# **1. INTRODUCTION**

A few months before the 2002 collapse of the currency peg, the Argentine government, in an attempt to make the Convertibility Plan more credible, passed a series of reforms including the introduction of a temporary tax on bank account debit and credit transactions. The Colombian government, in the middle of a financial crisis in 1998, introduced a temporary tax on transactions conducted through financial intermediaries to finance the bailout of mortgage, mutual and state-owned banks. In 1993, the Brazilian government created a new temporary tax on financial transactions to provide for universal health care coverage, a right given by a constitutional amendment passed in 1988. In 2002, the Venezuelan government instated a temporary bank debit tax to ease pressing budgetary imbalances. Today, all these countries have a form of tax on financial transactions in their codes, sometimes on a permanent basis (Colombia), sometimes continuously renewed on a temporary basis (Brazil), sometimes scrapped and then reinstated (Argentina and Venezuela) and sometimes earmarked for new purposes (e.g., Colombia).

Other countries in Latin America have resorted to bank debit taxation in the past. To ameliorate the effect of the collapse of world oil prices on the budget, Ecuador abolished its income tax system in 1998 and replaced it with a financial transaction tax, in hopes of increasing revenue. The income tax was soon reinstated and the transaction tax scrapped in 2001. Peru made use of this type of tax at the beginning of the 1990s and a proposal for its reintroduction has recently been approved by the government.

Bank debit taxation has had a bumpy ride in the region. After starting with enormous design problems that literally shut down foreign exchange, interbank and stock markets in some countries, and after numerous reforms directed at converting it into a more palatable levy (for instance, by exempting foreign exchange and stock market trades, transactions with the central bank, the treasury and other government agencies, investment funds, etc.), the most recent versions of the tax have gathered momentum and represent an important source of revenue for governments. In 2002, the contribution of bank debit taxes to federal government tax revenue came to 12.7% in Venezuela, 9.6% in Argentina, 6.1% in Brazil and 5.3% in Colombia. If the yield of other indirect “cascading” taxes is added, turnover taxes represent almost 23% of the government’s tax revenue in Brazil.

Although there is no more than a handful of empirical studies, the policy debate in the region, based on them, has been characterized by unequivocal and definite policy statements. According to the literature, a transaction tax is a particularly burdensome levy (Albuquerque, 2001a and 2001b; Arbeláez et al., 2002; Coelho et al., 2001; Lozano and Ramos, 2000; Koyama and Nakane, 2001), and its costs are higher the longer it remains in place (Kirilenko and Summers, 2003; Tanzi, 2000). It is strongly recommended that the tax be scrapped soon (Coelho, et al. 2001; IMF, 2000; Tanzi, 2000) and replaced with taxes such as the VAT and income taxes (Coelho, et al. 2001). However, the lack of theoretical and empirical analyses backing up such statements is surprising. The existing literature has not been able to address key issues, such as how a transaction tax distorts 2