Almost exactly one year ago, the CF&P released this short video as part of a series on the additional reforms Javier Milei should implement to maximize Argentinian prosperity.
Let’s take a closer look at the country’s tax policy, and I’ll start today’s column with an analogy.
When Milei took office, Argentina was in crisis. Thanks to Peronist mismanagement, there was triple-digit inflation, out-of-control-spending, rising poverty, and economic chaos. The country was like a dilapidated building that was burning while also being battered by flood waters and shaken by earthquakes.
Milei has ended the crisis. You can read this series if you want details.
Continuing the analogy, the fire has been extinguished, the flood waters have receded, and there are no more tremors.
But now it’s time to renovate.
Let’s consider how to fix the tax code.
As illustrated by the two charts, originally shared two months ago, there are a couple of obvious problems in Argentina.
The top chart shows that the tax burden has expanded dramatically.
The bottom chart shows that Argentina is regionally uncompetitive.
But measuring the tax burden as a share of GDP only tells part of the story.
Equally important – or perhaps even more important – is how much damage the tax code is doing per dollar collected. Or, in the case of Argentina, the damage per peso collected.
To address that issue, let’s review an excellent new study written by Geoffrey Lawrence for the Reason Foundation and Argentina’s Libertad y Progreso
The study notes that Milei has solved the immediate economic crisis, but tax reform is now needed to achieve strong growth.
…while this fiscal and monetary stabilization is a necessary condition to restore economic growth and opportunity in Argentina, on their own these measures may be insufficient. A key impediment to economic growth in Argentina is a tax system that is highly distortionary and inefficient. As a result, a substantial proportion of economic activity in Argentina has migrated to the illicit or “informal” market to avoid the taxes levied on legal or “registered” activity. This informality inhibits the type of capital formation and investment that could boost labor productivity and real gross output—the key drivers of real wage and income growth.
Lawrence covers an enormous amount of material in the 99-page study, so this column will merely skim some of the important findings.
Here’s a chart showing sources of tax revenue in Argentina.
And here are two problems covered in the report, both of which drive economic activity into the shadow economy.
First, the tax treatment of business.
Overlapping tax levies combine to impose an average corporate tax burden exceeding 106% of earnings, rendering full compliance impossible and eliminating all incentive for entrepreneurship. According to World Bank data, this is the second-highest effective corporate tax burden in the world out of the 238 countries for which it compiles data, behind only Comoros. For 197 of these countries, the effective corporate tax rate is less than 50% of earnings. Due to the onerous tax burden, many firms and businesses simply opt out of the legal economy and operate clandestinely.
Second, the payroll tax burden on workers.
Informality afflicts 44.1% of the employed workforce. Workers and firms opt for cash-based, unregistered arrangements to evade punitive levies… Argentina’s high payroll taxes and cascading levies create a tax wedge between formal and informal employment arrangements. When combined with labor mandates like mandatory annual bonuses and generous severance rules, these costs add 97% to the cost of legal employment beyond wages—far exceeding the Latin American average of 19%. …Social security contributions are intended to fund public pensions and healthcare and are assessed on both firms and workers. Employers must contribute 24–26.4% of payroll (higher for larger firms) while employees have 17% of gross wages withheld. …Together, these contributions amount to a combined 41-43.4% tax on employee earnings.
The study also has some important analysis of where Argentina is on the Laffer Curve (or, to be more accurate, the Laffer Curves).
…the current tax rate is beyond the revenue-maximizing level within at least some major economic sectors in Argentina. Both construction and domestic services are well beyond the revenue-maximizing level and both formality and public revenues could be increased by reducing the tax burden on these sectors. To a lesser degree, this is also true of the hospitality sector. The analysis reveals the revenue-maximizing levels of income and payroll taxes are 21-27.7% and 25.1-34.5%, respectively. Each of these rates are substantially below the prevailing tax rates.
And the author calculates how the government could lower tax rates while collecting the same amount of money.
…the effect of a large hypothetical reduction in both income (corporate and individual) and payroll taxes. The top income tax rates fall from 35% to 27% while the combined payroll tax rate (split between employer and employee) falls from 43.4% to 34%. As a result, formality would be expected to increase within the economic sectors dominated by private enterprise, including agriculture, retail commerce, construction, domestic services, and manufacturing. This effect would be substantial enough to hold revenues relatively steady in agriculture, hospitality, retail commerce, and manufacturing despite the substantial tax reductions and would generate substantially more revenue in construction and domestic services. These effects would compensate for a loss of revenue in the sectors not sensitive to tax rates and result in roughly the same amount of overall revenue.
Interestingly, the analysis mostly focuses on how revenues will grow if the shadow economy shrinks.
There’s not much focus, by contrast, on the additional revenue that will materialize if the economy grows faster. So I suspect the study’s findings understate the potential benefits.
I’ll conclude by noting there is much more to the study, including these specific recommendations to make the tax code more rational.
The bottom line is that people should read the report, whether they’re interested in theoretical tax policy or interested in Milei’s battle to liberalize Argentina’s economy.
P.S. I can’t resist sharing this analysis from the study. It’s not about anything specific to Argentina. Instead, it explains why it would be a very bad idea to try to be at the revenue-maximizing point of the Laffer Curve.
…reaching or approaching this peak is rarely, if ever, the socially optimal outcome. The revenue-maximizing point represents the highest rate the government can impose while still collecting the maximum possible funds in the short term, but it comes at the expense of significant economic distortions and opportunity costs. …Even at or near the peak, the marginal excess burden of taxation—the net loss in economic efficiency and well-being from each additional unit of revenue collected—is extraordinarily high. …In contrast, setting tax rates substantially below the revenue-maximizing level creates a virtuous cycle of economic expansion and formalization that benefits both the private sector and public finances over time.
