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The Taxation of Spirits in Colombia: Problems with the Current Regime and the Impact of Tax Reform

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The Taxation of Spirits in Colombia: Problems with the Current Regime and the Impact of Tax Reform The Taxation of Spirits in Colombia: Problems with the Current Regime and the Impact of Tax Reform Oxford Economic Forecasting, Fedesarollo and International Tax and Investment Centre October 2000 The Taxation of Spirits in Colombia The Key Contributors To This Paper This paper is the result of collaboration between three eminent and respected international institutions: the International Tax and Investment Centre (ITIC), Oxford Economic Forecasting (OEF) and Fedesarrollo. A brief description of each institution is given below. International Tax and Investment Centre Established in 1993, at the request of the Ministries of Finance of Russia and Kazakstan, International Tax and Investment Centre (ITIC) is an independent non-profit research and education foundation with offices in Russia, Kazakhstan, Ukraine, the United Kingdom and the United States. ITIC is organised to serve as a clearinghouse for policy information, and as a training centre to transfer Western taxation and investment know-how to key policy makers in the former Soviet Union and other transition economies across the world with the aim of improving the investment climate of transition countries, thereby spurring business formation and economic prosperity. Oxford Economic Forecasting Oxford Economic Forecasting was founded in 1981 to provide independent forecasting and analysis tailored to the needs of business economists and planners. It combines a strong research agenda with a large commercial client list. It commands a high degree of professional experience and technical expertise both through its own staff and its links with Oxford University and the London Business School, as well as through partner firms and institutes in Europe and in the US. Its services cover both the international economy and the UK, and range from regular reports and business seminars to user-friendly PC-based econometric models. In addition, OEF is able to offer consultancy across a broad range of economic issues. Fedesarrollo For 30 years FEDESARROLLO has contributed to the decisions of policymakers in Colombia in the economic and social areas, and has provided constant support to the private sector. FEDESARROLLO’s influence is based on rigorous and independent research, oriented towards the development of sound policies and the diffusion of knowledge in its areas of research. The Foundation for Higher Education and Development, FEDESARROLLO, is a private, non partisan, non-profit institution. THE TAXATION OF SPIRITS IN COLOMBIA CONTENTS Page EXECUTIVE SUMMARY 3 Chapter 2: What’s Wrong with the Current Tax and Legislative Regime for 5 Spirits in Colombia? Section 1: The Main Agents in the Colombian Spirits Market: the Departmental 6 Licoreras Section II: The Product Composition of the Colombian Spirits Market 7 Section III: The Prevailing Tax Regime for Spirits in Colombia 9 i) Import taxes 9 ii) Value-added tax 10 iii) The tax on consumption 12 iv) The special customs regime zones 14 Section IV: Problems in the Colombian Spirits Market Generated by, or 16 Associated with the Existing Legal and Institutional Framework i) Contraband and counterfeit 16 ii) High transaction costs for firms legally operating in the spirits market 18 iii) High tax collection costs for public authorities 19 iv) Alcohol taxes fall disproportionately on groups with relatively low 19 incomes v) Economic inefficiencies associated with tax distortions and the 20 existence of departmental monopolies vi) Failure to meet international trade agreements 23 Section V: Conclusions 23 CHAPTER 3: STATUS, COSTS AND COMPETITIVENESS OF THE LICORERAS 25 Section I: A closer look at the status of the departmental Licoreras 25 Section II: Operations and costs 26 i) Public versus private administration 26 ii)Vertical integration 28 iii) Alcohol costs 29 iv) Production costs of Licoreras 30 v) Domestic and international competitiveness of the Licoreras 33 Section III: Conclusions 35 CHAPTER 4: THE PRINCIPLES OF EXCISE TAX DETERMINATION 36 Section I: The Choice between Ad Valorem and Specific Excise Taxes 37 i) The Impact on Market Structure 37 ii) The Predictability and Stability of Tax Revenues 37 iii) Administrative Simplicity 38 iv) Externalities 38 v) Impacts on Competitiveness 39 vi) Equity considerations 39 vii) The influence of Inflation 39 viii) Conclusions 39 Section II: Principles for Determining Excise Tax Rates 41 i) Tax rates should be set to minimise distortions and maximise tax 41 revenue ii) Tax rates should be set in a way that does not penalise the poorer 41 sections of society iii) Tax rates should be set at levels which do not encourage smuggling, 41 corruption and counterfeiting iv) Tax rates should reflect any social problems (ie ‘externalities’) 42 associated with alcohol misuse Section III: Conclusions 42 Chapter 5: The Impact of Proposed Changes to the Colombian Alcohol Market 43 Section I: Introduction 43 i) The Proposal 44 Section II: The Base Forecast 45 Section III: Scenario Analysis 46 i) Shift to a lower average tax rate 47 ii) Shift to a specific tax regime 50 iii) Opening up the market to competition 52 iv) Conclusions from scenario analysis 53 Section IV: Indirect Benefits 53 Section V: Conclusions 54 Chapter 6: International Experience in the Taxation of Alcoholic Beverages 55 Section I: Case Study: Canada 56 i) The tax regime for alcoholic drinks in Canada 56 ii) Problems with the Canadian excise tax regime for alcoholic drinks 61 iii) Conclusions 63 Section II: Case Study: Argentina 65 i) The tax regime for spirits in Argentina 66 ii) The impact of tax duty changes on the structure of the Argentinian 67 spirits market iii) Conclusions 72 Section III: Case Study: Hong Kong 73 i) The tax regime for spirits in Hong Kong 73 ii) The impact of tax duty changes on the structure of the Hong Kong 74 spirits market iii) Conclusions 80 Section IV: Case Study: Trinidad and Tobago 81 Section V: Case Study: Peru 82 83 APPENDIX A: TAX ON BEER, WINES AND APERITIFS 88 APPENDIX B: THE ECONOMICS OF EXCISE TAX DETERMINATION 99 REFERENCES The Taxation of Spirits in Colombia: Problems with the Current Regime and the Impact of Tax Reform Oxford Economic Forecasting, Fedesarollo and International Tax and Investment Centre, November 2000 Executive Summary Colombia has an excessively complicated, cumbersome and distortionary system for the taxation of spirits. For example, there are myriad tax regimes for legally-imported spirits, compounded with many different excise tax rates which vary widely across the departments. Moreover, taxes on spirits in Colombia are substantially higher than in neighbouring economies. The existing tax and legislative regime for spirits in Colombia creates a number of problems: - It encourages smuggling and illegal production of spirits. This in turn undermines government tax revenue, encourages corruption and crime, and poses risks to public health. - It imposes high operating costs on firms operating legally in the spirits market and makes tax collection expensive for the authorities. - It penalises poorer sections of society. - It distorts consumer spending patterns, particularly by discriminating against internationally-traded spirits. - It means Colombia fails to meet international trade agreements. These problems are exacerbated by the inefficiencies of the Licoreras (departmental monopolies). Urgent reform is needed in Colombia to prevent the revenues of the Licoreras and from the consumption tax on spirits continuing to fall dramatically over the next few years as contraband and duty-free imports increase. Without action, we expect that revenues will drop by more than half in real (inflation-adjusted) terms in the next four years. The changes to spirits taxation that the government is considering including in the forthcoming Tax Reform Bill are to be welcomed, especially since they substantially reduce discrimination against imported spirits. But these proposals do not go far enough. In particular, they fail to reduce tax rates sufficiently to discourage smuggling and other illegal trade in spirits. We propose four changes to the tax and regulatory structure of the Colombian spirits market: 1. A shift from the current ad valorem consumption tax regime to a specific tax regime. 2. A reduction in the average tax rate, involving a cut in the consumption tax rate from a specific tax equivalent of around 100 pesos per degree of alcohol in a typical 75 cl bottle of aguardiente, to around 75 pesos per degree for the same bottle; and a cut in the VAT rate on spirits from 35% to 15% or, preferably, a specific tax of 25 pesos per degree of alcohol. These rates have been chosen to maximise tax revenues. 3. A reduction in import duty to 5% for goods from outside the Andean Community. 4. The opening up of the market to full competition – ie ending the monopoly rights of the Licoreras in both the supply and distribution of spirits. We calculate that these proposals would substantially increase tax revenues (compared to prospects without such reform) for all plausible assumptions about the behaviour of the spirits market in Colombia. The plausible ranges of elasticities are based on analysis of other spirits markets. There are two key mechanisms at work: first, lower taxes would encourage consumers to shift into the legal market, and second, the tax base would be increased by reducing the mark-up charged on domestic legally produced spirits. International experience clearly demonstrates the benefits for Colombia from adopting the reforms we are recommending. The rest of this paper is organised as follows: Chapter 2 highlights the problems caused by the current excessively complicated and cumbersome system for the taxation of spirits in Colombia. Chapter 3 analyses the particular problems associated with the departmental spirits monopolies (the Licoreras). Chapter 4 sets out the principles that economic theory suggests should influence the determination of excise taxes in market economies, and which underpin our recommendations for reform to the taxation of spirits in Colombia. In Chapter 5 we make proposals for the complete overhaul of the tax and legislative treatment of the spirits market in Colombia.
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