for these. Data on fiscal spending by program type was derived from an inventory of social protection programs, prepared by Espinosa (2011) as well as Nuñez (2009, 2011).

58. **On the basis of the caveats stated above, the following package of policy measures appears attractive and merit further analysis.** The proposal includes a reduction of tax incentives and benefits (tax expenditures) in the personal income and the value added taxes which would yield substantial additional tax revenues (2.4 percent of GDP). When put to their most effective use, the additional revenue could be used to finance the introduction of a tax declaration for independent workers (0.5 percent of GDP) and an expansion of the conditional cash transfer program (1.9 percent of GDP). This proposal would be fiscally neutral and would reduce Colombia‟s Gini coefficient by about 4.6 percentage points, bringing it lower than in Chile and close to that of Costa Rica. Alternative options are considered below.

59. **A reform of personal income tax exemptions could reduce the Gini coefficient by up to 3.1 percentage points, if additional tax revenues are spent effectively.** The reform proposal contains the following elements: (1) elimination of the exemption of tax of the first 25 percent of income; (2) elimination of deduction for voluntary savings and pensions accounts; (3) introduction of a tax on pension income.<sup>26</sup> These measures would initially lower the Gini coefficient by 0.7 points and increase tax revenues by 0.9 percent of GDP, as illustrated in example A.1 of Table 8. The most effective identified use of the additional tax revenue would be through a combination of two measures. First, the introduction of an income declaration for independent workers, which would cost 0.5 percent of GDP in lost tax revenues and reduce the Gini coefficient by a further 1.9 points. Second, by channeling the remaining resources (0.4 percent of GDP) into the conditional cash transfer program to reduce the Gini coefficient by a further 0.5 points (using the average effectiveness ratios reported in Table 7), totaling a 3.1 percentage points reduction (example A.1). If instead all additional tax revenues were used to expand the CCT program, a reduction of 1.9 Gini points would be expected (example A.2).

60. **A reform of the VAT system would reduce inequality by up to 2.6 Gini points through effective use of additional tax revenue.** As illustrated in Table 7, VAT exemptions/exclusions are not a cost-effective policy tool of reducing inequality. For every 0.1 percent of GDP lost in revenues, the Gini coefficient is only reduced by 0.039 percentage points. The proposed VAT reform would consist of the following elements: (1) elimination of all VAT exemptions (except education, health, transport and leasing); (2) elimination of exemptions on real estate transactions; (3) convert all VAT exemptions to exclusions; (4) convert all VAT rates below the general rate to 16 percent.<sup>27</sup> This package would initially raise 1.5 percent of GDP in additional tax revenues, but would also raise the Gini coefficient by 0.5 percentage points, as the poor would now pay VAT on previously exempt/excluded goods. Further reductions in inequality could be achieved by channeling the fiscal savings into two programs: financing the income declaration of independent workers and expanding the CCT program. If a combination

> 26 There is a possibility that the Constitutional Court may subsequently rule such taxation only to apply to new beneficiaries, i.e. those retiring after the legislation has been approved.  The Court may in this case use the recurrent argument of „expected net benefits‟ as occurred with reductions in replacement rates under Law 797 of 2007. 27 There are important legal aspects related to this proposal in light of a previous Constitutional Court ruling (C-776 of 2003) that limits the extent to which VAT can be increased (see Clavijo, 2004).

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