revenues (2.4 percent of GDP). When put to their most effective use, this additional revenue could be used to finance the introduction of a tax declaration for independent workers (to ensure reimbursement of presumptive taxes to low-income earners) and an expansion of the conditional cash transfer program.<sup>7</sup> This proposal would be fiscally neutral and would reduce the Gini coefficient by about 4.6 percentage points. The result is indicative of the unexploited potential of fiscal redistribution in Colombia, but further analysis would be needed to verify it with precision and to identify specific policy recommendations.

9. **Finally, it should be emphasized, that the paper does not engage in a political economy analysis.** Rather, it takes a „social engineering‟ approach to the topic of fiscal redistribution deliberately avoiding the important issue of how to implement the proposed reforms in the Colombian political economy context. The main objective of the paper is to illustrate to Colombian decision makers the unexploited potential of a policy tool, which has proven effective in reducing inequality elsewhere, particularly in the OECD. While illustrative examples are given on how inequality can be reduced using fiscal redistribution, the paper does not aim to be prescriptive on the specific measures to be implemented.<sup>8</sup> 10. **The remainder of the paper is structured as follows.** Section 2 compares fiscal redistribution in Colombia with peer countries. Section 3 takes a more detailed look at Colombia‟s tax system, highlighting its low degree of progressivity. Section 4 examines the structure of public spending, including its cash and non-cash components, to shed light on the beneficiaries of public outlays. Section 5 presents a methodological approach for identifying effective and fiscally neutral policy options. Section 6 concludes.

# **2. Fiscal Redistribution**<sup>**9**</sup>

11. **The potential of fiscal redistribution remains largely unexploited in Colombia, in line with the experience elsewhere in the region.** While taxes and transfers reduce inequality by about 12 Gini points in European OECD countries, fiscal policy does not appear to have a significant redistributive impact in Colombia. This pattern is, to some extent, similar to that found in other Latin American countries, where such policies result in an average reduction of inequality by just one Gini point, as illustrated in Figure 2.

12. **The redistributive effects of direct and indirect taxes cancel each other out in Colombia, and monetary transfers have no impact on the Gini coefficient.** A more detailed inspection of Figure 2 reveals that direct taxes reduce the Gini coefficient by 1 percentage point, while indirect taxes increase it by the same proportion, resulting in an overall neutral impact of

> 7 A substantial increase in the budget for the CCT program may seem exaggerated.  Nonetheless, this example is illustrative.  The key point is that the additional tax revenues are spent through public programs that are progressive and cost-effective.  The CCT program has these characteristics, but is by far the only option available.

> 8 The political economy of tax reform is discussed extensively in the literature.  See for instance: Mirrlees (2010) or John (2006).

> 9 This section draws upon the work of Goñi et al (2011), which is the source of all statistics quoted in the section, unless otherwise mentioned.

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