 100 90 80 70 60 50 40 30 20 Ecuador Argentina Bolivia Brazil Chile Colombia Costa Rica Dominican Republic Honduras Mexico Panama Peru Uruguay Non-LAC OECD (simple average) 2013 2023 Source: World Bank calculations using ILO (International Labour Organization) Modelled Estimates Database, ILOSTAT [database] (https://ilostat. ilo.org/data/) and OECD (Organisation for Economic Co-operation and Development) Data Explorer [database] (https://data-explorer.oecd.org/). Note: Minimum wages are presented relative to mean earnings of employees. For Argentina, Costa Rica, Honduras, and Panama, the 2022 value is used for 2023. For Peru, the 2012 value is used for 2013. For Uruguay, the 2020 value is used for 2023. LAC = Latin America and the Caribbean. OECD = Organisation for Economic Co-operation and Development In theory, minimum wages can serve multiple purposes. They can induce higher wages that have been artificially depressed by monopsony power (that is, where one or two employers provide the principal source of jobs in a region), without necessarily destroying jobs. In fact, a recent study finds that in local labor markets with higher levels of monopsonic power, increases in minimum wages results in more jobs (i.e. positive employment elasticities).a Even when this is not the case, minimum wages have been viewed as one component in a system of programs designed to lift workers from poverty and fight inequality. However, conceptually, there is a trade-off between wages and jobs, and minimum wages are not necessarily welfare-enhancing for all workers. In either case, something is wrong, by definition, when they fall toward the top of the labor income distribution, either because they ignore the underlying reality of the labor market and induce severe distortions, or they fail to protect workers because they are impossible to enforce. Most LAC countries make use of minimum wages, albeit with a wide variety of regulatory treatments across countries and often across workers within each country. A forthcoming study by the World Bank Latin America and Caribbean Chief Economist Office (LCRCE), “Shaping the Playing Field for Economic Growth: Critical Regulatory Frameworks for Business in Latin America” (Eslava and Meléndez 2024), examines labor market regulations in 11 Latin American countries, including minimum wage regulations.b All LAC countries in the sample have legislation establishing a monthly minimum wage, except Mexico, where the regulation establishes a daily minimum wage.c In addition to the mandatory monthly minimum wage, Argentina and Paraguay have rulings on minimum daily wages, and Argentina and Honduras have rulings on hourly wages. All other countries in the sample allow for adjustments in the minimum wage proportional to time Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 37 worked. However, definitions of full-time work and thresholds to calculate proportional daily or hourly minimum wage rates vary significantly across countries.d Moreover, in some countries, the definitions of full-time work vary across day and night shifts (Mexico, Paraguay) and genders (Bolivia). Definitions of upper thresholds are also relevant because overtime pay kicks in above it. These definitions affect workers’ and businesses’ decisions because they influence labor income and payroll costs. For policy makers and researchers, the variety of definitions affect wage comparability and matter when investigating how binding minimum wage regulations are and the impact that changes on minimum wages have on labor market outcomes. In general, how governments set minimum wages and adjust them over time often appears unrelated to key labor market fundamentals, such as the marginal labor productivity or even the market power of noncompetitive employers. Geographic variations of the minimum wage may be reasonable to account for differences in the cost of living. However, minimum wage increments driven by firm size can be outright distortive to firm employment and growth decisions. Figure B1.2.2 shows that for firms hiring formally, adding one extra worker —by going from 10 to 11 workers—may imply an 8 percent increase in the minimum wage in the Dominican Republic and an increase of 3 percent to 7 percent in Honduras. Best practices suggest that adjustments to minimum wages should be driven by fundamental factors affecting the labor market, such as labor productivity, cost of living, poverty lines, average or mean wages, and unemployment rates.e Figure B1.2.2 Minimum Wages that Increase with Firm Size Can Distort Employment Decisions a. Minimum wages in the Dominican Republic, 2023 b. Minimum wages in Honduras, selected sectors, 2023 2.0 1.6 1.76 1.41 1.8 1.36 1.62 1.4 1.31 1.32 1.24 1.24 1.6 1.20 1.19 1.19 Lowest MW in each regime = 1 Lowest MW in each regime = 1 1.2 1.15 1.4 1.06 1.07 1.03 1.03 1.03 1.00 1.00 1.00 1.00 1.00 1.18 1.0 1.2 1.08 1.0 0.8 1.00 1.00 1.00 1.00 1.00 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 0.0 1-10 workers 11-50 workers 51-150 workers 151+ workers 1-10 workers 11-50 workers 51-150 workers 151+ workers 1-10 workers 11-50 workers 51-150 workers 151+ workers 1-10 workers 11-50 workers 51-150 workers 151+ workers 1-10 workers 11-50 workers 51-150 workers 151+ workers 1-50 workers 51-150 workers 151+ workers 1-10 workers 11-50 workers 51-150 workers 151+ workers Accomodation and Other private sector Public Free Agriculture, Manufacturing Infraestructure Accomodation Human health food services sector zones forestry and servicesa and food and social work fishing services Source: Eslava and Meléndez 2024, based on resolutions CNS-01-2023, CNS-02-2023, and CNS-03-2023 for the Dominican Republic and Acuerdo No. SETRASS 014-2023 for Honduras. Note: MW = minimum wage. a. In Honduras, mining and quarrying, construction, wholesale and retail, transportation, storage and communications, financial, real estate and business activities, and community, social, and personal services have the same minimum wage ratios as infrastructure services. Chapter 1: The State of the LAC Region 38 Latin America and the Caribbean Economic Review October 2024 Moreover, minimum wage policies need to be conceived as one part of the overall package of regulations and taxes that affect the labor market. The region continues to rely on many policies (in taxes, wages, and labor market regulations) that distort investment and hiring decisions across firms. These policies may end up disincentivizing growth and end up fostering different degrees of informality in the labor market. While the relationship between the level of minimum wage and the share of informal workers is not linear or straightforward, evidence for developing countries suggests that increases in the level of minimum wage increase the share of workers in the informal sector.f Graphically, placing minimum wages in the overall labor income distribution shows how high the labor-income floor is and how it compares to what most workers in the economy earn. In the literature, economists say minimum wages are binding when the earnings distribution is clearly affected by them. As we can observe in figure B1.2.3 this is clearly the case for Colombia, particularly for those workers contributing to social security. However, as the examples in figure B1.2.3 illustrate, throughout the region, it is not uncommon for employers to avoid paying high minimum wages. Figure B1.2.3 also captures patterns of informality by displaying the share of workers not saving for old age in a contributory pension system—jobs considered “informal.” Clearly, high minimum wages protect some workers but are irrelevant to most. Figure B1.2.3 High Relative Minimum Wages Are Irrelevant to Many Workers Minimum wages and distributions of formal and informal workers in countries with high relative minimum wages a. Honduras, 2019 b. Peru, 2022 c. Colombia, 2022 .0015 .0020 .0015 .0015 Share of workers Share of workers Share of workers .0010 .0010 .0010 .0005 .0005 .0005 0 0 0 0 500 1,000 1,500 0 500 1,000 1,500 0 500 1,000 1,500 2,000 2,500 Earnings in USD PPP 2017 Earnings in USD PPP 2017 Earnings in USD PPP 2017 Contributing to SS Contributing to SS Contributing to SS Not contributing to SS Not contributing to SS Not contributing to SS Sources: Eslava and Meléndez 2024, using labor market regulations and National Household Surveys. Note: Distributions are weighted by employment to reflect their size. Distributions in each figure add up to 1. Vertical lines indicate the statutory minimum wage(s). PPP = purchasing power parity; SS = social security. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 39 Impacts on wages, poverty, and earnings distribution. Economic studies offer mixed evidence on the effects of minimum wage increases on employment, poverty and income inequality, although a recent meta-analysis review of the minimum wage literature for developing countries suggests some clear patterns.g Evidence of job loss is clearer for less-skilled, young, women, and formal-sector workers. In contexts where labor regulations are strongly enforced, studies show stronger evidence of negative employment effects, while in countries with weak enforcement studies are more likely to find no significant effects. The level of the minimum wage relative to mean or median wages seems to be critical to understand the impact of increases on employment, poverty, and inequality. In contexts where the minimum wage is relatively low, employment effects appear muted and instead a compression of the earnings distribution helps reduce inequality and contribute to lifting households out of poverty. The case of Mexico, where the minimum wage has traditionally been low provides a good example. A 2023 study finds that between 2019 and 2022 the number of people in poverty decreased by almost 24 percent because of the positive effects on workers’ earnings of increases in the minimum wage, with no significant effects on employment.h Similarly, studies in 2020, 2021, and 2022 find that in the context of Mexico there were no significant effects on employment, but they document significant increases in income.i Further back, a 2007 study found that as wages rose in Mexico with increases in the minimum wage, so did household income, with limited employment effects.j In the context of Brazil, a 2022 study finds that minimum wage increases between 1996 and 2018, representing a 128 percent increase in real terms and a movement from about 30 percent of the median wage to 55 percent, account for 45 percent of a large decline in earnings inequality over this period.k Yet, in the context where minimum wages are relatively high and enforced, further increases may have important negative effects on labor market outcomes. Studies have found that minimum wage increases resulted in large job losses for the cases of Colombial, Hondurasm, Costa Rican, and Trinidad and Tobagoo. Moreover, the results indicate that these negative employment effects are concentrated in workers who are more likely to earn near the minimum wage level: women, young workers and the less-skilled.p A multi-country analysis suggests that increases in the minimum wage also increase non-compliance and the proportion of workers who are informal and self-employed.q Similar results were found for Colombiar, Hondurass, and Costa Ricat. While the effects on inequality are less conclusiveu, one study found negative effects in Colombia.v Another study found that it had a negative effect on labor market flows, such as job creation, job destruction, hiring, and separation.w Adverse fiscal impacts. The minimum wage may have important fiscal impacts, as well. The region continues to rely on the minimum wage level as a reference point or “numeraire” for social expenditures. Hence, increases in the minimum wage also have large effects on the public deficit. This is a particular concern for dollarized economies in the region that do not have access to certain monetary levers that can counteract rigid increases in public expenditures. In most countries, the largest expenditure category affected is the pension system, but other benefits, ranging from salary bonuses to job training stipends, are also denominated in minimum wages. Eligibility for social programs is also often tied to the minimum wage in many countries, so an increase in the minimum wage may also increase the potential beneficiaries of social programs, along with the associated public expenditures. Barrier to macro adjustment in dollarized economies. Any wage rigidity, including the minimum wage, can complicate adjustments to macroeconomic shocks in economies that are either Chapter 1: The State of the LAC Region 40 Latin America and the Caribbean Economic Review October 2024 dollarized or where the exchange rate is pegged to foreign currencies. The necessary downward adjustment in real wages cannot be engineered by the devaluation, but nor can market forces reduce it in local currency terms, leading to persistent inflation and low growth. These results suggest that policy makers should carefully consider when and how much they should increase minimum wages. These decisions should be informed by a careful review not only of the relative level and ‘bindingness’ of the minimum wage, but also on the evolution of labor market fundamentals such as labor productivity, cost of living, poverty lines, and unemployment rates. As the level of minimum wages increases relative to workers’ earnings, further increases may result in more significant trade-offs between higher wages and lower employment. Notes: a. Munguia Corella (2020). Monopsonic power is proxied by measures of labor market concentration and the prevalence of low-mobility jobs. b. Argentina, Bolivia, Brazil, Chile, Colombia, the Dominican Republic, Ecuador, Honduras, Mexico, Paraguay and Peru. c. Argentina: Ley de Contrato de Trabajo No. 20744 (1976) and Law 26474 (2009). Bolivia: Ley General del Trabajo (1942). Brazil: Constituição Federal (1988) and Consolidação das Leis do Trabalho (1943, 2017). Chile: Código del Trabajo (2002), Law 19759 (2001), and Law 21561 (2023). Colombia: Código Sustantivo del Trabajo and Law 2101 (2021). The Dominican Republic: Código del Trabajo (1992) and Minimum Wage Resolutions (2015, 2023). Ecuador: Código del Trabajo (2005) and Acuerdo Ministerial MDT 2018-0135 (2018). Honduras: Código de Trabajo and Ley de Empleo por Hora. Mexico: Ley Federal del Trabajo. Paraguay: Law 213 (1993) and Law 6339 (2019). Peru: Decreto Legislativo No. 728. d. In Argentina the minimum monthly wage applies to salaried employees working more than 32 and up to 48 hours per week. Salaried employees who work less than 32 hours per week receive 1/25 of the minimum monthly wage per day and 1/8 of the minimum daily wage per hour. In contrast, the minimum monthly wage applies only to those salaried employees working 40 hours per week in Ecuador. A work week of any length below is considered part-time, with an immediate transition to proportional wages, and overtime pay applies for workweeks beyond 40 hours. Chile and Colombia have regulations in place to transit gradually from a regulatory 48-hour full-time work week to a 40 and 42-hour work week, respectively, more in line with the 40-hour full-time customary work week in advanced economies. Both countries, however, treat partial-time thresholds differently. e. For an in-depth discussion, see Kuddo et al. (2015). f. Lotti et al. (2017). g. Neumark and Munguia Corella (2021). h. Gomez Lovera and Munguia Corella (2023). i. Campos-Vasquez et al. (2020); Campos-Vasquez and Esquivel (2021); Campos-Vasquez and Esquivel (2022). j. Cunnigham (2007). k. Engbom and Moser (2022). l. Bell (1997); Maloney and Nunez Mendez (2004); Arango and Pachon (2007). m. Ham (2018). n. Gindling and Terrell (2007). o. Strobl and Wash (2003). p. Cunningham (2007). q. Lotti et al. (2017). r. Mora and Muro (2017). s. Ham (2018). t. Gindling and Terrel (2007). u. Gindling and Ronconi (2023). v. Angel-Urdinola (2008). w. Florez et al. (2022). Poverty and Inequality Poverty overall continues to fall in the region, led by gains in Brazil and Mexico, although the trend is not uniform (figure 1.24). The end of the COVID-19 pandemic and the need for fiscal adjustment continued to move the contribution of transfers to family incomes toward their lower, prepandemic levels. Meanwhile, labor incomes have been stagnant, as described earlier in the chapter. Together, these trends indicate that real household incomes in some countries are falling. For the region as a whole, small gains have been achieved in income inequality (figure 1.25), driven mostly by the strong increases in real labor incomes in Mexico and the new social benefits included in the Bolsa Familia program of Brazil. Current trends also raise concerns regarding hunger and food security among households, with economic consequences for individuals and society that are often large and persistent. These effects are discussed in box 1.3. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 41 Figure 1.24 The LAC Poverty Rate Has Fallen below 2019 Levels, Driven by Brazil and Mexico Evolution of poverty rates Percent 60 50 40 30 20 10 0 Ecuador El Salvador LAC Andean Region Central America Southern Cone Argentina Bolivia Brazil Chile Colombia Costa Rica Dominican Republic Honduras Mexico Panama Paraguay Peru Uruguay 2015 2019 2023e 2024f Source: World Bank Macro Poverty Outlook (October 2024, forthcoming). Note: The figure uses a poverty line for upper-middle-income countries of $6.85/day in 2017 PPP terms. For Argentina, data have only urban coverage and the 2014 value is used for 2015. For Chile, the 2017 value is used for 2019. For the Dominican Republic, the 2017 value is used for 2015. For Mexico, the 2016 value is used for 2015 and the 2018 value for 2019. 2023e = 2023 estimate. 2024f = 2024 forecast. For Argentina, Brazil, Colombia, Dominican Republic, El Salvador, Honduras, and Uruguay, 2023 values are preliminary. Mexico 2023 and 2024 figures are a projection using neutral distribution (2022) with pass-through = 0.87, based on GDP per capita in constant LCU. The LAC regional aggregate is based on 18 countries in the region for which microdata were available at national level. In cases where data were unavailable, values have been estimated using a combination of methods, including microsimulations, and then pooled to create regional estimates. Brazil and Mexico are not part of the aggregate of the subregions. The Andean region is the aggregate of Bolivia, Colombia, Ecuador and Peru. The Central America region is the aggregate of Costa Rica, Guatemala, Honduras, Nicaragua, Panama, El Salvador, and Dominican Republic and the Southern Cone region is the aggregate of Argentina, Chile, Paraguay and Uruguay. LAC = Latin America and the Caribbean; PPP = purchasing power parity, WDI = World Development Indicators. Updated September 17, 2024. Figure 1.25 Small Gains Have Been Achieved in Income Inequality in LAC, but Challenges Persist Evolution of Gini coefficient Percent 60 50 40 30 20 10 0 Ecuador El Salvador LAC Andean Region Central America Southern Cone Argentina Bolivia Brazil Chile Colombia Costa Rica Dominican Republic Honduras Mexico Panama Paraguay Peru Uruguay 2015 2019 2023e 2024f Source: World Bank Macro Poverty Outlook (October 2024, forthcoming). Note: For Argentina, data have only urban coverage and the 2016 value is used for 2015. For Chile, the 2017 value is used for 2019. For the Dominican Republic, the 2017 value is used for 2015. For Mexico, the 2016 value is used for 2015, the 2018 value for 2019, and the 2022 value for 2023. 2023e = 2023 estimate. 2024f = 2024 forecast. For Argentina, Brazil, Colombia, Dominican Republic, El Salvador, Honduras, and Uruguay, 2023 values are preliminary. The LAC regional aggregate is based on 18 countries in the region for which microdata were available at national level. In cases where data were unavailable, values have been estimated using a combination of methods, including microsimulations, and then pooled to create regional estimates. Brazil and Mexico are not part of the aggregate of the subregions. The Andean region is the aggregate of Bolivia, Colombia, Ecuador and Peru. The Central America region is the aggregate of Costa Rica, Guatemala, Honduras, Nicaragua, Panama, El Salvador, and Dominican Republic and the Southern Cone region is the aggregate of Argentina, Chile, Paraguay and Uruguay. LAC = Latin America and the Caribbean; PPP = purchasing power parity, WDI = World Development Indicators. Updated September 17, 2024. Chapter 1: The State of the LAC Region 42 Latin America and the Caribbean Economic Review October 2024 Box 1.3 Food Insecurity and the Economic Costs of Unhealthy Diets in Latin America and the Caribbean Since 2023, the World Bank has included food and nutrition security among its eight global challenges and as an important nonmonetary measure of poverty. Food insecurity is defined as the lack of consistent access to sufficient, safe, and nutritious food necessary for normal growth, development, and maintenance of an active, healthy life.a Over the past few decades, countries in Latin America and the Caribbean (LAC) have made significant efforts in addressing food insecurity, with varying levels of success, resulting in a highly diverse landscape by the end of 2023 (figure B1.3.1). The socioeconomic impacts of the COVID-19 pandemic, the increase in international food prices, and overall inflation rates have worsened the food security situation. As a result, the prevalence of food insecurity and the cost of a healthy diet have increased in recent years. Figure B1.3.1 The Heterogeneity in Food Insecurity is High across LAC Prevalence of food insecurity in the total population, three-year average, 2021–23 Percent of total population 90 80 70 60 50 40 30 20 10 0 El Salvador Ecuador Haiti Sub-Saharan Africa Guatemala Honduras Jamaica Peru Dominican Republic Belize Central America Trinidad and Tobago Caribbean South Asia Argentina Suriname Latin America and the Caribbean Dominica St. Vincent and the Grenadines Antigua and Barbuda Barbados Colombia St. Kitts and Nevis Middle East and North Africa South America Paraguay Guyana East Asia and Pacific St. Lucia Mexico Grenada Brazil Chile Bahamas, The Costa Rica Uruguay Europe and Central Asia North America Severe food insecurity (dark shade) Moderate food insecurity (ligth shade) Source: World Bank staff calculations using FAO (Food and Agriculture Organization of the United Nations) STAT [database], Suite of Food Security Indicators (https://www.fao.org/faostat/en/). Note: As per FAO’s definitions, severe food insecurity includes instances of people running out of food or going an entire day without eating at times during the year. Moderate food insecurity includes instances of people with insufficient money or resources for a healthy diet, uncertainty about the ability to obtain food, or occasionally skipped meals or running out of food. The figure displays both measures of food insecurity for individual countries in Latin America and the Caribbean (LAC) (in blue), LAC subregions (in orange), and World Bank regions (in green). Subregional and regional estimates are computed as simple/unweighted averages of the respective individual countries. LAC subregions are defined as: Caribbean, Central America, Mexico, and South America. North America consists of the United States and Canada. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 43 Unfortunately, sustaining a healthy diet is more costly in LAC than in any other region of the world (figure B1.3.2). A healthy diet protects against malnutrition in all its forms as well as noncommunicable diseases such as diabetes, heart disease, stroke, and cancer. A healthy diet consists of adequate calories as well as essential nutrients and diverse foods from several different food groups needed for an active and healthy life.b Diet quality is a critical link between food security and nutrition because poor diet quality can lead to different forms of malnutrition, including undernutrition, micronutrient deficiencies, overweight, and obesity. Figure B1.3.2 LAC Is the Region with the Highest Average Cost of a Healthy Diet Cost of a healthy diet, 2022 Current PPP dollars per person per day 7 6 5 4 3 2 Ecuador Jamaica Suriname Grenada St. Vincent and the Grenadines Guyana Bahamas, The Dominica Haiti Caribbean Trinidad and Tobago Antigua and Barbuda Panama Paraguay Nicaragua Latin America and the Caribbean St. Kitts and Nevis Chile East Asia and Pacific South America Honduras Dominican Republic Costa Rica Brazil Bolivia South Asia St. Lucia Colombia Central America Peru Middle East and North Africa Mexico Europe and Central Asia Sub-Saharan Africa Uruguay Guatemala North America Belize Source: FAO (Food and Agriculture Organization of the United Nations) STAT [database], Cost and Affordability of a Healthy Diet (CoAHD) (https:// www.fao.org/faostat/en/) Note: As per FAO’s definition, the cost of a healthy diet measures the population’s physical and economic access to the least expensive locally available foods that meet a healthy diet, as defined in food-based dietary guidelines (FBDGs). The figure displays the cost of a healthy diet for individual countries in Latin America and the Caribbean (LAC) (in blue), LAC subregions (in orange), and World Bank regions (in green). Subregional and regional estimates are computed as simple/unweighted averages of the respective individual countries. LAC subregions are defined as: Caribbean, Central America, Mexico, and South America. North America consists of the United States and Canada. PPP = purchasing power parity. LAC presents a mixed picture of success in some fronts and worrisome trends in others relating to nutrition and its consequences on health outcomes (figure B1.3.3). In the past two decades the LAC region has made notable progress in reducing child stunting and lowering anemia among women ages 15–49. Little progress has been made on reducing the incidence of low birthweight, while the incidence of overweight children under the age of 5 has increased. At the same time, adult obesity has increased dramatically in the region. This phenomenon is not unique to the LAC region; obesity has increased significantly in all regions of the world. Chapter 1: The State of the LAC Region 44 Latin America and the Caribbean Economic Review October 2024 Figure B1.3.3 Progress Has Been Made in Reducing Child Stunting in LAC, but Rising Obesity Is a Concern Progress on key global nutrition targets, comparing 2000 with the most recent year Percent of population within parentheses 50 40 30 20 10 0 North America Europe and Central Asia Latin America and the Caribbean East Asia and Pacific Middle East and North Africa Sub-Saharan Africa South Asia Europe and Central Asia North America Latin America and the Caribbean East Asia and Pacific Middle East and North Africa Sub-Saharan Africa South Asia North America Europe and Central Asia Latin America and the Caribbean Middle East and North Africa East Asia and Pacific South Asia Sub-Saharan Africa South Asia Sub-Saharan Africa East Asia and Pacific Europe and Central Asia Latin America and the Caribbean North America Middle East and North Africa South Asia Sub-Saharan Africa Europe and Central Asia East Asia and Pacific Middle East and North Africa Latin America and the Caribbean North America Anaemia, 2019 Low birthweight, 2020 Stunting, 2022 Overweight, 2022 Obesity, 2022 (Women aged 15-49 years) (Infants) (Children aged < 5 years) (Children aged < 5 years) (Adults aged 18+) Average in 2000 Source: World Bank staff calculations using FAO (Food and Agriculture Organization of the United Nations) STAT [database], Suite of Food Security Indicators (https://www.fao.org/faostat/en/) Note: As per FAO’s definitions, anaemia refers to low levels of hemoglobin in the blood; low birthweight refers to weight at birth of less than 2,500 grams (or 5.5 pounds); child stunting refers to low height-for-age (that is, height-for-age is two standard deviations below the median of World Health Organization Child Growth Standards); child overweight refers to high weight-for-age (that is, weight-for-age is two standard deviations above the median of World Health Organization Child Growth Standards); and adult obesity refers to a Body Mass Index (BMI) greater than or equal to 30 kilograms per square meter. The figure displays the evolution of these five key global nutrition targets for World Bank regions. Regional estimates are computed as simple/unweighted averages of the respective individual countries. LAC = Latin America and the Caribbean. The increase in overweight children and adult obesity is a worrisome trend that has potentially large economic costs and demands urgent attention from policy makers. The prevalence of overweight children in LAC is above the world average, has been increasing in most countries in the region, and has reached very concerning levels, particularly in countries of the Southern Cone (figure B1.3.4, panel a). Overweight and obese children face both immediate and potentially long-term health and economic impacts.c They score lower on cognitive tests and may face stigmatization, poor socialization, and depression, further reducing educational achievement.d Moreover, evidence from the United States shows that childhood overweight is highly correlated with adolescent obesity and that about 80 percent of obese adolescents will become obese adults.e Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 45 The adult obesity rate increased by 50 percent or even doubled in many LAC countries from 2000 to 2022 (figure B1.3.4, panel b). The medical literature has solidly established links between obesity and increased risk of diabetes, cancer, and cardiovascular diseases, among others. In addition to the medical costs associated with the increased prevalence of these diseases, the scientific literature has also found that there are economic costs because the obese population is less productive in the labor market.f If current obesity trends continue in Brazil and Mexico, the costs of premature mortality alone—calculated as the number of years of potential life lost due to obesity multiplied by estimates for the value of a life year—could increase from around 1 percent of GDP in 2020 to almost 4 percent by 2060 (figure B1.3.5).g Well-rounded nutrition policies and programs should be strengthened across the region, as the potential costs of current unhealthy trends are substantial. Figure B1.3.4 The Trends in Overweight Children and Adult Obesity in LAC are Worrisome a. Prevalence of overweight among children (under 5 years of age) Percent 16 14 12 10 8 6 4 2 0 Ecuador El Salvador Paraguay Trinidad and Tobago Argentina Barbados Uruguay Panama Brazil Cuba Peru Bolivia Chile Nicaragua Costa Rica Dominican Republic Mexico Venezuela, RB Colombia St. Lucia Belize Guyana Jamaica Guatemala Honduras Suriname Average in 2022 Average in 2000 Haiti Source: World Bank staff calculations using FAO (Food and Agriculture Organization of the United Nations) STAT [database], Suite of Food Security Indicators (https://www.fao.org/faostat/en/) Note: As per FAO’s definitions, childhood overweight refers to weight-for-height at least two standard deviations above the median of World Health Organization Child Growth Standards. The figure displays childhood overweight per LAC country. As reference, in 2022 the unweighted average of the childhood overweight rate was 8.4 for the LAC region, compared to a global average of 6.7. LAC = Latin America and the Caribbean. Chapter 1: The State of the LAC Region 46 Latin America and the Caribbean Economic Review October 2024 b. Prevalence of obesity in the adult population (18 years and older) Percent 50 40 30 20 10 0 El Salvador Ecuador Bahamas, The St. Kitts and Nevis Belize Chile Barbados Panama Mexico Argentina Jamaica Nicaragua St. Lucia Antigua and Barbuda Uruguay St. Vincent and the Grenadines Paraguay Costa Rica Dominica Grenada Honduras Dominican Republic Suriname Bolivia Guyana Brazil Trinidad and Tobago Peru Guatemala Colombia Venezuela,RB Cuba Haiti Average in 2022 Average in 2000 Source: World Bank staff calculations using FAO (Food and Agriculture Organization of the United Nations) STAT [database], Suite of Food Security Indicators (https://www.fao.org/faostat/en/) Note: As per FAO’s definitions, adult obesity refers to a Body Mass Index (BMI) greater than or equal to 30 kilograms per square meter. The figure displays adult obesity per LAC country. As reference, in 2022 the unweighted average of the adult obesity rate was 31.5 for the LAC region, compared to a global average of 23.1. LAC = Latin America and the Caribbean. Figure B1.3.5 Rising Obesity Will Lead to Major Economic Costs Estimated economic impact of current obesity trends Total cost of obesity (percent of GDP) 6 5 4 3 2 1 0 2020 2030 2040 2050 2060 2020 2030 2040 2050 2060 2020 2030 2040 2050 2060 2020 2030 2040 2050 2060 2020 2030 2040 2050 2060 2020 2030 2040 2050 2060 2020 2030 2040 2050 2060 2020 2030 2040 2050 2060 Spain Australia South Africa India Saudi Arabia Brazil Mexico Thailand Direct medical cost Direct non-medical cost Premature mortality cost Productivity losses Source: World Bank staff calculations using Okunogbe et al. 2021. Note: Estimates are based on a cost-of-illness approach that incorporates both direct and indirect costs. Direct costs encompass both direct medical costs, such as health care expenditures attributable to obesity, and direct nonmedical costs, such as additional expenses incurred by the patient or caregiver while seeking care. Indirect costs comprise the economic losses due to premature mortality and the productivity losses associated with increased morbidity, such as missed workdays and reduced productivity while at work. The losses from premature mortality are computed based on estimates of the number of years of potential life lost due to obesity multiplied by estimates of the economic value of a life year. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 47 The region thus faces two simultaneous challenges: undernutrition, with its effects on child stunting and wasting; and overnutrition, reflected in the increased prevalence of overweight and obese children and adults. This is known in the literature as the double-burden of malnutrition.h Ironically, part of the region’s success in addressing stunting may be contributing to the rise in overweight children and obese adults. Medical literature has clearly established that rapid weight gain during early life (which might occur in response to interventions aimed at treating or preventing undernutrition) increases the risk of adult obesity and diet-related noncommunicable diseases.i Fortunately, the successful systems and programs that address undernutrition in the region can be modified to address both undernutrition and avoid overnutrition. Programs designed to address undernutrition can be modified to promote healthy diets as the default to avoid undernutrition, including nutrition counselling on healthy diets and snacks for mothers and young children in all programs that distribute nutrition supplements. Clear criteria and guidelines should be established for the distribution of energy-dense and micronutrient- fortified foods and supplements based on household food insecurity and individual nutritional status. Duration of food supplementation should be carefully managed to avoid excessive or rapid weight gain beyond what is needed for recovery or prevention of moderate or severe acute malnutrition. Strong educational and behavioral components promoting high-quality varied diets and physical activity can be added to support programs. Increasing access and affordability to a healthy diet is an important component of addressing food insecurity and malnourishment. Conditional cash transfers, food subsidies, and food voucher programs can be redesigned to reward consumption of nutritious food and avoid foods and beverages high in energy, sugar, fat, and salt. Regular health check-ups, with monitoring of health outcomes including overweight and obesity, can become part of the conditions for cash transfer programs. Nutritional guidelines can be established for day-care, preschool, and school feeding programs that restrict foods and beverages that are high in energy, sugar, fat, and salt. Another area for reform is on the supply side, refocusing agricultural subsidies and support programs toward the production of nutritious foods such as fruits, vegetables, nuts, legumes, and whole grains, and making these foods more affordable for all. The nutritional quality of the food supply can be improved by extending incentives to food producers, and via fortification, biofortification, and reformulation of current processed foods. Programs can help connect small agricultural producers to school feeding programs, incentivizing the provision of healthy and nutritious food.j Finally, policy makers may want to consider policies that shape the food environments surrounding consumers. The marketing of foods, snacks, and beverages high in energy, sugar, fat, and salt— particularly those aimed at children—can be restricted and/or monitored. Warning labels can be placed on foods high in sugar, fat, or salt. Monitoring of health and nutrition claims on foods and beverages can be increased. Some countries are also experimenting with targeted taxes on foods and beverages that are high in sugar. Chapter 1: The State of the LAC Region 48 Latin America and the Caribbean Economic Review October 2024 Notes a. FAO (2024). b. WHO (2024). c. WHO (2020). d. UNICEF (2019). e. Simmonds et al. (2016). f. Biener, Crawley, and Meyerhoefer (2018); Segal et al. (2021). g. Okunogbe et al. (2021). h. The Lancet (2019). i. Wells et al. (2020). j. World Bank (2024). Conclusion LAC has almost passed through its inflation crisis. While needing to remain vigilant about weak financial portfolios and fiscal deficits, the region is slowly freeing itself of the imbalances induced by the pandemic. That said, investment and growth are low, and progress on poverty and inequality remain uneven and weak. The region is in a state of robust mediocrity. But, as flagged by previous LACERs, the region has been presented with opportunities, both in the green transition and with the realignment of global value chains and the receding macro challenges now permit taking a strategic look ahead. Taking advantage of these opportunities, and stimulating investment more generally, will require reforms to reduce transaction costs, raise workers’ skills, reduce financing costs, and lower uncertainty. An additional agenda to facilitate taking advantage of these and other growth promoting activities while generating fiscal space and making progress on inequality is the reform of the region’s revenue collection strategy. Brazil has been one of the countries promoting a greater reliance on wealth taxes, in particular. The pros and cons of this strategy for the region are discussed in the next chapter. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 49 References Angel-Urdinola, D. F. 2008. “Can a Minimum Wage Increase Have an Adverse Impact on Inequality? Evidence from Two Latin American Economies.” Journal of Economic Inequality 6: 57-71. Arango, C. A., and A. Pachon. 2007. “The Minimum Wage in Colombia 1984-2001: Favoring the Middle Class with a Bite on the Poor.” Revista ESPE – Ensayos Sobre Politica Económica (Banco de la República de Colombia) 25 (55): 148-93. Bell, L. A. 1997. “The Impact of Minimum Wages in Mexico and Colombia.” Journal of Labor Economics 15 (3): S102-35. Biener, A., J. Cawley, and C. Meyerhoefer. 2018. “The Impact of Obesity on Medical Care Costs and Labor Market Outcomes in the US.” Clinical Chemistry 64 (1): 108–17. BIS (Bank for International Settlements). 2023. “Basel Committee Consults on a Disclosure Framework for Climate- Related Financial Risk.” BIS Press Release, November 29, 2023. https://www.bis.org/press/p231129.htm. Calice, P., and F. Miguel. 2021. “Climate-Related and Environmental Risks for the Banking Sector in Latin America and the Caribbean: A Preliminary Assessment” Policy Research Working Paper 9694, World Bank, Washington, DC. Calice, P., F. Diaz Kalan, and F. Miguel. 2021. “Nature-related Financial Risks in Brazil.” Policy Research Working Paper 9759, World Bank, Washington, DC. Campos-Vasquez, R. M. and G. Esquivel. 2022. “The Effect of the Minimum Wage on Poverty: Evidence from a Quasi- Experiment in Mexico.” Journal of Development Studies 59 (3): 360-80. Campos-Vasquez, R. M., and G. Esquivel. 2021. “The Effect of Doubling the Minimum Wage on Employment and Earnings in Mexico.” Economic Letters 209: 110124. Campos-Vasquez, R. M., V. Delgado, and A. Rodas. 2020. “The Effects of a Place-Based Tax Cut and Minimum Wage Increase on Labor Market Outcomes.” IZA Journal of Labor Policy 10:12. Cunningham, W. 2007. Minimum Wages and Social Policy: Lessons from Developing Countries. Washington, DC: World Bank. Dominican Republic, Banco Central de la República Dominicana. 2022. Financial Stability Report 2021. Santo Domingo, Dominican Republic, July. https://cdn.bancentral.gov.do/documents/informe-de-estabilidad-financiera/documents/ InformeEstabilidadFinanciera2021.pdf?v=1686770473267. Engbom, N. and C. Moser. 2022. “Earnings Inequality and the Minimum Wage: Evidence from Brazil.” American Economic Review 112 (12): 3803-47. Eslava and Meléndez. 2024. Shaping the Playing Field for Economic Growth: Critical Regulatory Frameworks for Business in Latin America. Washington, DC: World Bank. Forthcoming. FAO (Food and Agriculture Organization of the United Nations). 2024. “Hunger and Food Insecurity.” https://www.fao. org/hunger/en/ Florez, L. A., D. Hermida, and L. F. Morales. 2022. “The Heterogeneous Effect of Minimum Wage on Labor Market Flows in Colombia.” Borradores de Economía (Banco de la República de Colombia) 1213. Gindling, T. H. and K. Terrell. 2007. “The Effects of Multiple Minimum Wages Throughout the Labor Market: The Case of Costa Rica.” Labour Economics 14 (3): 485-511. Gindling, T. H. and L. Ronconi. 2023. “Minimum Wage Policy and Inequality in Latin America and the Caribbean.” LACIR: Latin America and Caribbean Inequality Review Working Paper 93. Gomez Lovera, M. A. and L. F. Munguia Corella. 2023. “The Minimum Wage Impact on Poverty in Mexico.” SSRN Electronic Journal: http://dx.doi.org/10.2139/ssrn.4626139. Chapter 1: The State of the LAC Region 50 Latin America and the Caribbean Economic Review October 2024 Hallegatte, S., C. Jooste, and F. J. McIsaac. 2022. “Modeling the Macroeconomic Consequences of Natural Disasters: Capital Stock, Recovery Dynamics, and Monetary Policy.” Policy Research Working Paper 9943, World Bank, Washington, DC. Ham, A. 2018. “The Consequences of Legal Minimum Wages in Honduras.” World Development 102: 135-57. Korea, Republic of. Bank of Korea. Quarterly Bulletin (December 2021). https://www.bok.or.kr/eng/bbs/E0000829/ view.do?nttId=10069260&menuNo=400216&pageIndex=1 Kuddo, A., D. Robalino, and M. Weber. 2015. Balancing Regulations to Promote Jobs: From Employment Contracts to Unemployment Benefits. Washington, DC: World Bank. Lancet, The. 2019. “The Double Burden of Malnutrition.” https://www.thelancet.com/series/double-burden-malnutrition. Lotti, G., J. Messina, and L. Nunziata. 2017. “Minimum Wages and Informal Employment in Developing Countries.” Mimeo. Washington, DC: World Bank and IADB. Ma, J., B. Caldecott, and U. Volz. 2020. “Case Studies of Environmental Risk Analysis Methodologies.” NGFS Occasional Paper, Network for Greening the Financial System. Maloney, W. and J. Nunez Mendez. 2004. “Measuring the Impact of Minimum Wages: Evidence from Latin America.” In J. J. Heckman and C. Pages (eds.), NBER Chapters - Law and Employment: Lessons from Latin American and the Caribbean. Chicago, Illinois: University of Chicago Press. Mora, J. J. and J. Muro. 2017. “Dynamic Effects of the Minimum Wage on Informality in Colombia.” LABOUR (CEIS) 31 (1): 59-72. Munguia Corella, L. F. 2020. “Minimum Wages in Monopsonistic Labor Markets.” IZA Journal of Labor Economics 9 (7): 1-28. Neumark, D. and L. F. Munguia Corella. 2021. “Do Minimum Wages Reduce Employment in Developing Countries? A Survey and Exploration of Conflicting Evidence.” World Development 137: 105165. Nie, Owen; Regelink, Martijn; Wang, Dieter. 2023. Banking Sector Risk in the Aftermath of Climate Change and Environmental-Related Natural Disasters. Policy Research Working Papers; 10326. © World Bank, Washington, DC. http://hdl.handle.net/10986/39641 License: CC BY 3.0 IGO. OCHA (United Nations Office for the Coordination of Humanitarian Affairs). 2020. Natural Disasters in Latin America and the Caribbean. Panama: UN OCHA ROLAC. Okunogbe, A., R. Nugent, G. Spencer, J. Ralston, and J. Wilding. 2021. “Economic Impacts of Overweight and Obesity: Current and Future Estimates for Eight Countries.” BMJ Global Health 6 (10). Reinders, H. J., M. G. J. Regelink, P. Calice, and M. E. Uribe. 2021. Not-So-Magical Realism: A Climate Stress Test of the Colombian Banking System. Equitable Growth, Finance and Institutions Insight. Washington, DC: World Bank Group. Segal, A. B., M. C. Huerta, E. Aurino, and F. Sassi. 2021. “The Impact of Childhood Obesity on Human Capital in High‐ Income Countries: A Systematic Review.” Obesity Reviews 22 (1): e13104. Simmonds, M., A. Llewellyn, C. G. Owen, and N. Woolacott. 2016. “Predicting Adult Obesity from Childhood Obesity: A Systematic Review and Meta-Analysis.” Obesity Reviews 17 (2): 95–107. South Africa, South African Reserve Bank. 2021. Financial Stability Review: Second Edition 2021. Pretoria, South Africa, November. https://www.resbank.co.za/content/dam/sarb/publications/reviews/finstab-review/2021/financial- stability-review/second-edition-fsr/Second%20edition%202021%20Financial%20Stability%20Review.pdf.pdf Strobl, E. and F. Wash. 2003. “Minimum Wages and Compliance: The Case of Trinidad and Tobago.” Economic Development and Cultural Change 51 (2): 427-50. Chapter 1: The State of the LAC Region Latin America and the Caribbean Economic Review October 2024 51 Telling, Oliver, William Langley, Andy Lin, and Chan Ho-him. 2024. “Chinese Businesses Target Vietnam and Mexico as Trade Tensions with US Rise.” Financial Times, June 3, 2024. U.S. Department of the Treasury. 2023. “Remarks by Secretary of the Treasury Janet L. Yellen at Inter-American Development Bank Responsible Investment Forum.” Secretary Statements and Remarks, November 2, 2023. https:// home.treasury.gov/news/press-releases/jy1870. UNDRR (United Nations Office for Disaster Risk Reduction). 2015. The Human Cost of Weather-Related Disasters: 1995–2015. Geneva: UNDRR. UNICEF (United Nations International Children’s Emergency Fund). 2019. “Prevention of Overweight and Obesity in Children and Adolescents.” UNICEF Programming Guidance. UNICEF, New York. Vermeulen, R., E. Schets, M. Lohuis, B. Kölbl, D. J. Jansen, and W. Heeringa. 2018. “An Energy Transition Risk Stress Test for the Financial System of the Netherlands.” Occasional Studies 16 (7, October). Wellenstein, A., and G. Connors. 2022. “Let’s Give Back to Nature What Nature Gives to Us.” Latin America and the Caribbean (blog). November 15, 2022. https://blogs.worldbank.org/en/latinamerica/lets-give-back-nature-what- nature-gives-us. Wells, J. C., A. L. Sawaya, R. Wibaek, M. Mwangome, M. S. Poullas, C. S. Yajnik, and A. Demaio. 2020. “The Double Burden of Malnutrition: Aetiological Pathways and Consequences for Health.” The Lancet 395 (10217, 4-10): 75–88. WHO (World Health Organization). 2020. “Noncommunicable Diseases: Childhood Overweight and Obesity.” https:// www.who.int/news-room/questions-and-answers/item/noncommunicable-diseases-childhood-overweight-and- obesity. WHO (World Health Organization). 2024. “Healthy Diet.” https://www.who.int/health-topics/healthy-diet. World Bank. 2022a. Greening the Financial Sector in Honduras: Climate Risk Assessment, June 2022. World Bank. 2022b. Latin America and Caribbean Economic Review, April 2022. Seizing Green Growth Opportunities. Washington, DC: World Bank. World Bank. 2023. Latin America and Caribbean Economic Review, April 2023. The Promise of Integration: Opportunities in a Changing Global Economy. Washington, DC: World Bank. World Bank. 2024a. Latin America and Caribbean Economic Review, April 2024. Competition: The Missing Ingredient for Growth? Washington, DC: World Bank. World Bank. 2024b. Finance and Prosperity 2024. Finance and Prosperity. Washington, DC: World Bank. DOI: 10.1596/978-1-4648-2060-1. License: Creative Commons Attribution CC BY 3.0 IGO. World Bank. 2024c. “Repurposing Agricultural Support Policies for Sustainable Food Systems–Toolkit.” World Bank, Washington, DC. World Bank. Various years. Global Economic Prospects. Washington, DC: World Bank. World Bank. Various years. Macro Poverty Outlook. Washington, DC: World Bank. World Economic Forum. 2023. How Biodiversity Conservation Can Unlick Opportunities for Latin America and the Caribbean. https://www.weforum.org/agenda/2023/06/biodiversity-conservation-latin-america-caribbean/. Chapter 2: Taxing Wealth 52 Latin America and the Caribbean Economic Review October 2024 Chapter 2 Taxing Wealth for Equity and Growth Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 53 Why Tax Wealth? T axing wealth has generated renewed interest among academics and policy makers, and holds particular salience for Latin America and the Caribbean (LAC) for three reasons. First, the region is short of fiscal space. Progress in infrastructure, education, and productivity all require substantial government investments, while high debt levels and steep interest rates have sharply increased debt service. An important way to marshal more government resources is to improve the efficiency of state spending. Estimates indicate that 12 percent of public spending, equivalent to 4 percent of GDP, could be saved by improving procurement and human resource (HR) management.7 However, in many countries, more revenues will be needed and the question of how they will be raised has become a topic of hot debate. Second, persistent income inequality suggests that existing tax and transfer mechanisms are not fulfilling the function of equalizing incomes as is occurring, for instance, in various member countries of the Organisation for Economic Co-operation and Development (OECD). Third, the persistence of low growth and stagnant investment over decades in the region points to serious inefficiencies in the designs of tax systems, particularly when behavioral responses of agents are taken into account. The high and very concentrated personal income tax burden has been shown to lead to evasion and reduced economic activity.8 Value added tax (VAT) rates have been criticized for becoming a drag on the economy when they reach levels close to the ones in Argentina, Chile, Colombia, and Uruguay today.9 Of particular concern at this conjuncture, the region’s high effective average and marginal tax rates on firm profits in LAC are among the highest in the world. This is mainly due to relatively high corporate income tax statutory rates and tax provisions that are less generous than those observed in other jurisdictions (e.g., allowances for corporate equity, half-year conventions, and inventory valuation methods).10 In fact, the average regional statutory corporate tax rate (25 percent) is the highest in the world, above the OECD (24 percent), and far above Asia (19 percent) (figure 2.1) and adjusting for exemptions and other modifications, the average effective rates across all firms remain above those in the OECD. As LAC seeks to attract links in global value chains, increase investment for the green transition, and raise growth above the mediocre levels of the recent past, these high tax rates are seen as offsetting the advantage the region has developed in terms of wages or proximity to the United States, and compound the region’s relatively unfriendly business environment—as measured by excessive regulation, inefficient judiciary systems, complex trade and tax compliance procedures, and a shortage of skilled human capital (figure 2.2), as well as rising crime and violence.11 Further, high tax rates also prompt corporations to evade by underreporting revenue and overreporting costs, and by shifting profits to low-tax subsidiaries in tax havens. 7 Izquierdo, Pessino, and Vuletin (2018). 8 Riera-Crichton, Venturi, and Vuletin (2024). 9 Gunter et al. (2021). 10 Hanappi et al. (2023). 11 World Bank (2023). Chapter 2: Taxing Wealth 54 Latin America and the Caribbean Economic Review October 2024 Figure 2.1 Statutory Corporate Tax Rates in LAC Countries Are Higher than in Other Groups of Countries Percent 40 35 30 25 20 15 10 5 0 Bahamas, The Belize Barbados Paraguay Aruba Antigua and Barbuda Dominica Jamaica Panama Uruguay Chile Dominican Republic Grenada St. Vincent and the Grenadines Peru Argentina Costa Rica Haiti Honduras Mexico St. Lucia Trinidad and Tobago St. Kitts and Nevis Brazil Colombia LAC Average Asia Average OECD Source: OECD Corporate Tax Statistics (doi: 10.1787/0959240d-en). Note: LAC = Latin America and the Caribbean; OECD = Organisation for Economic Co-operation and Development. Figure 2.2 LAC Has a Relatively Unfriendly Business Environment Enterprise Survey measures Time spent dealing with govermment regulations 100 90 Identification of an inadequately 80 Days for operating license educated workforce as a major 70 constraint 60 50 40 30 Identification of courts as 20 10 Days for import license a major constraint 0 Firms identifying labor Time spent on tax regulations as a major compliance constraint Cost to comply with Days for exported goods import requirements to clear border control agencies East Asia and Pacific Europe and Central Asia Latin America and Caribbeean South Asia Sub-Saharan Africa Middle East and North Africa Source: World Bank Enterprise Surveys (www.enterprisesurveys.org). Note: Indicators were normalized to range from 0 to 100, with 0 representing the best performance and 100 the worst. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 55 Another feature of the fiscal landscape of the region that merits policy discussion is the unusually high reliance of subnational fiscal units (states/provinces, municipalities, cities, and so on) on fiscal transfers from the federal/central government relative to local generation of resources. While subnational governments in Argentina, Brazil, and Germany account for approximately 40 percent of total public spending, their dependence on transfers from the central government is 60 percent to 70 percent in Argentina and Brazil, compared to only 30 percent in Germany. This disparity between spending and revenue decentralization is a well-recognized source of political economy challenges and fiscal profligacy. The Renewed Global Focus on Wealth Taxes Wealth taxes have been enacted or considered in various countries at various times. Several European nations implemented wealth taxes in the aftermath of World War II to generate resources to rebuild their economies, while more recently, the COVID-19 pandemic spurred discussions and, in some cases, temporary wealth taxes to offset stimulus costs. Interest is spreading in LAC. Brazilian President Lula da Silva has pushed for a minimum global wealth tax, along with French President Macron. The EU Tax Observatory, which advises the G20 Brazilian presidency, has proposed imposing a minimum 2 percent levy on the world’s 3,000 richest billionaires, which, in Brazil’s case is estimated to raise an additional $2.1 billion.12 President Petro of Colombia has proposed an annual wealth tax on savings and property above $460,000. Wealth taxes were first introduced in Colombia in 1935, repealed in 1992 and then introduced again in 2002 to finance Seguridad Democratica—the Uribe administration’s security effort against drug trafficking, guerrilla, and paramilitary groups—with revenues earmarked for defense and security expenditures.13 Chile has repeatedly considered implementing a wealth tax but has yet to enact one. While proposals have been introduced in recent years, including a significant attempt in 2023, the measure has faced opposition and remains under debate. In December 2020, Bolivia implemented a wealth tax targeting individuals with assets exceeding $4 million. The tax features progressive rates ranging from 1.4 percent to 2.4 percent. In its first year, the tax affected 204 taxpayers and generated approximately $35 million in revenue, accounting for merely 0.38 percent of the country’s total tax income for that year. Argentina’s wealth tax was first introduced in 1972 and allowed for debt deductions. This net wealth taxation was discontinued in 1989 but reintroduced in 1991 as a global tax on gross wealth, without debt deductions. The Uruguayan wealth tax applies to individuals based on their assets in the country and is progressive, ranging from 0.1 percent to 0.4 percent for residents and from 0.7 percent to 1.5 percent for nonresidents. Which Wealth to Tax? Wealth taxes have been criticized for requiring intensive administrative capacity, for discouraging investment, and for sometimes leading to wealth flight and low collection, but these criticisms depends greatly on precisely the type of wealth that is targeted.14 For instance, even in advanced economies, taxing liquid assets can be challenging, especially in countries with weak enforcement because they are easy to move across borders and hide offshore. Strengthening global enforcement efforts to track them, and to address concerns related to crime and money laundering, will continue to be priority, although the levels of international coordination needed will likely remain elusive over the medium term. 12 https://www.politico.eu/article/emmanuel-macron-brazil-lula-da-silva-global-minimum-tax-billionaires-wealthiest-people/. 13 Londoño-Vélez and Ávila-Mahecha (2021). 14 Enache (2024); OECD (2018). Chapter 2: Taxing Wealth 56 Latin America and the Caribbean Economic Review October 2024 Property taxation, on the other hand, has fewer negative behavioral consequences and more manageable administrative burdens. By nature, property is a relatively fixed and easily identifiable asset and hence less susceptible to flight, and real estate is the main type of wealth in LAC. Despite relatively standard marginal taxation rates, low valuations have led real estate to be underutilized as a revenue source. The availability of modern platforms for obtaining more accurate market value data and identifying the locations of wealthy neighborhoods offers potential to remedy this going forward. Moreover, this tax could be a valuable tool for empowering subnational governments and reducing their excessive reliance on transfers from higher levels of government. Importantly, property taxes are less likely to hinder growth. Property holdings generally contribute less to economic dynamism in terms of fostering innovation, creating positive synergies with other strategic productive sectors, or nurturing human capital. Thus, taxing property can potentially create jobs and accelerate growth. By contrast, excessively high marginal rates in corporate and personal income taxes and other distortive taxes, such as gross receipts and financial transaction taxes, penalize investors and entrepreneurs, who may be adding innovation and jobs to the economy. The double taxation implied because wealth is often the accumulation of savings from already taxed income can discourage investment and innovation and send productive entrepreneurs to lower tax jurisdictions. Lowering taxes on high-return and skilled individuals could reallocate capital; in turn, the higher yields could potentially motivate greater savings.15 Numerous European countries have repealed wealth taxes or refocused them over the last decade. As a final caveat, the chapter also suggests that the proposals for taxing billionaires in LAC, while they should be taken seriously and probably can reach their stated goals for raising funds for the green transition are not a silver bullet for generating fiscal space more generally. Even without considering potential mobility responses, the potential revenue gains are modest due to the region’s relatively smaller number of billionaires and their lesser wealth compared to billionaires in more advanced economies and emerging markets. However unpopular, to reach both revenue and equity goals, all tax systems will need to increase the base of those taxed.16 A Tale of Two Models: Wealth Taxation in Advanced Economies Essential to the analysis of wealth taxes is the concept of net worth. This represents the total value of an individual’s assets minus their liabilities. Assets encompass a broad spectrum of possessions, including readily tradable financial ones like stocks and bonds, as well as tangible assets like real estate, artwork, and even luxury vehicles. Liabilities, on the other hand, represent financial obligations such as mortgages, student loans, and credit card debt.17 In principle, the idea is to levy taxes on the net position and, even more than the personal income tax, wealth taxes often follow a progressive structure, meaning the tax rate increases as net worth rises.18 This said, the advanced world has taken very different approaches to implementing wealth taxes. In North America, neither the United States nor Canada has a federal general wealth tax. However, property taxes on real estate (property taxes, hereafter) are a cornerstone of local revenue, primarily funding schools, 15 Guvenen et al. (2023). 16 This chapter is part of a forthcoming World Bank report, Rethinking Taxation in LAC: Behavioral Insights for More Equitable and Effective Policymaking. 17 Rudnick and Gordon (1996). 18 See Saez and Zucman (2016). Wealth taxes are inherently more progressive than income taxes. Unlike income taxes, which focus on annual earnings, wealth taxes target accumulated assets. Given that a disproportionate amount of wealth is concentrated among a small segment of society, a well-designed wealth tax can more effectively target the ultra-wealthy. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 57 public safety, and infrastructure. This heavy reliance on property taxes can impose significant burdens on homeowners, especially in areas with high property values. Furthermore, some states impose estate taxes, a form of wealth tax levied upon the transfer of assets at death, contributing to the overall tax burden on high- net-worth individuals in these jurisdictions. While estate taxes can be in principle a source of revenue, they can also be difficult to enforce and may incentivize wealthy individuals to engage in tax avoidance strategies, such as gifting assets during their lifetime, establishing trusts, or holding assets in foreign jurisdictions. In contrast, many European countries have adopted a broader approach to taxing wealth. Germany’s wealth tax is levied on net assets exceeding a specific threshold, including real estate, financial assets, and business holdings. Switzerland, known for its tax-friendly environment, imposes a relatively low wealth tax but applies it to a broad range of assets. Countries like the United Kingdom, France, and Germany impose substantial taxes on wealth transfers at death. The United Kingdom’s inheritance tax, for example, applies to estates exceeding a certain value, with progressive rates based on the size of the inheritance. France and Germany also have progressive inheritance tax systems, with higher rates for larger inheritances. Recently, European countries have reduced the scope of wealth taxed. France now focuses on a real estate wealth tax targeting high-value properties. Other countries have also joined a recent trend of repealing their wealth taxes, including Austria (1994); Denmark and Germany (1997); the Netherlands (2001); Finland, Iceland, and Luxembourg (2006); and Sweden (2007). In 2021, the Netherlands Supreme Court ruled that the country’s wealth tax violated European law primarily due to issues of property rights and nondiscrimination.19 In fact, as of 2024, only three Western European countries still levy the broader net wealth taxes: Norway, Spain, and Switzerland. These divergent paths of wealth taxation in North America and Europe are deeply intertwined with the historical and political evolution of each. The United States, founded on principles of individual property rights and limited government, developed a system heavily reliant on property taxes for local revenue.20 This emphasis on local property taxes reflects the nation’s agrarian roots (where land is often the most valuable asset) and a political culture averse to strong central authority. In contrast, European nations, experienced earlier industrialization and the subsequent concentration of wealth. These factors, coupled with Europe’s more centralized authority, led to discussions about larger welfare states21 and the implementation of direct wealth taxes as a means to address inequality.22 Wealth Tax Revenues The contribution to total government revenue from wealth taxes, on both net wealth and property, varies greatly by region and, within them, countries (figure 2.3). As discussed, North America and Europe are the regions with the most significant wealth taxation, with North America relying more heavily on property taxes compared to Europe (panels a, b, d, and e). While the United States and Canada lack a federal-level wealth tax like some European nations, property taxes constitute a substantial revenue source for subnational governments in both countries. These taxes can be considerable, especially in areas with high property values. Consequently, it is inaccurate to claim that the United States and Canada do not tax wealth. In fact, overall revenue in these North American nations often far exceeds that of their European counterparts (panels a, b, and e). 19 Specifically, the court found that the tax system, which used a flat-rate return on assets to calculate the taxable amount, did not accurately reflect the actual returns individuals earned on their investments. This was deemed to be discriminatory and to violate property rights because it did not treat all taxpayers equally based on their actual financial circumstances. 20 Bailyn (1967) 21 Esping-Andersen (1990). 22 Piketty (2014). Chapter 2: Taxing Wealth 58 Latin America and the Caribbean Economic Review October 2024 Wealth tax collection in the LAC region is very low, representing only about 0.5 percent of GDP (figure 2.3, panel a) or 2.7 percent of total revenue collection (figure 2.3, panel b). Sub-Saharan Africa is the only region with lower wealth tax collection. There is, however, high variation among LAC countries: wealth tax collection exceeds 5 percent of total tax revenues in Uruguay, Barbados, Colombia, the Bahamas, and Chile (figure 2.3, panel c). Variation is also high in other emerging markets and developing economies (EMDEs) (figure 2.3, panel e). Figure 2.3 Wealth Taxes Vary Greatly by Region and Country Size of wealth tax revenue a. As percent of GDP, by region b. As percent of total tax revenue, by region Percent Percent 3.0 14 2.5 12 10 2.0 8 1.5 6 1.0 4 0.5 2 0 0 Latin America and Caribbean Eastern Europe and Central Asia East Asia and Pacific Western and Central Europe Sub-Saharan Africa North America Middle East and North Africa Latin America and Caribbean Eastern Europe and Central Asia East Asia and Pacific Western and Central Europe Sub-Saharan Africa North America Middle East and North Africa Property tax Net wealth tax Property tax Net wealth tax c. As percent of total tax revenue, by LAC country Percent 10 8 6 4 2 0 Antigua Argentina Bahamas Barbados Belize Bolivia Brazil Chile Colombia Costa Dominican Ecuador and Rica Republic Barbuda Property tax Net wealth tax Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 59 Percent 10 8 6 4 2 0 El Guatemala Guyana Honduras Jamaica Mexico Nicaragua Panama Paraguay Peru Saint Trinidad Uruguay Salvador Lucia and Tobago Property tax Net wealth tax d. As percent of total tax revenue, by advanced economies Percent 16 14 12 10 8 6 4 2 0 Australia Canada Switzerland Germany Spain France Greece United Italy Japan Korea, Norway New Portugal Sweden United Kingdom Rep. Zealand States Property tax Net wealth tax e. As percent of total tax revenue, by emerging markets and developing economies Percent 6 5 4 3 2 1 0 China Czechia Egypt, Hungary Indonesia Morocco Philippines Poland Thailand Türkiye Viet Nam South Arab Rep. Africa Property tax Net wealth tax Sources: World Bank staff calculations using OECD Global Tax Revenue Database and World Bank data. Note: Social security revenues are excluded from total tax revenues. The figure uses consolidated government statistics. LAC = Latin America and the Caribbean. Another dimension where LAC countries differ in their taxation is regarding the main property that is subject to taxation from a revenue collection point of view. Many countries in the region, such as Barbados and Chile, primarily tax land values. Others, such as Argentina, Colombia, and Peru, primarily tax building values. Mexico and Brazil, like other countries, incorporate land value into their property tax calculations in addition to building value. Several, such as Uruguay and Costa Rica, have made efforts to shift the tax burden more toward land values, recognizing the potential for fairer and more efficient taxation. Chapter 2: Taxing Wealth 60 Latin America and the Caribbean Economic Review October 2024 Tax rates, exemptions, deductions, and administrative structures also differ widely. For instance, some nations offer generous exemptions for residential property, especially for low-income owners (Chile, Colombia), while others impose higher rates on commercial and luxury properties (Argentina, Brazil). Administrative systems vary dramatically. Countries like Uruguay and Costa Rica have centralized property valuation, ensuring consistent assessments. Conversely, many LAC nations, including Mexico, Peru, and Central American countries, rely on self-reported values, often leading to underassessment. Administrative Challenges of Wealth Taxes: Chasing the Elusive Liquid Asset While wealth taxes may seem attractive, their administrative feasibility can be challenging, depending on the type of wealth. This is particularly the case in environments with weak enforcement, such as those prevalent in EMDEs, including those in LAC. The Achilles’ heel of policies to tax highly liquid assets (such as stocks, bonds, and cash) is the ease with which the wealthy can transfer these assets across borders. Tax havens, offering minimal or no wealth taxes, secrecy, and lax regulations, further exacerbate this issue. The ability to relocate liquid wealth poses a substantial risk of tax evasion and avoidance.23 These tax havens, which complicate wealth tracking, also undermine the overall effectiveness of the tax system. Plugging the Wealth Loophole: Can the World Act Together? Governments worldwide face challenges taxing financial assets due to opacity and cross-border mobility. International cooperation is crucial. Advanced economies are leading the way with innovative strategies. This dictates a need for a coordinated international approach. Several strategies are emerging to this end, particularly in advanced economies. • Information-sharing agreements. Governments are increasingly collaborating to exchange data on taxpayers’ foreign assets. These agreements enable tax authorities to access information on individuals’ holdings in other countries, making it more difficult to conceal offshore wealth. This coordinated effort, led by organizations like the OECD, aims to create a global framework to prevent the exploitation of tax loopholes by the wealthy. • Closing loopholes in tax havens. The international community is actively working to curtail the advantages offered by tax havens. These jurisdictions often provide secrecy and minimal regulations, hindering wealth tracking. Initiatives such as the OECD’s Base Erosion and Profit Shifting (BEPS) project are establishing minimum tax standards, reducing the appeal of shifting profits and assets to these havens.24 Indeed, the fear of being caught and punished appears to be an effective deterrent. For instance, the increased scrutiny from Colombian authorities following the Panama Papers leak significantly discouraged tax evasion.25 This heightened scrutiny led to a remarkable fifteen-fold increase in voluntary disclosures of foreign assets by Colombian taxpayers. 23 Atkinson, Piketty, and Saez (2011). 24 OCDE (2023). 25 Londoño-Vélez and Ávila-Mahecha (2021). Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 61 • Disincentivizing asset flight. Some countries are implementing measures to deter the movement of liquid assets, including levying exit taxes on high-value assets. These taxes are imposed on certain valuable assets, like stocks, when transferred offshore beyond a specific threshold. This discourages individuals from relocating wealth to avoid taxes.26 The practice of presumptive taxation assumes a minimum level of income from foreign assets, even without reported income. This incentivizes taxpayers to keep their assets within the country’s tax jurisdiction to avoid the presumptive tax burden.27 By employing exit taxes and presumptive taxation, countries can discourage the offshore movement of liquid wealth. In a world where tax authorities can seamlessly access a comprehensive overview of a taxpayer’s global assets, tax havens are neutralized. Though there have been advances in developing the infrastructure and capacity for such a system, the advanced economies still face challenges, and the EMDEs, including those in LAC, even more so. Establishing the necessary systems is complex, resource intensive, and fraught with bureaucratic obstacles. Developing technical infrastructure, training personnel, and ensuring robust data security are demanding tasks, compounded by often pervasive corruption. Further, achieving the necessary consensus among all countries can be arduous and even a very small number of noncompliant countries provide havens for tax evaders and undermine the effort. For these reasons, even the advanced economies with robust tax systems are recognizing the difficulties of taxing highly liquid assets. Box 2.1 shows the paradigmatic and recent case of France, which in 2017, under President Emmanuel Macron, replaced the longstanding broad-based wealth tax, the ISF, with the IFI, a tax specifically targeting real estate holdings. Box 2.1 The Great French Wealth Tax Shuffle Origins and history of the wealth tax. The French wealth tax has a complex history, marked by periods of implementation and abolition. Introduced in 1981 by the Socialist Party under President François Mitterrand as the “Impôt sur les Grandes Fortunes” (IGF), it was aimed at redistributing wealth and reducing inequality. However, the tax was abolished in 1986 by the right-wing government of Jacques Chirac. Reinstated in 1988 as the “Impôt de Solidarité sur la Fortune” (ISF) after Mitterrand’s reelection, the tax underwent several modifications over the years. It imposed a levy on individuals with assets exceeding a certain threshold, with the proceeds intended to fund social programs. Despite its reintroduction, the ISF remained a controversial policy, with critics arguing that it discouraged investment, prompted wealthy individuals to leave the country, and generated limited revenue. The shift to the wealth tax on real estate. In September 2017, the French government, led by President Emmanuel Macron, abolished the ISF and replaced it with the Impôt sur la Fortune Immobilière (IFI), a wealth tax specifically targeting real estate holdings. This significant policy change was driven by several factors: 26 Brondolo (2011). 27 Brondolo (2011). Chapter 2: Taxing Wealth 62 Latin America and the Caribbean Economic Review October 2024 • Economic concerns. Critics of the ISF argued that it hindered economic growth by discouraging investment and prompting wealthy individuals to relocate their assets or residences.a As former French Prime Minister Manuel Valls stated in 2016, “The ISF is a tax on the French who succeed... It’s a tax on the French who create jobs.” • Equity considerations. The IFI was seen as a fairer tax, as it focused on a tangible asset that is less easily hidden or transferred compared to other forms of wealth. • Political considerations. The shift to the IFI aligned with Macron’s pro-business agenda and his desire to curbing asset flight and attract investment to France. This policy change seems to have had led to some shifts in the French economy. A recent paper has found that five years after the reform, the IFI appears to have incentivized individuals to at least modestly reallocate their assets away from real estate toward financial assets.b Notes: a. N. Cheysson-Kaplan, “Impôt sur la fortune immobilière: ce qu’il faut savoir pour la declaration,” Le Monde, May 23, 2019, https://www. lemonde.fr/argent/article/2019/05/23/impot-sur-la-fortune-immobilere-ce-qu-il-faut-savoir-pour-la-declaration_5465799_1657007. html; N. Cheysson-Kaplan, “Impôt sur la fortune immobilière : comment estimer ses biens à leur juste Valeur,” Le Monde, May 28, 2024, https://www.lemonde.fr/argent/article/2024/05/28/impot-sur-la-fortune-immobiliere-comment-estimer-ses-biens-a-leur-juste- valeur_6235973_1657007.html b. Le Guern Herry (2024). The challenge of achieving global consensus on these initiatives is exacerbated by the fact that not all countries benefit equally from them. Countries that stand to lose the most revenue or investment from increased international cooperation may be less inclined to participate fully, especially if the additional revenue generated globally is not shared. Moreover, as more countries agree to participate in these initiatives, the incentives for some countries to deviate and not agree may increase. These factors pose a significant challenge to the implementation of such policies. Targeting the Tangible: Real Estate as a Potential Anchor for Wealth Taxes in LAC Unlike stocks, bonds, and cash, which can be easily transferred across borders, real estate is an immobile physical asset with a fixed location and hence offers a potentially more promising target of wealth taxes. Further, taxing less productive wealth, such as unused land, instead of capital accumulation, shifts incentives toward projects with higher returns. As with income taxes, systems can be designed to ensure progressivity by targeting high-value properties or providing exemptions or credits for low-income homeowners. Further, property is by far the greatest type of wealth in LAC, as documented by survey-based microdata from OECD, as well as from local sources for Chile, Colombia, Mexico, and Uruguay (figure 2.4). Thus, property is a logical target for revenue. Relative to financial and other assets (such as cars), owner-occupied and secondary housing is dominant in LAC (86 percent) compared to Eastern Europe (75 percent); Greece, Italy, Portugal, and Spain (GIPS) (73 percent); and other advanced economies (62 percent) (figure 2.4, panel a). Within individual Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 63 countries in LAC, the importance of real estate in total wealth is even higher than the regional average: 90.5 percent in Mexico, 85.7 percent in Colombia, 85.2 percent in Chile, and 83.2 percent in Uruguay. It represents a considerably lower share in some major advanced economies, including Canada (56.4 percent), the United Kingdom (54.6 percent), and the United States (38.6 percent) (figure 2.4, panel b). Figure 2.4 Property is the Greatest Type of Wealth in LAC Composition of gross household wealth a. By region Percent 100 90 80 70 60 50 40 30 20 10 0 LAC Eastern Europe GIPS Rest of OECD Owner-occupied housing Secondary real estate Financial assets Others b. By country Percent 100 80 60 40 20 0 Chile Colombia Mexico Uruguay Estonia Hungary Latvia Lithuania Poland Slovak Greece Italy Portugal Spain Republic Owner-occupied housing Secondary real estate Financial assets Others Percent 100 80 60 40 20 0 Australia Austria Belgium Canada Denmark Finland France Germany Korea New Zealand Norway Slovenia United United Rep. Kingdom States Owner-occupied housing Secondary real estate Financial assets Others Sources: World Bank staff calculations using OECD and survey-based microdata for Chile, Colombia, Mexico, and Uruguay. National data sources include: Survey of Financial Security, 2019 (Canada, Statistics Canada); Encuesta Financiera de Hogares, 2017 (Chile, Banco Central de Chile); Encuesta de Carga Financiera y Educación, 2017 (Colombia, Departamento Administrativo Nacional de Estadística); Encuesta Financiera de las Familias, 2017 (Spain, Banco de España); Encuesta Nacional sobre las Finanzas de los Hogares, 2019 (Mexico, Instituto Nacional de Estadística y Geografía); Módulo Financiero de los Hogares Uruguayos, 2017 (Uruguay, Universidad de la República); Wealth and Assets Survey, 2016–2018 (United Kingdom, Office for National Statistics); and Survey of Consumer Finances, 2019 (United States, Federal Reserve System). Note: All countries in the data set belong to the OECD, except for Uruguay (in LAC). The regional groups are composed as follows. LAC (Colombia, Chile, Mexico, Uruguay); Eastern Europe (Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Republic); GIPS (Greece, Italy, Portugal, Spain); Rest of OECD (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Korea, New Zealand, Norway, Slovenia, United Kingdom, United States). LAC = Latin America and the Caribbean; OECD = Organisation for Economic Co-operation and Development. Chapter 2: Taxing Wealth 64 Latin America and the Caribbean Economic Review October 2024 The case is even stronger for the top 10 percent of income earners in LAC (figure 2.5), where real estate accounts for 81 percent of household wealth, compared to 55 percent in Eastern Europe and 47 percent in other advanced economies (figure 2.5, panel a). While the importance of real estate in total wealth of households is 88.1 percent in Uruguay, 79.3 percent in Colombia, 78.8 percent in Chile, and 76.7 percent in Mexico, it is 46.3 percent in Canada and 24.3 percent in the United States (figure 2.5, panel b). Figure 2.5 Real Estate Accounts for a Very Large Share of Household Wealth of the Top Earners in LAC Composition of gross household wealth for the top 10 percent of income earners a. Composition of gross household wealth across regions (using the 8 countries in panel b) Percent 100 80 60 40 20 0 LAC GIPS Rest of OECD Owner-occupied housing Secondary real estate Financial assets Others b. Composition of gross household wealth across countries Percent 100 90 80 70 60 50 40 30 20 10 0 Chile Colombia Mexico Uruguay Spain Canada United Kingdom United State Owner-occupied housing Secondary real estate Financial assets Others Sources: World Bank staff calculations using OECD and survey-based microdata. Note: All countries in the dataset belong to the OECD, except for Uruguay (in LAC). The groups are composed as follows. LAC (Colombia, Chile, Mexico, Uruguay); GIPS (Spain); Rest of OECD (Canada, United States). GIPS = Greece, Italy, Portugal, Greece; LAC = Latin America and the Caribbean; OECD = Organisation for Economic Co-operation and Development. Figure 2.6 sheds further light on wealth distribution across income percentiles in LAC countries compared to the United States. A closer look a at the data reveals several significant patterns: • The enduring importance of real estate in LAC. First, real estate remains a significant wealth holding across income levels in LAC, even more than in the United States or other advanced economies (figure 2.6, panels a and b). While the importance of real estate in total wealth declines between the first and last income percentile by 20.4 percent in Chile (from 93.4 percent to 74.3 percent), by 18.4 percent in Mexico (from 97.4 percent to 79.5 percent), by 9.7 percent in Colombia (from 94.8 percent to 85.5 percent), and by 9.1 percent in Uruguay (from 96.8 percent to 88 percent), it Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 65 falls considerably more in the United States, by 65.1 percent (from 60.9 percent to 21.2 percent). This finding suggests that real estate taxation could be an effective tool for taxing wealth in LAC countries. • The rise of secondary housing. The rise of secondary housing is a notable trend across all studied countries, with its importance increasing as income rises (figure 2.6, panel c). This suggests a growing emphasis on investment properties or vacation homes among wealthier individuals. Moreover, many of these secondary properties are located in different areas than the primary residence. This geographic separation, such as in the case of vacation homes or weekend getaways, could offer additional benefits from a taxation point of view. In some cases, it could simplify taxation because the properties are situated in regions with different tax constituencies than the primary residence. For instance, a highly valued vacation home located in a wealthy neighborhood, owned by a wealthy nonresident and subject to low property taxes, could create opportunities to increase property taxes on such properties, thereby capturing more revenue from wealthy nonresidents. This potential revenue increase could alleviate the tax burden on local homeowners, who would likely be the primary voters on any such tax increase. • The lag in financial assets in LAC, even at the top of the income distribution. The picture of financial assets differs between LAC and, for example, the United States. In LAC, the importance of financial assets like stocks and bonds increases modestly only for the very top earners (figure 2.6, panel d). For example, the proportion of financial assets in total wealth for the top 5 percent income earners reaches 14.3 percent in Chile, 11.6 percent in Mexico, 4.8 percent in Uruguay, and 2.3 percent in Colombia. In contrast, in the United States, the presence of financial assets is strong across all income levels, including middle-income households. For example, the share of financial assets in total wealth for median income earners in the United States reaches 32.9 percent, far surpassing that of the top 5 percent earners in LAC. Figure 2.6 Real Estate Is Important as a Source of Wealth across All Income Percentiles in LAC Composition of gross household wealth, by income percentile a. Share of real estate assets in total assets Percent of total wealth 100 90 80 70 60 50 40 30 20 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 Percentile Chile Colombia Mexico Uruguay Spain Canada United States Chapter 2: Taxing Wealth 66 Latin America and the Caribbean Economic Review October 2024 b. Share of owner-occupied housing assets in total assets Percent of total wealth 100 90 80 70 60 50 40 30 20 10 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 Percentile Chile Colombia Mexico Uruguay Spain Canada United States c. Share of secondary real estate assets in total assets Percent of total wealth 45 40 35 30 25 20 15 10 5 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 Percentile Chile Colombia Mexico Uruguay Spain Canada United States Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 67 d. Share of financial assets in total assets Percent of total wealth 60 50 40 30 20 10 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 Percentile Chile Colombia Mexico Uruguay Spain Canada United States e. Share of other assets in total assets Percent of total wealth 35 30 25 20 15 10 5 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 Percentile Chile Colombia Mexico Uruguay Spain Canada United States Sources: World Bank staff calculations using survey-based microdata. Note: The share of each percentile is built from actual data smoothed by a weighted average that combines the evaluated data point and the 4 closest percentiles. The weights were based on a Gaussian kernel with bandwidth 0.6. Chapter 2: Taxing Wealth 68 Latin America and the Caribbean Economic Review October 2024 The cross-country evidence highlights a strong Figure 2.7 relationship between wealth composition and As Countries Develop, their Wealth Composition Shifts from Real Estate to a More Diversified Portfolio economic development. For middle-income countries, real estate remains the dominant asset class, accounting for about 80 percent to 90 percent a. Share of real estate in total wealth versus economic of total wealth (figure 2.7, panel a). However, this development importance diminishes in countries with higher income per capita. Conversely, the share of financial 100 Percent of real estate assets in total wealth MEX assets tends to increase with the level of economic 90 COL CHL LVA LTU development (figure 2.7, panel b). Assets other than 80 URY GRC POL SVN ITA DNK real estate and financial assets (such as cars) appear 70 SVK HUN ESP FIN AUS BEL NOR KOR to be negatively related with income levels, yet not 60 PRT EST FRA DEU AUT as markedly (figure 2.7, panel c). This suggests that 50 GBR CAN as countries develop, their wealth composition shifts 40 NZL from being concentrated in real estate to a more 30 USA diversified portfolio that includes a greater share of 10,000 20,000 30,000 40,000 50,000 60,000 70,000 financial assets. GDP per capita b. Share of financial assets in total wealth versus economic c. Share of other assets in total wealth versus economic development development 70 14 Percent of financial assets in total wealth Percent of other assets in total wealth USA COL GBR 60 12 NZL NZL 50 10 AUS CAN URY FRA 40 EST GBR 8 BEL CAN PRT AUT SVK 30 ESP FIN 6 MEX SVN KOR HUN DEU CHL AUT FRA NOR LVA HUN PRT KOR DNK USA 20 GRC SVK POL AUS 4 LTU ITA ITA GRC DEU URY FIN SVN POL ESP 10 MEX LTU 2 EST BEL LVA DNK COL CHL NOR 0 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 10,000 20,000 30,000 40,000 50,000 60,000 70,000 GDP per capita GDP per capita Sources: World Bank staff calculations using OECD 2022 and survey-based microdata. Note: Data labels use International Organization for Standardization (ISO) country codes. Countries in Latin America and the Caribbean are shown in orange. In light of the evidence, it is clear that wealth concentration in real estate is a prominent feature in LAC, persisting even among high-income earners. This suggests a strong reliance on real estate as a wealth-building tool across income levels in the region. However, the dynamics shift as countries develop economically. As development progresses, the significance of real estate in the overall wealth composition tends to decline dramatically, particularly for the very top earners. Wealth holdings diversify toward other asset classes, such as financial instruments, as economies mature. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 69 Why Is It that Real Estate Reigns Supreme as a Form of Wealth in LAC? The prominence of real estate in LAC portfolios arises from several factors: • Restricted variety of investment vehicles. Developing countries, including many in LAC, often have nascent or immature financial markets with limited options for investment. In such an environment, real estate emerges as the primary, and sometimes the only, viable option for those seeking to build wealth or invest their savings. For example, in Colombia and Mexico, where stock and bond markets are relatively underdeveloped, real estate has historically been a dominant asset class.28 • Tangibility and security. Real estate offers a unique sense of tangibility and security, as well as serving as an inflation hedge, particularly in countries with recent past histories of economic crises. Investors may view land and buildings as a safer way to store value compared to the perceived risks associated with stock market fluctuations, currency devaluation, or even confiscation. A study by the Inter-American Development Bank (IDB) found that real estate acts as a hedge against inflation in LAC,29 especially in countries like Argentina and Brazil, which have experienced periods of high inflation and economic instability. • Low levels of financial literacy. Societies in advanced economies often have higher levels of financial literacy, leading to more diversified investment approaches. In LAC, limited knowledge about liquid assets can concentrate wealth into real estate.30 • Cultural preference for land ownership. In many countries, there is a strong cultural preference for land ownership, driven by factors like social status and inheritance. This can influence investment decisions, leading individuals to prioritize real estate ownership even if alternative options might offer higher returns. For example, in countries like Colombia and Mexico, where social hierarchies have historically been tied to land ownership, acquiring property can be a way to elevate one’s social standing. The Property Tax Paradox in LAC This unusual concentration of wealth in real estate, combined with the low share of tax collection from this source, constitutes a LAC property tax paradox (figure 2.8, panels a and b). While 80 percent of wealth, on average, is held as real estate, LAC collects about 2 percent of tax revenues from real estate taxes, while many countries in the region collect almost none (figure 2.8, panel c). Barbados, the Bahamas, Colombia, Uruguay, and Chile lead, collecting about 4 percent of their tax revenues from this source. Conversely, Argentina, Mexico, Paraguay, and Ecuador collect about 1 percent, and El Salvador, Trinidad and Tobago, Bolivia, and Cuba almost none. 28 Cavallo and Serebrisky (2016). 29 Bouillon (2012). 30 Klapper, Lusardi, and van Oudheusden (2015). Chapter 2: Taxing Wealth 70 Latin America and the Caribbean Economic Review October 2024 Figure 2.8 While Most Wealth in LAC is Held as Real Estate, Property Taxes Yield Very Little Revenue Property tax collection a. As percent of GDP, by region b. As percent of total tax revenue, by region Percent Percent 3.5 14 12.8 2.9 3.0 12 2.5 10 2.0 8 1.5 6 1.0 0.8 0.8 3.0 3.4 4 2.4 2.8 0.4 0.5 0.5 0.1 2 0.6 0.0 0 Latin Europe East Asia Sub- North Middle Latin Europe East Asia Sub- North Middle America and and Saharan America East and America and and Saharan America East and and Central Pacific Africa North and Central Pacific Africa North Caribbean Asia Africa Caribbean Asia Africa c. As percent of total tax revenue, by LAC country Percent 9 7.9 8 7 6 5.0 4.5 4.7 5 4.0 4 2.9 3.0 2.5 2.4 3 2 1.2 0.7 0.5 1 0 Antigua Argentina Bahamas Barbados Belize Bolivia Brazil Chile Colombia Costa Dominican Ecuador and Rica Republic Barbuda Percent 6 5.0 5 4 3 2.5 1.9 1.7 1.8 1.7 1.5 2 1.4 1.1 0.8 1 0.4 0.1 0.1 0 El Salvador Guatemala Guyana Honduras Jamaica Mexico Nicaragua Panama Paraguay Peru Saint Trinidad Uruguay Lucia and Tobago Sources: World Bank staff calculations using OECD Global Tax Revenue Database and World Bank data. Note: Social security revenues are excluded from total tax revenues. Consolidated government statistics. GDP-weighted regional averages. LAC = Latin America and the Caribbean. Indeed, LAC’s adjusted real estate revenue—the difference between the predicted value as a share of GDP given real estate wealth and actual collections—illustrates the paradox: LAC countries (except for Uruguay) tend to collect “too little”—about 30 percent less than what would be expected based on the relevance of wealth (figure 2.9, panels a and b). The adjusted revenue tends to increase with the level of development, but LAC is largely below trend (panel c). Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 71 Figure 2.9 LAC Countries Tend to Collect Too Little Real Estate Tax Given the Prominence of Real Estate Wealth Estimates of overtaxation and undertaxation in real estate a. Adjusted real estate tax revenue, by region Difference between real and predicted value as a share of GDP 0.7 0.6 0.6 0.5 0.4 0.3 0.3 0.2 0.1 0 -0.1 -0.2 -0.3 -0.2 -0.3 -0.4 LAC Eastern Europe GIPS Rest of OECD b. Adjusted real estate tax revenue, by country Difference between real and predicted value as a share of GDP 2 1.5 1 0.5 0 -0.5 -1 Colombia Lithuania Austria Estonia Slovak Republic Mexico Slovenia Germany Korea Chile Hungary Portugal Norway Spain Finland Poland Uruguay Italy Belgium Latvia Australia Denmark New Zealand Greece France United Kingdom United States Canada LAC Eastern Europe GIPS Rest of OECD c. Relationship between real estate tax collection and wealth Real estate tax collection as a share of GDP, expressed in logarithms 2.0 1.5 CAN GBR FRA USA 1.0 DNK NZL AUS BEL POL 0.5 GRC LVA URY ITA ESP 0.0 FIN CHL PRT HUN KOR COL -1.0 DEU SVN SVK NOR -1.5 EST LTU MEX -2.0 AUT -2.5 0.5 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 Real estate wealth as a share of GDP, expressed in logarithms LAC Eastern Europe GIPS Rest of OECD Linear (ALL) Sources: World Bank staff calculations using OECD 2022 and survey-based microdata. Note: Adjusted real estate revenue refers to the difference between the predicted value as a share of GDP given real estate wealth and actual collections. In panels a and b, GIPS = Greece, Italy, Portugal, Greece; LAC = Latin America and the Caribbean; OECD = Organisation for Economic Co-operation and Development. In panel c, data labels use International Organization for Standardization (ISO) country codes. Countries in Latin America and the Caribbean are shown in orange. Chapter 2: Taxing Wealth 72 Latin America and the Caribbean Economic Review October 2024 A recent analysis, using simulations for 2014, supports the significant potential for growth in property tax revenue collection in LAC.31 This potential is based on reasonable assumptions about the tax base (value of immovable property) and tax effort (tax rates, exemptions, and administration). Figure 2.10 presents the study’s findings in terms of actual revenue collection for 2014 as well as potential revenue collection, expressed in terms of GDP. While on average the actual property revenue reaches about 0.3 percent of GDP, its potential is estimated to be about 3 percent. Given that the average share of consolidated government expenditure in LAC is about 34 percent of GDP,32 and about 40 percent of it corresponds to subnational governments, this means additional financing could represent about 8 percent of consolidated expenditure and about 20 percent of subnational expenditure. Figure 2.10 There is Significant Potential for Growth in Property Tax Revenue in LAC Actual and potential revenues from property taxes in LAC: Simulations for 2014 Percent of GDP 6 5 4 3 2 1 0 Ecuador El Salvador Argentina Belize Bolivia Brazil Chile Colombia Costa Rica Guatemala Guyana Honduras Mexico Nicaragua Panama Paraguay Peru Uruguay Observed Potential Source: Ahmad, Brosio, and Jiménez 2019. Note: LAC = Latin America and the Caribbean. If LAC countries were to fully realize this kind of potential, the impact on their ability to finance public services, reduce poverty, and support a pro-growth tax reform agenda could be substantial. Additional revenues could be used to fund education, health care, infrastructure, and other essential services. Furthermore, these increased revenues could help reduce corporate taxes, excessively high personal income marginal rates, and other distortive types of taxation. Such a reduction would promote economic growth by encouraging investment and enhancing productivity. Anatomy of the Real Estate Tax in LAC: A Patchwork of Systems with a Serious Valuation Problem The roots of the paradox do not seem to originate in the tax rates themselves. As figure 2.11 shows, in the United States, a high real estate tax country, tax rates on residential properties range from 0.32 percent 31 Ahmad, Brosio, and Jiménez (2019). 32 Consolidated government expenditure refers to the total spending of all levels of government within a country. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 73 in Hawaii to 2.23 percent in New Jersey, and averaging 1.04 percent in all 50 states and the District of Columbia. In LAC, the rates range between 0.20 percent in Venezuela to 2.28 percent in Uruguay, averaging 0.91 percent in the entire region (all LAC countries), 1.43 percent in the Southern Cone, and 0.85 percent in Central America and the Caribbean. Figure 2.11 Property Tax Rates in LAC Countries Are Within the Range of US States Average residential property tax rates Percent 2.5 2.0 1.5 1.0 0.5 0.0 Ecuador Venezuela Costa Rica Hawaii Honduras Alabama Mexico Colorado Louisiana Wyoing South Carolina Utah West Virginia Nevada Peru Delaware DC Arizona Arkansas Idaho Mississippi New Mexico Tennessee Montana California Colombia Brazil North Carolina Kentucky Indiana Virginia Washington Oklahoma Guatemala Florida Georgia Bolivia Oregon Argentina North Dakota Nicaragua Paraguay Dominican Republic Missouri Alaska Maryland Chile Minnesota Massachusetts South Dakota Maine Kansas Michigan New York Rhode Island Pennsylvania Iowa Ohio Wisconsin Nebraska Texas Connecticut Vermont Panama New Hampshire Illinois New Jersey Uruguay LAC US states Sources: World Bank calculations based on Lincoln Institute, https://www.businessinsider.com/personal-finance/mortgages/property-tax-by-state#:~:text=For%20 the%20US%20as%20a,each%20year%20in%20property%20taxes. https://www.lincolninst.edu/data/property-tax-in-latin-america/. Note: For the United States, all 50 states and the District of Columbia are shown. LAC = Latin America and the Caribbean; US = United States. The problem lies rather in low and poorly calculated property valuation.33 Outdated cadastral systems (land ownership records) often struggle to keep pace with rapid urbanization and the emergence of informal settlements. This lack of accurate data makes it difficult to determine the true value of properties, leading to undervaluation and lower tax bills for landowners. Moreover, lower-priced properties are assessed at a higher proportion of their market value than higher-priced ones, increasing the regressivity in practice. For example, figure 2.12 shows that fiscal valuation in the City of Buenos Aires, Argentina, is, on average, only 18 percent of market value. This means that for a property with a market value of US$100,000, the fiscal valuation used to calculate property taxes might be only about US$18,000! Similar, although less dramatic, discrepancies exist in other LAC countries. Data from the Lincoln Institute suggest that property valuations in Chile were at 55 percent of market value in 2013, and in Colombia, they ranged from 45 percent to 60 percent in different localities in 2011. In contrast, Uruguayan property valuations were closer to 80 percent in Montevideo, potentially explaining the higher adjusted value there. In the United States, fiscal property valuations typically range between 80 percent and 90 percent of market value. 33 Bahl and Martinez-Vazquez (2008); Norregaard (2015). Chapter 2: Taxing Wealth 74 Latin America and the Caribbean Economic Review October 2024 Figure 2.12 Fiscal Valuations Are Very Low on Properties in Buenos Aires Fiscal valuation estimate, as percent of market value, in Buenos Aires, by neighborhood, 2018–21 Percent 35 30 25 20 15 10 5 0 Villa Ortuzar Nuñez Belgrano Almagro Flores Barracas Saavedra Agronomía Parque Chacabuco Constitución Caballito Monte Castro Villa Duro Colegiales Villa Real Villa Crespo Mataderos Cohlan Palermo Boca Balvanera Versalles Villa Devoto Boedo Chacarita San Cristobal San Telmo Parque Patricios Villa del Parque Floresta Liniers Villa Urquiza Velez Sarsfield Parque Chas Nueva Pompeya Parque Avellanada Monserrat Villa General Mitre Paternal Villa Pueyrredon Villa Lugano Puerto Madero Villa Santa Rita San Nicolas Recoleta Retiro Source: Castano et al. 2024. Note: The fiscal valuation of the properties was imputed based on the tax code and the tax law of the autonomous City of Buenos Aires. Information from Properati publications was used. In the case of missing information in the publications, estimates were built at the neighborhood level with data from the cadastral system of the City of Buenos Aires. Reliance on Presumptive Taxes Attempting to more solidly ground property valuations, many LAC countries have turned to presumptive taxes as a tool to generate revenue from the real estate sector. Presumptive taxes are a type of indirect tax levied to estimate property value based on proxies like size, location, and property type. In the context of real estate taxation, these assumptions might be based on factors such as: • Property size. While property size (that is, square footage) is a common approach for presumptive real estate taxes, it raises concerns. Larger properties are generally assumed to be more valuable, but this can be inaccurate and inequitable. A small, luxurious condo packed with amenities might be worth more than a sprawling, outdated house. Similarly, warehouses with vast square footage used for storage might be taxed heavily despite generating lower rental income compared to a smaller, well-located office space. • Location. Properties in prime locations are presumed to be more valuable than those in less desirable areas. Location is another factor used in presumptive taxes, but it has its own conceptual issues. Defining “prime location” can be subjective. Up-and-coming areas or those with unique features might be undervalued. Furthermore, what is desirable can change over time. A formerly neglected area might become trendy, rendering the initial location-based tax unfair. • Type of property. Presumptive real estate taxes often differentiate between residential and commercial properties, but this simplicity masks complexity. Income generation and societal impact vary widely within both categories. A small, thriving store earns more than a vast warehouse, and residential housing serves a different purpose than commercial spaces that create jobs. A recent study provides a detailed breakdown of some of the most common presumptive taxes used in LAC, EMDEs, and advanced economies. Box 2.2 summarizes this study. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 75 Box 2.2 Unpacking the Presumptive Tax The design of real estate taxes in Latin America and the Caribbean is quite complex.a From a theoretical point of view, the tax should be designed to account for the fiscal valuation of the property and a specific tax rate,b regardless of whether the goal is to tax house consumption or housing as an asset. In any case, the valuation should encompass the flow of consumption or cash involved. Then, if valuations are accurate, all complexity would stem from the tax rate itself. Ultimately, only equity concerns would justify variations between tax rate brackets. Assuming valuations are accurate, there is no need for deviations from simple tax schedules. In fact, variations from these plans could be associated with some form of government intervention and evidence of favoritism for vested interests. More specifically, industrial or urban policy might be behind the overly complex structures found in the tax design. Castano et al. (2024) assessed the tax design in Argentina, Brazil, Chile, Colombia, and Mexico. The study considered 43 entities from different levels of government (central/federal, regional/ state, and local) and found that 10 of them differentiate between urban and rural areas; 6 governments include land size as a dimension of the design; 29 entities consider what purpose the property is used for (such as industrial, commercial, or residential); and 9 target duties by zones. One local government in Colombia considers the environmental impact of the properties. The Brazilian national government takes into account the share of the land used for specific activities. Other countries use alternatives in addition to, or as a substitute for, fiscal valuation. However, advanced economies use fewer of these dimensions. Indeed, the authors find that land use is the only method commonly used in these countries. All the entities reviewed from France, Japan, the Republic of Korea, Spain, and United Kingdom included land use in their design. So did the Philippines, South Africa, and four out of five entities in New Zealand. Nevertheless, other dimensions were rare in these countries. Table B2.2.1. summarizes these stylized facts. Table B2.2.1 The Nature of Property Valuation is Very Complex in LAC Countries Elements of real estate tax design a. Latin America and the Caribbean Level of Urban/ Services Country # Entities Land Size Land Usea Impact Utilization Zones Government Rural available Central Argentina Regional/State 7 6 2 4 0 0 0 0 Local 4 0 0 4 0 0 2 0 Central 1 _b 1 0 0 1 0 0 Brazil Regional/State 1 _b 0 1 0 0 0 0 Local 8 _b 0 8 0 0 2 0 Central 1 0 0 1 0 0 0 0 Chile Regional/State Local 7 0 0 0 0 0 0 0 Chapter 2: Taxing Wealth 76 Latin America and the Caribbean Economic Review October 2024 Level of Urban/ Services Country # Entities Land Size Land Usea Impact Utilization Zones Government Rural available Central Colombia Regional/State Local 5 2 1 5 1 0 5 0 Central Mexico Regional/State 1 0 0 1 0 0 0 0 Local 7 2 2 5 0 0 0 0 b. Rest of the world Level of Urban/ Services Country # Entities Land Size Land Usea Impact Utilization Zones Government Rural available Central 1 1 0 0 0 0 0 0 Egypt, Arab Regional/State Rep. Intermediate Local Central Regional/State 1 0 1 0 0 0 0 0 France Intermediate 10 0 0 10 0 0 2 0 Local 223 0 0 223 0 0 0 0 Central 1 0 0 1 0 0 0 0 Regional/State 0 0 0 0 0 0 0 Korean, Rep. Intermediate Local 0 0 X 0 0 0 0 Central Regional/State 1 0 1 1 0 0 1 0 Japan Intermediate Local 3 0 3 3 0 0 0 0 Central New Regional/State 3 2 0 2 0 0 3 3 Zealand Intermediate Local 2 1 0 2 0 0 0 2 Central Regional/State 1 0 0 1 0 0 0 0 Philippines Intermediate 3 0 0 3 0 0 0 0 Local Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 77 Level of Urban/ Services Country # Entities Land Size Land Usea Impact Utilization Zones Government Rural available Central Regional/State South Africa Intermediate Local 5 0 0 5 0 0 0 0 Central Regional/State Spain Intermediate Local 4 4 0 4 0 0 0 0 Central United Regional/State Kingdom Intermediate 3 0 0 3 0 0 0 0 Local 15 0 0 15 0 0 0 0 Source: Castano et al. 2024. Note: C/F = central/federal government; L = local government; R/S = regional/state government. Notes: a. Includes undeveloped land. b. Urban/rural divided by the level of government. The lack of robust property price assessment capabilities appears to be the main driver of the complicated nature of property valuation in LAC countries. Some of the tools, such as those targeting the impact of real estate or specific zones, likely represent a form of intervention in private decisions. However, most of the special elements used in taxation seem to be a way to compensate for weak valuations. Because comprehensively updating valuations is a costly endeavor, utilizing alternative data points could be a relatively objective appraisal mechanism (or at a least not overtly arbitrary one). In any case, improving administrative capabilities to assess valuations regularly and properly is key to a simpler and clearer tax design. Ultimately, this would be central to achieving fairer and more predictable property taxation. Summing up, better valuations would result in avoiding hidden assumptions within the tax system (that is, de facto presumptive taxation). Notes: a. This box is based on Castano et al. (2024). b. Mirrlees (2011). Presumptive property taxes, while useful for increasing government revenue, often lag real estate market trends, leading to significant inaccuracies, inequities, and potential distortions in investment. To address these challenges, enhancing their fiscal valuation systems becomes a priority for LAC governments. A study conducted in Buenos Aires demonstrated that increasing property tax payments through higher fiscal valuations did not have a significant impact on rents, suggesting that this approach is both effective and neutral on renters (box 2.3). Chapter 2: Taxing Wealth 78 Latin America and the Caribbean Economic Review October 2024 Box 2.3 Do Higher Property Taxes Raise Rents: Evidence from Buenos Aires Anecdotal evidence in the literature on the real estate tax suggests that the tax on immobile properties has few distorting effects on the economy in general.a Even quantitative evidence is quite ambiguous regarding its effects on directly related variables, such as the price of the associated properties. For the most part, the empirical literature analyzes cases of cities in developed countries due to the availability of administrative data. Overall, little is known about the impact of the real estate tax in developing countries. To address this scarcity of evidence, Castano et al. (2024) analyzes the effect of real estate taxes on the sale and rental value of properties in the City of Buenos Aires, Argentina. Using a difference-in-differences quasi-experiment approachb and unexplored data, they study variations in the effective tax rate that are usual in Argentina due to uneven yearly reassessments of taxes in a context of high inflation. The quasi-experimental design relies on the fact that, before each year begins, the City of Buenos Aires passes the yearly tax law, specifying changes in tax rates and other variables that modify the real estate tax base. The authors leverage a novel database from Properati, a real estate marketplace specializing in listings across Argentina, Colombia, Ecuador, Peru, and Uruguay.c The data cover listed properties, both for rent and sale, between 2018 and 2021. They include listed price, date, location, and property characteristics (such as area and number of rooms). Some listings include more details. The tax liability is also calculated based on a formula that multiplies the tax base by the tax rate. The tax base is constructed from observable data—such as location and area—with assumptions made about depreciation and construction quality (the latter is based on economic household survey data). Tax rates are obtained from the yearly tax law. On average, the tax rate for residential property in the City of Buenos Aires is about 0.55 percent, ranging between 0.4 percent and 0.7 percent progressively with property values. In Argentina, while rental prices are typically listed in Argentine pesos, sales are usually agreed upon in US dollars. Using a difference-in-differences approach, the authors estimate the impact of changes in tax liability on sale prices per square meter. In the first analysis, properties with a tax increase— defined as a percentage increase from the previous year’s tax liability—exceeding the median were classified as the treated group. Properties with an increase below the median formed the control group. Additional tests were run using properties exceeding the 75th percentile as the treated group and those below the 25th percentile as the control group. Figure B2.3.1 depicts the results for this initial analysis, showing rental before and after the change in tax rate. The horizontal axis displays months, with the lower axis corresponding to calendar months (where -5 represents July) and the upper axis centered on December (0), which is when the tax bill is approved. Data for the three years considered were combined, but additional tests were run analyzing each year separately. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 79 Figure B2.3.1 An Analysis of Properties in Buenos Aires Found No Direct Impacts of Higher Real Estate Taxes on Rental Prices Evolution of prices per square meter Housing rentals Rent prices per square meter (constant AR$ 2015) 230 220 210 200 190 180 170 160 150 140 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Control Treatment Source: Castano et al. 2024. Note: The bottom row of numbers in the x-axis correspond to calendar months, staring with July (-5) and proceeding to June of the following year (6). The top row is centered on December (0), when the City of Buenos Aires passes a tax law each year. Castano et al. (2024) found no direct impact of higher real estate taxes on rental prices. While one might expect this to translate to lower sale prices due to a decrease in cash flow—from an increase in taxes without an increase in rents—the study also found no significant effect on sale prices. It is important to note that listing prices typically involve negotiation unlike rents, which are often fixed. This bargaining process might be masking a potential impact on sale prices. The no-effect results are likely a consequence of low effective rates. When property taxes are a small burden on property ownership, any distortions they introduce into the market are likely to be minimal. Imagine a scenario where property taxes constitute only a small percentage of rental income. Landlords would still have a strong incentive to rent their properties, and tenants would not be significantly deterred by the small increase in rent due to taxes. This would minimize any potential dampening effect on rental prices or property values. This evidence suggests that rising property fiscal liabilities, particularly when starting from a low level of taxation, have minimal impact on either sale prices or rents in the real estate market. Notes: a. This box is based on Castano et al. (2024). b. As in Elinder and Persson (2017) and Löffler and Siegloch (2011). c. The data were collected during a small time window when they were available. Nowadays, data are not open. Chapter 2: Taxing Wealth 80 Latin America and the Caribbean Economic Review October 2024 Using New Technologies for Better Valuation Traditional methods of property valuation struggle to keep pace with the dynamic nature of real estate markets. Fortunately, technological advancements offer a powerful toolkit to address this challenge. The discussion that follows take a deeper dive into how leveraging digital platforms and modernizing cadastre systems can unlock the untapped potential of property valuation. Leveraging digital platforms. Real estate websites like Zillow and Trulia are not simply listing services; they are treasure troves of real-time market data. These platforms aggregate information on property listings, recent sales trends, and neighborhood demographics. By harnessing this data through Application Programming Interfaces (APIs) or web scraping techniques, governments can gain valuable insights for several purposes: • Comparative analysis. Digital platforms provide a vast pool of similar properties, allowing for a more accurate assessment of an individual property’s value based on comparable features, location, and recent sales. This approach goes beyond simply looking at size and location, leading to a more nuanced and accurate valuation. • Identifying discrepancies. Data integration can reveal properties where the assessed value significantly deviates from market trends. This can be a red flag for potentially undervalued and undertaxed properties. By analyzing these discrepancies, governments can identify areas where valuations need to be adjusted, ensuring a fairer and more equitable tax system. • Staying on trend. Real-time data allow governments to track market fluctuations and adjust valuation models accordingly. This ensures valuations remain relevant and reflect current market conditions. For example, if a particular neighborhood experiences a surge in property values due to new development, the valuation model can be adjusted to capture this increase, ensuring property taxes accurately reflect the current market price. Modernizing cadastre systems. Traditionally, cadastre systems relied on paper records and manual data entry—a recipe for inaccuracies and inefficiencies. But modernizing them with digital tools like Geographic Information Systems (GIS) is a game-changer.34 Here is how: • Digital mapping. GIS technology can produce a digital map that integrates property boundaries, zoning information, and infrastructure data, enhancing transparency and facilitating property identification and valuation. Officials can easily visualize property locations, zoning restrictions, and nearby amenities, all of which influence a property’s value. • Boosting data collection. Mobile data collection tools can streamline the process of gathering property details, ensuring data accuracy and reducing reliance on outdated records. Appraisers can use tablets to capture property features like square footage, number of bedrooms, and presence of a garage. This eliminates the need for manual data entry and reduces the risk of errors. • Improving data-sharing. Modern cadastre systems can establish secure data-sharing protocols with other government agencies, fostering better coordination and a more holistic view of property information. For example, data can be shared with building departments to ensure property characteristics align with construction permits, or with tax departments to streamline the tax assessment process. 34 Enemark (2010). Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 81 The World Bank has been actively involved in helping countries in LAC modernize their cadastre systems. These initiatives have focused on digitizing land records, implementing modern land registration systems, strengthening land administration institutions, and promoting land tenure security. As a result, these efforts have significantly enhanced land governance, reduced land conflicts, fostered economic development, and increased revenue collection, particularly through property taxes.35 Box 2.4 demonstrates how the determined efforts of local authorities in Bogotá and Barranquilla, Colombia, led to significant improvements in the property registry in a remarkably short time. Increased transparency in registration practices enabled these cities to achieve significant increases in local revenues and conduct a more accurate assessment of city developments. This, in turn, has facilitated effective policies related to urban planning, investment, construction, and the purchase and sale of land and real estate in these cities.36 Box 2.4 Property Registry Success Stories: Lessons from Bogotá and Barranquilla Catastro Bogotá and Barranquilla, Colombia, represent best practice examples of cadastral reforms demonstrating the potential for such initiatives to drive significant improvements in property administration systems. Its innovative approaches and significant achievements could serve as a model for other cities and countries in LAC seeking to enhance their own cadastral systems and reap the associated benefits. Bogota’s Revolution: A Map to a Brighter Future Catastro Bogotá, established in 1959, was Colombia’s first decentralized cadaster. Originally a department of the city’s Finance Secretariat, it has since evolved into a vital entity reporting to the tax administration sector. In 2010, Catastro Bogotá initiated a permanent update process focused on urban areas. This update proved highly successful, expanding the cadastral database from 1,279,000 to 2,181,000 plots in just two years. The taxable value for property tax increased by 42 percent during this period, reaching 280 trillion pesos. To enhance data quality and correlation with registry information, Catastro Bogotá underwent a major technological transformation in 2016. This modernization allowed for a shift from intensive fieldwork to a more efficient model relying on secondary sources like the SNR database. This approach has led to significant cost savings and improved accuracy. By leveraging registry data, Catastro Bogotá has been able to identify 75 percent of built areas, particularly new horizontal properties, and streamline conservation procedures for 60 percent of annual requests. Catastro Bogotá has evolved from a purely fiscal cadaster to a multipurpose resource. It now provides valuable information to various entities in Bogotá, supporting decision-making in areas such as infrastructure management, risk management, and property formalization. 35 World Bank (2013). 36 This box was put together with original work shared by Urban Team at the World Bank: Dean Cira, Paula Restrepo Cadavid, Ivonne Moreno Horta, and Alvaro Barra. Chapter 2: Taxing Wealth 82 Latin America and the Caribbean Economic Review October 2024 In terms of fiscal performance, property tax revenue in Bogotá has increased by 142 percent in the last decade. This growth has made property tax the second most important tax source after the ICA tax, a municipal tax imposed on businesses that operate within the city. The ICA tax, which has seen a 62 percent increase during the same period, remains the city’s primary tax revenue source. Revitalizing Barranquilla: The Role of Cadastral Modernization Barranquilla, Colombia, has also emerged as a model for effective cadastral management in the country. Prior to 2017, the city relied on the national cadastral agency, IGAC, for these services. However, recognizing the need for greater autonomy and improved efficiency, Barranquilla assumed direct control of its cadastral management. To modernize its cadastral system, Barranquilla invested heavily in technology. It developed its own proprietary information system, “Iguana,” which integrates alphanumeric and graphic data, enabling efficient data collection and analysis. The city also prioritized the cross-referencing of cadastral and land registry databases, increasing their interconnection from 45 percent in 2018 to 65 percent in 2022. Barranquilla has focused on making cadastral information accessible to citizens. It launched the “Easy Cadaster” platform for online inquiries and the “Virtual Cadaster” tool for requesting and tracking cadastral procedures. Additionally, the city created the “Ubibaq” Map Portal, offering a comprehensive view of cadastral information, land use plans, and other city services. By taking control of its cadastral management, Barranquilla achieved significant improvements in efficiency and revenue generation. The city’s cadastral update process was accelerated, leading to a 100 percent updated base in 2022. This modernization contributed to a 26 percent increase in property tax collections in 2018 alone. Barranquilla’s cadastral system now serves as a valuable resource for various city departments. It supports decision-making in areas such as urban planning, infrastructure management, and risk assessment. The system also provides data for the Real Estate Observatory, which offers insights into market trends and property values. Prioritizing the property’s substantive value over market whims. Policy makers may overemphasize the concept of accurately assessing property values for tax purposes. Given the inherent medium-term volatility of real estate markets, pinning down an exact market value at any given moment is a challenging, if not futile, exercise. Asset prices, including property values, fluctuate significantly due to factors beyond simple cash flow changes.37 This suggests that property tax assessments could reasonably focus on capturing a fair approximation of long-term value rather than attempting to mirror short-term market fluctuations. More 37 See discussion in Aguiar, Moll, and Scheuer (2024). Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 83 modest improvements in valuation accuracy, rather than a pursuit of perfect alignment with market prices, could yield substantial benefits for revenue generation without imposing undue burdens on property owners How Property Taxes Can Help Reduce Vertical Fiscal Imbalance LAC exhibits an unusual degree of what is called vertical fiscal imbalance, the mismatch between the revenue- raising capacity of subnational governments and their expenditure responsibilities. The resulting reliance on fiscal transfers from higher levels can create a moral hazard problem: local officials may be less inclined to exercise fiscal restraint because they know that taxpayers in other jurisdictions actually bear the burden of their spending decisions. Moreover, this vertical imbalance can create “rent-seeking” behavior, where local officials prioritize short-term gains and political popularity over long-term fiscal sustainability. For instance, they may engage in excessive spending on populist programs (including excessive public employment) or infrastructure projects that are not financially viable, leading to unsustainable debt levels. The lack of fiscal autonomy can also weaken accountability and incentivize local governments to engage in wasteful spending or corruption, as they may perceive a reduced risk of consequences. These political economy problems can undermine the effectiveness of subnational governance and hinder economic development. This section explores how subnational property taxes can be a tool to address this vertical fiscal imbalance.38 Public Spending Decentralization and Vertical Imbalance Public expenditure is typically distributed across different levels of government, including central/federal, state/provincial, and local levels. The type of expenditures associated with each level varies based on the country’s specific governance structure and policy priorities. Central governments typically handle national- level policies such as defense, security, foreign affairs, social security, and sometimes health care and education. State governments frequently oversee regional policies including transportation, infrastructure, environmental regulations, and sometimes education, health care, and police. Local governments (which include municipalities and cities) often manage local services such as public safety, waste management, parks, transportation, and other community-based services. Cities may have their own budgets for specific services such as street maintenance, libraries, and local events. The degree of public expenditure decentralization—defined as the share of total public expenditure conducted by subnational governments—varies significantly across countries (figure 2.13), including in LAC. Larger economies in the Southern Cone and the Andean region, as well as Mexico, tend to be more decentralized, often attributed to the complexity of managing public services in larger economies, as well as the need to address diverse regional needs and preferences more effectively and the greater capacity of subnational governments in those countries to do so. Smaller countries such as Panama, El Salvador, and Paraguay tend to be less decentralized, potentially due to the economies of scale associated with centralized service. In general, decentralization is greater in more advanced economies, perhaps reflecting a greater confidence in state/provincial and local governance and responsiveness. This is often supported by strong institutions, democratic governance, and a culture of civic participation, which can enhance the capacity and accountability of subnational governments, fostering a more decentralized and responsive system of public service delivery. 38 Also see discussion in Bird (2014) and Bird and Slack (2014). Chapter 2: Taxing Wealth 84 Latin America and the Caribbean Economic Review October 2024 Figure 2.13 LAC Countries Vary in the Degree They Devolve Public Expenditures to Subnational Governments Percent of public expenditures conducted by subnational governments Percent 70 60 50 40 30 20 10 0 El Salvador Ecuador Panama Paraguay Honduras Ireland New Zealand Luxembourg Guatemala Chile Portugal France United Kingdom Colombia Italy Peru Netherlands Iceland Mexico Austria Norway Germany Brazil Argentina Spain Belgium Australia Sweden North America Switzerland Denmark Canada LAC Advanced economies Sources: OECD Fiscal Decentralisation Database (most recent year 2021-2022) for OECD (excluding Latin America and Caribbean) countries; IMF Global Finance Statistics, Statement of Operations (most recent year 2020-2022) for Latin America and Caribbean countries. Note: LAC = Latin America and the Caribbean. Fiscal Federalism (Decentralization) is defined as total expenditure of the state and local governments, over total expenditure of all levels of government. Despite the varied levels of public spending decentralization across the LAC region, the region exhibits a high degree of vertical fiscal imbalance, unlike advanced economies, as illustrated in figure 2.14. This imbalance, measured as the share of a subnational government’s revenue originating from central government transfers, highlights the heavy reliance of subnational governments in LAC on such transfers. Figure 2.14 The Vertical Fiscal Imbalance Is Larger in LAC Countries than in Advanced Economies Percent of subnational governments’ revenue originating from central government transfers Percent 120 100 80 60 40 20 0 Ecuador El Salvador Sweden Iceland Denmark Spain Italy Germany Canada France Luxenbourg Switzerland Norway North America Portugal Belgium United Kingdom New Zealand Austria Ireland Chile Brazil Netherlands Panama Australia Honduras Colombia Argentina Paraguay Guatemala Mexico Peru LAC Advanced economies Sources: OECD Fiscal Decentralisation Database (most recent year 2021-2022) for OECD (excluding Latin America and Caribbean) countries; IMF Global Finance Statistics, Statement of Operations (most recent year 2020-2022) for Latin America and Caribbean countries. Note: LAC = Latin America and the Caribbean. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 85 The Potential of Subnational Real Estate Taxes Subnational real estate taxes, levied by local governments on the value of land and property, can be a powerful tool to help mitigate vertical fiscal imbalance, particularly in LAC. Here is how: • Enhanced revenue generation and reduced reliance on transfers. As discussed, real estate taxes are a reliable source of revenue for local governments. By increasing their own revenue base, subnational governments in LAC can lessen their dependence on national transfers and gain greater autonomy in managing their finances. This can allow them to become more responsive to local needs and priorities, fostering a sense of ownership and accountability. • Greater accountability. When citizens in LAC see a direct link between the value of their property and the level of local services provided, it can foster a sense of accountability between taxpayers and the government. This can encourage responsible spending and efficient service delivery by local authorities. While subnational real estate taxes offer potential benefits, there are also considerations and challenges to navigate:39 • Equity concerns. Real estate taxes can be regressive, meaning they place a higher burden on low- income earners who may own less valuable properties. Careful design and implementation of exemptions or tiered tax rates can help mitigate this concern. • Administrative capacity. Effective administration of property taxes requires a robust system for property valuation and collection. This can be a challenge for local governments in Latin America and the Caribbean with limited resources. Investments in technology and training for property assessors can improve efficiency and accuracy. • Coordination between jurisdictions. To avoid distortions and ensure fairness, coordination among neighboring localities regarding real estate tax rates and policies may be necessary. This can help prevent residents from moving to areas with lower tax rates, thereby eroding the tax base for all municipalities. Subnational real estate taxes, when implemented thoughtfully, can be a valuable tool for promoting fiscal decentralization and reducing vertical fiscal imbalance in LAC, by empowering local governments to generate their own revenue and make independent spending decisions. Despite the challenges, subnational real estate taxes hold significant promise for fostering a more equitable and responsive system of public finance in LAC. By addressing equity concerns, strengthening administrative capacity, and fostering coordination between jurisdictions, these taxes can empower local governments to become more effective agents of development and improve the overall well-being of their citizens. 39 See Bird (2014); Bird and Slack (2014); Kelly, White, and Anand (2020). Chapter 2: Taxing Wealth 86 Latin America and the Caribbean Economic Review October 2024 How Rural Land Tax Can Help with Environmental Protection This chapter has argued that shifting to property taxes could lead to efficiency gains by lightening the burden on entrepreneurs and penalizing inefficiently used wealth such as land. An example is the rural land tax, a levy imposed on the value of unimproved land in rural areas. It can be a promising tool for environmental stewardship by incentivizing sustainable land use practices, which in turn could mitigate deforestation and preserve biodiversity. Historically, land taxation has deep roots, dating back to ancient civilizations. The Roman Empire, renowned for its administrative prowess, implemented a comprehensive land taxation system. The tributum soli, a direct tax on land ownership, formed a cornerstone of Rome’s fiscal structure, generating revenue and playing an organization role in the rural sector.40 The concept reemerged with vigor during the Enlightenment, when philosophers and economists, grappling with the complexities of industrialization and inequality, explored alternative tax models. Henry George, in particular, became a prominent advocate for land value taxation, arguing that land, as a finite resource, should be the primary object of taxation rather than labor or capital.41 His ideas sparked intense debate and influenced subsequent land tax reforms in various countries. Contemporary applications of rural land tax vary across countries. South Africa integrates it into broader land reform agendas, while in Australia, it has been employed to fund environmental protection efforts. The efficacy of a rural land tax in this sphere hinges on several core principles. Primarily, it disincentivizes land hoarding, encouraging owners to utilize their land productively or divest.42 By imposing a higher tax burden on idle or degraded land, it incentivizes farmers to adopt methods that improve soil health, reduce erosion, and enhance biodiversity.43 This mechanism can deter large-scale land acquisitions for speculative purposes, often linked to deforestation and habitat loss. Secondarily, the generated tax revenue can be directly channeled into environmental programs, such as reforestation, watershed management, and biodiversity conservation. Hence, land taxes can lead to toward more sustainable agriculture and bolster ecosystem services while ensuring long-term agricultural productivity. A unit tax on land can promote sustainable land use as it will prevent the acquisition of any land with a marginal productivity below the tax rate.44 This is particularly the case if land can be appropriated by clearing and cultivating open-access forest area. Box 2.5 argues that, with important modifications, Brazil’s rural land tax can offer a promising avenue for addressing deforestation and promoting sustainable land use. 40 Rostovtzeff (1957). 41 George (1879). 42 Turner (2012). 43 Pretty (2001). 44 In this context, a “unit tax on land” refers to a tax levied based on the physical size or unit of land, rather than its value. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 87 Box 2.5 Brazil’s Land Tax: A Tool for Conservation The rural land tax currently applied in Brazil, the Imposto sobre a Propriedade Territorial Rural (ITR), incentivizes the conversion of forest land toward extensive cattle ranching—which is classified as a productive use, resulting in very low tax rates. Changing the parameters of the tax to reward the adoption of sustainable practices and the efficient use of areas that can be farmed or ranched would help foster climate-smart agriculture while reducing incentives toward deforestation of additional land.a The rural tax base in Brazil is underutilized. The current ITR is ineffective as a revenue source. It produces very little revenues: in 2022 federal and municipal governments jointly collected R$3.1 billion (US$0.6 billion, equivalent to 0.03 percent of GDP). Thus, rural land remains an underused tax base, failing to generate meaningful revenue, especially for rural municipalities that lack other significant tax bases.b The effective tax rate, using the estimated market value of rural land, is about 0.03 percent, implying that wealth held as rural land is considerably undertaxed compared to other factors of production, especially labor. The average tax per hectare of privately owned rural land is only about R$6.2 (US$1.20), limiting its effectiveness to incentivize efficient and climate-friendly land use. The current tax design is counterproductive for incentivizing conservation or efficient land use. The design of the ITR is flawed. The current ITR applies to all rural properties above a minimum size and is assessed on the value of unimproved land (not the actual market value) which is self- declared, leading to widespread underdeclaration. The tax rate can vary from 0.03 percent to 20 percent, rising with the size of the property and declining with the percentage of property being used productively. For example, a property between 500 and 1,000 hectares that uses at least 80 percent of useable land (excluding legally mandated conservation areas and other forested areas) is subject to an annual tax of 0.15 percent of the self-assessed value. To be considered in use, pastureland requires a minimum stocking rate. However, these rates, expressed in animals per hectare, are very low, ranging from 0.15 in some Amazonian municipalities to a maximum of 0.9 in much of the South and Southeast of Brazil. This implies that extensive cattle ranching, a very inefficient use of land associated with high agricultural emissions and deforestation, is consistent with a low ITR tax rate. From Disincentive to Incentive: How Reforming the ITR Can Address Deforestation and Land Productivity A reform of the ITR should change the assessment of the tax base as well as the rate assessment. The Brazilian Constitution assigns both fiscal and para-fiscal objectives to the ITR, though it does not explicitly name environmental objectives. Several detailed reform proposals have been put forward to make the tax more effective as a source of revenue as well as for incentivizing efficient land use and conservation.c These proposals all include some key features: Chapter 2: Taxing Wealth 88 Latin America and the Caribbean Economic Review October 2024 • Use an estimate of market value of land, rather than self-declared unimproved land value. This would provide an important incentive to municipalities to participate in administering the tax, as they would directly benefit from greater tax revenue that would result from more realistic valuations. • Apply a minimum rate to all land that is not under permanent protection, including forested land. While applying a minimum tax to standing forest seems counterintuitive, this reduces the incentive to acquire forest land for speculative purposes, with the option to deforest it in the future. To avoid this minimum tax, landowners would need to commit to protecting their forest land permanently (by creating an Área de Preservação Permanente, APP). • Increase the tax rate with the size of the property, though the extent of this progressivity would depend on the policy maker’s preferences regarding concentration of land ownership. • Increase the tax rate on inefficiently used pastures. The criteria for considering a property productive or unproductive, including cattle stocking rates, should be set in line with current agricultural practices. • Ensure consistency with environmental regulations, especially the forest code and the environmental rural cadastre. The impacts of a land tax reform on emissions could be significant. A 2014 study estimates that a tax linked to intensity of land use for cattle could result in a 61 percent reduction in deforestation as the intensification of cattle ranching reduces demand for land.d Intensification of cattle ranching would also reduce emissions from agriculture—mostly methane—because animals tend not to live as long and ranchers can supplement feed or switch from grass-fed ranching to using animal feed that reduces bovine methane emissions. A more effective land tax could reduce the dependency of rural municipalities on transfers. Due to the negligible yield of the ITR, municipalities currently have little incentive to cooperate in collection of the tax. A more robust tax could become an attractive own source of revenue for rural municipalities, which currently rely almost exclusively on federal and state transfers. A more effective land tax would also strengthen the case for an environmental fiscal transfer to compensate municipalities for revenue forgone from protected areas. A general land tax reform could be complemented with a payment for environmental services or fee-bate scheme to encourage forest protection and restoration. Given the government’s pledges to eliminate illegal deforestation by 2030 and restore 12 million hectares of forests and 15 million hectares of degraded pasture, part of the additional revenue from the land tax could be used to provide a subsidy for landowners, especially those at the forest-agriculture frontier, for restoring forests or restoring degraded pastureland (through reforestation, and/or implementation of sustainable productive systems such as agroforestry and integrated agro- livestock-forest systems). Such a subsidy could be combined with the ability to claim carbon offsets based on carbon sequestration under Brazil’s proposed Emissions Trading System (ETS). Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 89 Formal and transparent land tenure systems are a prerequisite for effectively levying the land tax and engaging in other land-based policies. Land governance remains a challenge in Brazil, especially in the Amazon biome, with vast territories not formally registered or subject to several, disputed claims. Problems stem from the overlapping functions of government agencies and inconsistent regulations. For example, five different federal entities handle the registration of different land tenure categories.e They do not coordinate with the multiple state and municipal agencies that have overlapping mandates and manage separate and disconnected databases. The limited interoperability between rural cadastres and urban cadastres and of these with respect to tax administrations at all levels of government undermines the effectiveness of fiscal policies based on land administration—as standardized, updated, and interoperable cadastral information on public and private lands is a basic requirement for consistent land use policies. These complexities, along with antiquated, inefficient, and untransparent (often paper-based) administrative and judicial processes, facilitate illegal land grabbing and encroachment of cattle ranching on public or undesignated land, which is a key driver of deforestation. Establishing formal and transparent land rights through a land registry has been shown to increase agricultural investments as well as sustainable land use practices. This will require setting up a robust institutional and technical infrastructure to use data from multiple sources effectively. Notes: a. This box builds upon key input from Cornelius Fleischhaker (Senior Economist, ELCMU), drawing from Fendrich et al. (2022). b. By contrast, the urban property tax (IPTU) generates about 0.6 percent of GDP in municipal revenue; however, this is highly concentrated in large cities. c. These proposals are described in detail in Appy (2015); Instituto Escolhas (2019); and Fendrich et al. (2022). d. Cohn et al. (2014). e. The most important land cadastre in Brazil is the Cadastro Nacional de Imóveis Rurais (CNIR), created by Law 10.267 of 2001 and which is based on data from the Sistema Nacional de Cadastro Rural (SNCR) (the system used by the Instituto Nacional de Colonização e Reforma Agrária, INCRA) and from CAFIR (the cadastre of rural real estate property administered by the Receita Federal do Brasil). Although there are provisions in Law 10.267 to strengthen the interconnection among institutions, interconnections remain weak due to use of different concepts, lack of standardization of data, and weak law enforcement. The Billion Dollar Question: Is Taxing the Ultra-Wealthy the Solution to LAC’s Fiscal Shortfalls? Brazil has made headlines as Chair of the G-20 in 2024, along with France, for proposing a “billionaire tax” on the world’s richest citizens. Though the equity rationale is clear and the initiative enjoys substantial support, many of the challenges associated with taxing wealth, especially liquid assets, discussed earlier are amplified when targeting billionaires. These individuals often possess access to sophisticated financial advice and have greater mobility, making it difficult to impose and collect taxes effectively. The case of the founder of Mercado Libre, who moved from Argentina to Uruguay, illustrates how high-net-worth individuals can leverage tax differences to reduce their tax liabilities within the Latin American region (see box 2.6). In the Latin American context, such a tax, even if perfectly implemented, would not contribute much to reducing the region’s fiscal shortfalls. Chapter 2: Taxing Wealth 90 Latin America and the Caribbean Economic Review October 2024 Box 2.6 Why Might Argentine Entrepreneurs Move to Uruguay? A Deep Dive into Differential Taxes on Wealth Tax considerations weighed heavily in the decision of several notable entrepreneurs to relocate from Argentina to Uruguay. A comparative analysis of the tax regimes in both countries provides a clearer picture of the incentives driving this decision. Argentina’s tax environment. Argentina imposes a progressive income tax on both residents and nonresidents on income sourced within the country. Top marginal rates can reach as high as 35 percent. Additionally, Argentina levies a wealth tax, which is a significant burden for high- net-worth individuals. Moreover, the country’s complex tax system, frequent changes in tax legislation, and economic instability create an environment of uncertainty for taxpayers. Uruguay: A tax-friendly jurisdiction. Uruguay has strategically positioned itself as a tax-friendly jurisdiction, particularly for high-net-worth individuals and foreign investors. Key tax incentives include: • Territorial taxation. Uruguay primarily taxes income generated within its borders. This means that income from foreign sources is generally exempt from Uruguayan taxation. • Nonresident taxation. Nonresident individuals are subject to a flat income tax rate of 12 percent on income sourced in Uruguay. This rate is significantly lower than the progressive rates in Argentina. • Corporate income tax. Uruguay’s corporate income tax rate of 25 percent is competitive compared to other countries in the region. • Tax treaties. Uruguay has an extensive network of tax treaties, which help to prevent double taxation and facilitate cross-border investments. • Financial secrecy. While Uruguay has made strides in tax transparency, it still offers a degree of financial privacy that appeals to some high-net-worth individuals. All these features amount to strong incentives to relocate to Uruguay. Global Billionaire Spotting There are relatively few billionaires in the world. As shown in figure 2.15, the number of billionaires surged from 355 in 2001 to 2,615 in 2023. Given that the global population was approximately 8 billion in 2023, this equates to roughly 1 billionaire for every 3 million people. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 91 Figure 2.15 The Number of Billionaires Has Surged, but There Are Relatively Few Billionaires in the World Number of billionaires around the world 3,000 2,000 1,000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Source: Forbes World’s Billionaires List. Approximately 75 percent of all billionaires are primarily domiciled in ten economies: the United States; China; India; Germany; the United Kingdom; Russian Federation; Switzerland; Hong Kong SAR, China; Italy; and Singapore (map 2.1). The United States and China together house half, with 753 and 564 individuals, respectively. Map 2.1 LAC Has Relatively Few Billionaires in Absolute Numbers Number of billionaires, by country Num. of billionaires (600 - 800) (200 - 600) (100 - 200) (50 - 100) (30 - 50) (10 - 30) (5 - 10) (0.99 - 5) (0 - 0.99) Source: Forbes World’s Billionaires List. Chapter 2: Taxing Wealth 92 Latin America and the Caribbean Economic Review October 2024 Although LAC comprises 8.1 percent of the world’s population, 7.3 percent of global GDP, and 12.5 percent of the planet’s total land area, the region is home to only 82 billionaires across 12 countries (figure 2.16), representing a mere 3.1 percent of the global billionaire population. In contrast, the state of California alone hosts 100 billionaires, while the United Kingdom, Russian Federation, and Switzerland have 83, 80, and 78 billionaires, respectively. On a per capita basis (figure 2.17), while there are 2 billionaires per million inhabitants in North America (excluding Mexico) and 1 in Western Europe, this figure drops dramatically for EMDEs, including LAC, which averages only 0.13 billionaires per million people. LAC seems to underperform in billionaires, too! Figure 2.16 Billionaires are Concentrated in a Few Countries in LAC Number of billionaires in LAC, by country 50 40 30 20 10 0 Ecuador El Salvador Antigua and Barbuda Aruba Barbados Belize Bolivia Costa Rica Cuba Curacao Dominica Dominican Republic Grenada Guatemala Guyana Haiti Honduras Jamaica Nicaragua Panama Paraguay Puerto Rico Saint Maarten (Dich part) St. Kitts and Nevis Sta. Lucia St. Vincent and the Grenadines Suriname Trinidad and Tobago Venezuela British Virgin Island Colombia Turks and Caicos Island Uruguay Bahamas Bermuda Peru Cayman Island Argentina Chile Mexico Brazil Sources: World Bank calculations based on the Forbes World’s Billionaires List and World Bank World Development Indicators. Figure 2.17 LAC Has Relatively Few Billionaires Given its Population Number of billionaires per million people, by region 2.5 2.0 1.5 1.0 0.5 0 Sub- South Middle East and Latin America East Europe East Asia Western North Saharan Asia North and and and Pacific Europe America Africa Africa Caribbean Central Africa Sources: World Bank calculations based on the Forbes World’s Billionaires List and World Bank World Development Indicators. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 93 Latin America’s Modest Billionaires In addition, not all billionaires are created equal. LAC’s billionaires, while rich, are not spectacularly so by global standards. Elon Musk’s net worth hovers around $225 billion, followed by Jeff Bezos at approximately $190 billion, Mark Zuckerberg at $180 billion, and Bernard Arnault at $175 billion. In fact, the combined wealth of the top ten billionaires worldwide—nine of whom reside in the United States—totals an astounding $1.7 trillion, nearly equal to Brazil’s GDP, and almost triple that of Argentina. By contrast, the top ten wealthiest billionaires in LAC together collectively possess about $250 billion, or just over the wealth of the world’s richest person, and the region’s billionaires in total account for 5 percent of GDP, far below those of North America, South Asia, and Western Europe at 16 percent, 14 percent, respectively (figure 2.18). Figure 2.18 Billionaires in Other Regions Are Much Wealthier than Billionaires in LAC Total wealth of billionaires by region, expressed as percent of regional GDP, and number of billionaires per region Billonaries´worth (percent of GDP) 18 16 795 14 161 12 482 881 10 148 8 82 6 56 4 10 2 0 Sub-Saharan Middle East Latin America East Europe East Asia Western South North Africa and North and and and Pacific Europe Asia America Africa Caribbean Central Asia Sources: World Bank calculations based on the Forbes World’s Billionaires List and World Bank World Development Indicators. Note: The number of billionaires per region are included above each region’s bar. Is Taxing Billionaires the Silver Bullet for LAC’s Fiscal Problems? Again, the point is emphatically not that governments shouldn’t ask the best-off in society to contribute their fair share as society determines it. Rather, it is that given the low concentration of billionaires in LAC, combined with the relatively modest amount of wealth held by these highly mobile individuals, it is unclear whether a 2 percent wealth tax—a figure often proposed in policy circles—could generate significant additional government revenue. Figure 2.19 indicates that even assuming no billionaire migration, the potential revenue collection might reach 0.1 percent of GDP in LAC—triple the 0.35 percent figure in the United States. That is, it is unlikely to solve LAC’s fiscal space problems and if star entrepreneurs migrate the overall economic impacts could be smaller. Chapter 2: Taxing Wealth 94 Latin America and the Caribbean Economic Review October 2024 Figure 2.19 A Wealth Tax on Billionaires in LAC Would Yield Little Revenue, and Less Revenue than in Other Regions Estimate of possible additional revenue resulting from wealth tax of 2 percent on billionaires Revenue as a percent of GDP 0.4 0.3 0.2 0.1 0 Sub-Saharan Middle East Latin America East Europe East Asia Western South North Africa and North and and and Pacific Europe Asia America Africa Caribbean Central Asia Sources: World Bank calculations based on the Forbes World’s Billionaires List and World Bank World Development Indicators. Note: The figure assumes no country mobility response. Conclusion While global attention has shifted to wealth taxes, taxing property in particular has the potential to attack the three big fiscal issues facing LAC. Property taxes are underutilized relative to the United States and other advanced economies as sources of revenue. They are easy to make progressive and hence contribute to mitigating the persistent inequality in the region. And they have the potential to stimulate growth by shifting the tax burden away from productive investments to less productive types of investment. Though exceptions and evasion make them only indicative of actual burden, corporate rates exceeding 30 percent in many large countries of the region—compared to, for instance, the 19 percent average in Asia—are seen as disincentives to domestic investment and any FDI resulting from the move to nearshoring. Property taxes also offer a logical means to redress vertical imbalance where subnational units are dependent on transfers from central governments to cover expenses. The level of imbalances is high in LAC by global standards, and is accompanied by political economy challenges such as lack of independence and accountability or even corruption. Though taxing the wealth of billionaires has moved to center stage in policy debates, and has the potential to raise the hoped-for funds for the green transition, it is unlikely to be a magic bullet for the region’s broader fiscal shortfalls. LAC has few billionaires, they are less wealthy than those elsewhere, and they are extremely mobile. As with most sources of taxation, including income and the VAT, there is a need to expand the base of those who pay the tax. This said, the proposals for greater utilization of wealth taxes point to a broader agenda of reconsidering how the region’s tax systems can be restructured to best achieve the goals of equity, growth and sufficient government resources, as well as an even broader agenda on how to ensure these resources are well spent. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 95 References Aguiar, M., B. Moll, and F. Scheuer. 2024. “Putting the ‘Finance’ in Public Finance: A Theory of Capital Gain Taxation.” https://benjaminmoll.com/wp-content/uploads/2024/06/PFPF.pdf. Ahmad, E., G. Brosio, and J. P. Jiménez. 2019. “Options for Retooling Property Taxation in Latin America.” Macroeconomics of Development Series, 202. United Nations ECLAC (Economic Commission for Latin America and the Caribbean) and Cooperación Española. Appy, B. 2015. O Imposto Territorial Rural como forma de induzir boas práticas ambientais. Instituto de Pesquisa Ambiental da Amazônia (IPAM). Atkinson, A. B., T. Piketty, and E. Saez. 2011. “Top Incomes in the Long Run of History.” Journal of Economic Literature 49 (1): 3–71. Bahl, R. W., and J. Martinez-Vazquez. 2008. “The Determinants of Revenue Performance.” In Making the Property Tax Work: Experiences in Developing and Transitional Countries, edited by R. W. Bahl, J. Martinez-Vazquez, and J. M. Youngman. Cambridge, MA: Lincoln Institute of Land Policy. Bailyn, B. 1967. Ideological Origins of the American Revolution. Cambridge, MA: Harvard University Press. Bird, R. M. 2014. “A Better Local Business Tax: The BVT.” IMFG Papers on Municipal Finance and Governance 18, Institute on Municipal Finance and Governance, University of Toronto. Bird, R. M., and E. Slack. 2014. “Local Taxes and Local Expenditures in Developing Countries: Strengthening the Wicksellian Connection.” Public Administration and Development 34 (5): 359–69. Bouillon, C. P., ed. 2012. Room for Development: Housing Markets in Latin America and the Caribbean. Development in the Americas. Washington, DC: Inter-American Development Bank. Brondolo, J. D. 2011. “Taxing Financial Transactions: An Assessment of Administrative Feasibility.” IMF Working Paper WP/11/185, International Monetary Fund, Washington, DC. Castano, F., P. Garriga, I. Guardarucci, and G. Vuletin. 2024. “Real Estate Tax: Toward a Practical Wealth Tax in LAC.” World Bank, Washington, DC. Cavallo, E., and T. Serebrisky, eds. 2016. Saving for Development: How Latin America and the Caribbean Can Save More and Better. Development in the Americas. Washington, DC: Inter-American Development Bank. Cohn, A. S., A. Mosnier, P. Havlík, H. Valin, M. Herrero, E. Schmid, M. O’Hare, and M. Obersteiner. 2024. “Cattle Ranching Intensification in Brazil Can Reduce Global Greenhouse Gas Emissions by Sparing Land from Deforestation.” Proceedings of the National Academy of Sciences 111 (20): 7236–41. Elinder, M., and L. Persson. 2017. “House Price Responses to a National Property Tax Reform.” Journal of Economic Behavior & Organization 144 (December): 18–39. Enache, Cristina. 2024. “The High Cost of Wealth Taxes.” Tax Foundation, Europe. June 26, 2024. Enemark, S. 2010. “From Cadastre to Land Governance in Support of the Global Agenda—The Role of Land Professionals and FIG.” FIG Article of the Month, December 2010, International Federation of Surveyors, Copenhagen. Esping-Andersen, G. 1990. The Three Worlds of Welfare Capitalism. Princeton, NJ: Princeton University Press. Fendrich, A. N., A. Barretto, G. Sparovek, G. W. Gianetti, J. da Luz Ferreira, C. F. Marés de Souza Filho, B. Appy, C. M. Guedes de Guedes, and S. Leitão. 2022. “Taxation Aiming at Environmental Protection: The Case of Brazilian Rural Land Tax.” Land Use Policy 119 (August): 106164. Chapter 2: Taxing Wealth 96 Latin America and the Caribbean Economic Review October 2024 George, H. 1879. Progress and Poverty: An Inquiry into the Cause of Industrial Depressions and the Increase of Want with Increase of Wealth. New York: D. Appelton and Company. Gunter, S., D. Riera-Crichton, C. A. Vegh, and G. Vuletin. 2021. “Non-linear Effects of Tax Changes on Output: The Role of the Initial Level of Taxation.” Journal of International Economics 131 (July): 103450. Guvenen, F., G. Kambourov, B. Kuruscu, S. Ocampo, and D. Chen. 2023. “Use It or Lose It: Efficiency and Redistributional Effects of Wealth Taxation.” Quarterly Journal of Economics 138 (2): 835–94. Hanappi, T., S. Nieto Parra, J. Orozco, and A. Rasteletti. 2023. “Corporate Effective Tax Rates in Latin America and the Caribbean.” Tecnical Note IDB-TN-2782. Instituto Escolhas. 2019. Imposto Territorial Rural: justiça tributária e incentivos ambientais. Instituto Escolhas. Izquierdo, A., C. Pessino, and G. Vuletin, eds. 2018. Better Spending for Better Lives: How Latin America and the Caribbean Can Do More with Less. Development in the Americas. Washington, DC: Inter-American Development Bank. Kelly, R., R. White, and A. Anand. 2020. Property Tax Diagnostic Manual. Washington, DC: World Bank. Klapper, L., A. Lusardi, and P. van Oudheusden. 2015. Financial Literacy around the World: Insights from the Standard and Poor’s Ratings Services Global Financial Literacy Survey. Stanford, CA: Global Financial Literacy Excellence Center. Le Guern Herry, S. 2024. “Wealth Taxation and Portfolio Allocation.” April 23. Available at SSRN: https://ssrn.com/ abstract=4911583 or http://dx.doi.org/10.2139/ssrn.4911583. Löffler, M., and S. Siegloch. 2021. “Welfare Effects of Property Taxation.” Discussion Paper 21-026, ZEW-Centre for European Economic Research, Mannheim, Germany. Londoño-Vélez, J., and J. Ávila-Mahecha. 2021. “Enforcing Wealth Taxes in the Developing World: Quasi-experimental Evidence from Colombia.” American Economic Review: Insights 3 (2): 131–48. Mirrlees, J., ed. 2011. Tax by Design: The Mirrlees Review. Oxford: Oxford University Press/Institute for Fiscal Studies. Norregaard, J. 2015. “Taxing Immovable Property: Revenue Potential and Implementation Challenges.” Chapter 11 in Inequality and Fiscal Policy, edited by B. Clements, R. de Mooij, S. Gupta, and M. Keen. Washington, DC: International Monetary Fund. OECD (Organisation for Economic Co-operation and Development). 2018. “The Role and Design of Net Wealth Taxes in the OECD.” OECD Tax Policy Studies 26. OECD Publishing, Paris. OECD (Organisation for Economic Co-operation and Development). 2022. “Housing Taxation in OECD Countries.” OECD Tax Policy Studies 29. OECD Publishing, Paris. OECD (Organisation for Economic Co-operation and Development. 2023. “Base Erosion and Profit Shifting (BEPS) Project.” OECD. https://www.oecd.org/tax/beps/. Piketty, T. 2014. Capital in the Twenty-First Century. Belknap Press. Pretty, J. 2001. “Social Capital and the Environment.” World Development 29 (2): 209–27. Riera-Crichton, D., L. Venturi, and G. Vuletin. 2024. “The Income and Labor Effects of Individual Income Tax Changes in Latin America: Evidence from a New Measure of Tax Shocks in Latin America.” Unpublished manuscript. Rostovtzeff, M. 1957. The Social and Economic History of the Roman Empire. Oxford University Press. Rudnick, R. S., and R. K. Gordon. 1996. “Taxation of Wealth.” Chapter 10 in Tax Law Design and Drafting, Vol. 1, edited by V. Thuronyi. Washington, DC: International Monetary Fund. Chapter 2: Taxing Wealth for Equity and Growth Latin America and the Caribbean Economic Review October 2024 97 Saez, E., and G. Zucman. 2016. “Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data.” Quarterly Journal of Economics 131 (2): 519—78. Turner, B. L. 2012. The Earth as Transformed by Human Action: Global and Local Ecological Change. Cambridge, United Kingdom: Cambridge University Press. World Bank. 2013. Land Governance Assessment Framework Implementation Manual. Washington, DC: World Bank. World Bank. 2023. Latin America and Caribbean Economic Review, April 2023. The Promise of Integration: Opportunities in a Changing Global Economy. Washington DC: World Bank. World Bank. Forthcoming. Rethinking Taxation in LAC: Behavioral Insights for more equitable and More Effective Policymaking. Washington, DC: World Bank.