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The following OECD assessment and recommendations summarise chapter 2 of the Economic Survey of Chile published on 27 January 2010.
The fiscal framework is working well and receives wide support, but could be improved further
Chile’s macroeconomic framework -- a structural fiscal rule, inflation targeting and flexible exchange rate -- has been largely successful in shielding the economy against overheating in the last copper price boom. Nevertheless, the framework could be strengthened further. For instance, Chile should consider the experiences of OECD countries that complement their fiscal rule with a ceiling on expenditure growth. During booms, such ceilings help to accumulate additional funds, which can then be used counter-cyclically in sharp downturns. Any improvement should seek to balance the cost of changing a rule that is working and receives wide support with the benefits that it might bring. Fiscal policy could also be made more counter-cyclical by strengthening the automatic stabilisers, including through an enhanced unemployment benefit system.
Unemployment protection could be made more effective
Unemployment benefits largely rest on individual savings accounts with small complements from an insurance fund, the Fondo Solidario, which had very restrictive access until recently. Severance pay rights are often several times higher than unemployment benefits, contributing to slower adjustment of the economy after adverse shocks. Furthermore, severance pay is only available to workers on indefinite contracts; it is likely that this discourages employers from offering indefinite contracts, thus contributing to the comparatively large share of workers on fixed term contracts. The government has recently strengthened the unemployment benefit system by easing access to the Fondo Solidario and opening it to workers on short term contracts, who account for the largest part of job turnover. Increasing unemployment benefit replacement rates for all workers and extending duration, both of which are currently very low compared to OECD countries, while simultaneously restricting severance pay would provide more effective protection. It would also allow for more efficient job search, thus maximising workers’ productivity through a good match. Strengthening the Fondo Solidario would be the best option as insurance would provide more effective income protection than individual savings. Unemployment benefits should be moved up with great care, however, as excessively high unemployment benefit replacement rates could reduce incentives for job search.
Public spending is likely to increase in the medium term. This will require higher levels of tax receipts
As in other emerging economies, public spending accounts for a small share of national income at present. As Chile converges towards higher levels of living standards, it is likely that the demand for public services will increase. The goals of economic convergence and of building an equitable society also call for developing further public policies, such as for poverty reduction or better educational outcomes. Existing social programmes to reduce poverty and inequality are well targeted and efficient, but they remain small by OECD standards, despite significant expansion in recent years. A further increase of public spending in these areas is therefore not only plausible, but also desirable, although it should continue to be well targeted, efficiently implemented, and sustainably financed.
In order to increase the provision of public goods and keep public finances sustainable in the medium term, government tax revenues may need to be expanded. Broadening the tax base by abolishing some of the less efficient and regressive tax exemptions and working to increase the yield of the income tax system would contribute to this goal. The government has already limited the VAT tax credit for housing construction. It could also reassess the highly regressive exemption from VAT of health and education services, which benefit mainly higher income households. Tax exemptions for contributions to private pension funds and accrued returns to savings, although common in OECD countries, are costly and they disproportionately benefit high-income earners with high marginal income tax rates, while the vast majority of tax-exempt workers do not benefit. Moreover, evidence that tax subsidies are effective in increasing pension savings of higher income earners is scant. The government recently introduced the opportunity for medium-and low-income earners to opt for a pension subsidy instead of a tax allowance. The government should further strengthen subsidies for low- and medium-income earners while capping tax benefits for high-income earners. This could be done with refundable tax credits or flat subsidies to ensure that support for savings reaches those who need it most.
The large difference between the corporate and the top marginal income tax rates creates incentives for high income individuals to keep their savings in corporations often solely created for this purpose, such as sociedades de inversión. The government should close the tax loophole associated with these vehicles.
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The OECD Secretariat's report was prepared by Nicola Brandt, Cyrille Schwellnus and Rodrigo Paillacar under the supervision of Patrick Lenain. Research assistance was provided by Roselyne Jamin, Jehan Sauvage and Valéry Dugain.