Comments on Latin American Outlook 2009: Fiscal Policy and Development William Maloney Office of the Chief Economist for Latin America World Bank March

Two Points  The importance of Fiscal Policy to the development process  Informality, taxation and the Social Contract

The Role of the Fiscal Policy: Distribution  Differences in inequality of market or disposable incomes? A story. Perry et. al (2006)  LAC tax collections are below similar countries.  LAC public expenditures are neutral or regressive.

Role of Fiscal Policy: Growth  Yes, Infrastructure  I’d add: Resolving market failures in knowledge adoption and creation LAC is low in on TFP (productivity growth), patents, R&D/GDP Suggests subsidies, tax incentives, direct gov’t investment  Issue: How design mechanisms such that governments do these things well? LAC is low on patents per unit of R&D, university quality and collaboration etc.

In any case, crisis augurs badly for LR considerations of fiscal policy Sources: Consensus Forecasts (as of February 09), ECLAC and World Bank. LAC growth range is based on LCRCE Estimations

Keeping fiscal spending from falling may be hard to achieve in 2009 Source: EIU

Coping ability varies across countries, reflecting varying quality in domestic policies The index of growth prospects combines information on annual variation of the investment to GDP ratio, annual average growth in GDP and TFP over the period The median of the growth prospects index for the entire LAC sample is 0.5. LCRCE Staff calculations based on Bloomberg, WDI and ECLAC

Most spending calculations conjunctural:  How can we preserve existing investment projects?  Infrastructure to boost demand vs.  Transfers to adversly affected families?

2. Informality, taxation, the social contract  Useful findings on taxes Evasion only 30% of potential revenues Evasion by small firms not so important  Informality of the rich Real issue is distribution-tax base too small  Still, we know evasion, informality is high Focus on exit AND exclusion critical But why exit: Why don’t agents engage with the state?

“Social Norms” of Compliance: Perceptions of State, of Each Other  Collective perceptions of fairness/efficacy of state  Strong reciprocity: I’ll comply if others comply Ex: tax morale is negatively correlated to perceptions of State capture  Lead to exit and a “culture of informality”  Symptom of a dysfunctional” social contract?

New surveys: workers tell us of both exit and exclusion Self-rated Poverty Relative to Formal Workers Source: (Arias 2007)

And their transitions often suggest voluntary entry Mexico Self Employment to Formal Salaried Formal Salaried to Self Employment Source: Bosch and Maloney (2007)

Why don’t informal value their state? Why do microfirms not register?  Small firms: DR, MX 60%- and 80% say “they’re too small” or “they don’t need to formalize”  Suggests lack of need for existing services: design? quality?  Impact of tax reduction policies in MX, BR, Sri Lanka… small effect

However, in the end, these may be second order considerations 2 Measures of Informality vs Income per Capita

Informality: Exit and Exclusion Perry et. al (2007) Chief Economist Office for Latin America and the Caribbean Complementary Bedside Reading

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