Assessing the Impact of the 2007 Tax Reform on Poverty and Inequality in Uruguay

Abstract

In the context of a sharp rise in poverty incidence and an increase in inequality since the end of the last decade, a major Tax Reform was enforced by the middle of 2007, with the explicit goals of promoting greater efficiency and equity in the Uruguayan tax system. Overall, the Reform substantially increased direct taxation on personal income with increasing marginal rates, lowered indirect taxes and direct taxes on firms, uniformed the employer contribution to social security across sectors of activity and eliminated some highly distortive taxes. We asses the joint effect of these main changes on macro balances, labour market, poverty and inequality using a top down static CGE – microsimulation approach. We find that the full implementation of the Tax Reform has significant general equilibrium effects, which jointly reinforce the observed “next day” reduction of poverty incidence, poverty gap and severity of poverty due to the implementation of its main policy, the introduction of a dual direct personal income tax. General equilibrium effects provoke a minor additional reduction of inequality. The full reform is expansive though it actually increases the tax burden, as its main changes tend to reduce price distortions of goods and factors, provoking a better reallocation of resources and stimulating activity expansion.