In this paper we document the performance of Latin American fiscal systems from the perspective of redistribution. Using recently-assembled data on the incidence of taxes and transfers in major Latin American countries, we place the region against the comparative benchmark provided by industrial countries. This serves to highlight two key facts. First, the biggest contrast between the two regions in terms of income inequality concerns the distributional impact of the tax and transfer system. In contrast with industrial countries, in most Latin American countries the fiscal system is of little help in reducing inequality. This is the combined result of two adverse factors. One is that transfers do help redistribution, but not much. The other is that the scope for active fiscal redistribution is severely constrained by the region’s low levels of tax collection, which (with a couple of exceptions) are well below the international norm – a fact that also underlies the shortcomings of Latin America’s public sectors in the other classic functions of efficiency and stability.

Second, the bulk of redistribution in industrial countries is achieved through transfers, rather than taxes. This has important policy implications for the debate on the type of taxes (income or VAT) that policy makers should consider in the context of fiscal reforms that have among their objectives an increase in tax collection.

On the whole, the evidence we present shows ample room for enhancing the distributive performance of Latin America’s fiscal systems through appropriate fiscal reform – with specific reform priorities determined by country circumstances. Our analysis is subject to some caveats, however. First, we focus on the distribution of annual income, rather than that of lifetime income, which would be impossible to study with the available data. This in turn implies that we ignore the potential dynamic distributive effects arising from social expenditures such as health and education. These might affect asset accumulation by the poor and hence have an impact of the distribution of future market income. Second, our use of European countries as benchmark of comparison is also a reflection of data availability rather than a normative statement about the desirability (or lack thereof) of the ‘European model’ as a specific choice between redistributive activism and efficiency costs. Related to this, we do not discuss the institutional and implementation challenges that Latin American countries might face should they wish to expand significantly the role of taxes and/or transfers as redistributive vehicles.<sup>10</sup> Third, we rely on standard incidence analysis, leaving aside incentive effects of fiscal interventions whose proper analysis would require empirical implementation of a fully-specified general equilibrium model.

The rest of the paper is structured as follows. In Section 2, we compare the distributional impact of taxes and transfers in Latin America and in Europe. Section 3 explores in detail why Latin America’s fiscal policy is largely ineffective at reducing income inequality. The section reviews the three key ingredients of fiscal redistribution --

> 10 See for example Dethier (2007) for a discussion of the difficulties that developing countries would likely encounter if they tried to raise social security coverage to levels similar to those found in the developed world.

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