The Effects of Economic Development on the Base of a Sales Tax: A Case Study of Colombia
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

An earlier version of this paper was presented to a conference on the topic “Is the Business Cycle Obsolete?” organized by the Social Science Research Council and held in London, England, on April 3–7, 1967.

Abstract

An earlier version of this paper was presented to a conference on the topic “Is the Business Cycle Obsolete?” organized by the Social Science Research Council and held in London, England, on April 3–7, 1967.

In fiscal studies, as in other areas of economic analysis, the principal focus in recent years has shifted to development. As more and more government operations are expected to make some positive contribution to economic development, analysis of tax and expenditure instruments must be extended to an examination of their effects on economic development as well.

Even as these fiscal instruments are used to promote growth, however, they are themselves affected by the economic and social changes which accompany development. Accordingly, intelligent selection of workable fiscal measures appropriate to various stages of development requires a better understanding of how fiscal possibilities change as the development process unfolds.

In recent years some attention has been devoted to the differences in tax structures of countries at different levels of development. Professor Harley Hinrichs, for example, has noted the sequence of government dependence upon traditional direct taxes on property and gross income, taxes on foreign trade, internal indirect taxes, and modern direct taxes on net income, at succeedingly higher stages of development.1 What has not been fully investigated, however, is why these changes occur and how the underlying possibilities for taxation—which may or may not be used—are altered in the course of development.

One possible approach to this question lies in the study of changes in the base upon which each tax must be levied. The characteristics of a base may provide a specific indicator for the diverse effects of economic developments upon the possibilities for taxation. Because the base of a tax can exist even when the tax is not utilized, it may be studied as one fiscal dimension of the economy when the tax itself cannot.

Following this approach, and utilizing several new methods of analysis, this paper examines one major part of tax structure alteration—the changing possibilities for the application of a sales tax.2 The study is carried out primarily in the context of historical developments in one country, Colombia, which has 18 million people, an area of 400,000 square miles (roughly twice the size of France), and per capita income of about US$325 in 1966. No sales tax was imposed in Colombia until the end of the period studied (1925–65), so that this paper focuses upon the base of a hypothetical sales tax, defined essentially along the lines of the 1965 tax. To provide background for study of this base, an account is presented of two earlier consumption tax episodes as well as of the sales tax levied in 1965. The paper then considers changes over the 40-year period in the size of the base, the incidence of a tax upon it, the adequacy of actual coverage of the base by customs and sumptuary excises, and accessibility of the base to the collection of a possible tax upon it. The findings indicate substantial changes in some, but not all, of these characteristics.

I. Three Consumption Taxes

While the main concern of this paper is with the base underlying possible sales taxation, three episodes in consumption taxation over the past half century offer revealing insights into the effects of changes in the base during this period. The first two episodes, interestingly enough, occurred in wartime—in 1914 and 1942—when the sharp reduction of imports and customs revenues generated some of the same pressures for greater domestic taxation that arose again at later stages of development. The third episode, embodying a far broader sales tax than earlier efforts, points to a number of significant effects of intervening economic developments which later analysis explores.

1914

With the reduction of imports that accompanied the outbreak of World War I in 1914, Colombian customs receipts—which furnished about three fourths of the Government’s ordinary revenue—dropped markedly, falling by 38 per cent between 1913 and 1915. To counter this decline, while restricting expenditures and borrowing from various local sources, the Government imposed a consumption tax on various luxury items. Carrying specific charges which for some products became proportional at higher prices, this tax applied to wines and liquors, beer, patent medicines, cosmetics, imported tobacco and tobacco products, and matches.3 Few of these items were produced within the country, however, and the authorities eventually found it much simpler to make the tax on imported items a part of the customs tariff.4 As a result, McQueen in Colombian Public Finance (page 29) states

By law No. 83 of 1922 and decree 208 of 1923 the imported articles in these categories, comprising the large volume of those paying the tax, were made subject to new customs duties, and the consumption tax proper was restricted to articles produced in the country—limiting the tax, as a practical matter, to beer, matches, and playing cards.

Collection of the remaining tax, which under provision of a 1923 law was scheduled to be transferred to the Departments, came through contracts with the factories for lump-sum payments to cover production during specified periods. The consumption tax yielded only between 1 per cent and 2 per cent of total national government revenues in 1923, roughly the magnitude of the new income tax that was imposed in 1918. Given the importance of customs and public enterprise revenues, however, this amounted to about 13 per cent of all revenues derived from domestic taxes. This early consumption tax, therefore, ended with the transformation of most of the tax into increased customs duties and the transfer of sumptuary levies on domestic goods to the Departments.5

1942

A second consumption tax episode occurred some two decades later, when supply and shipping shortages accompanying the U.S. entry into World War II once more reduced the flow of Colombia’s imports and customs revenues. The intervening years had seen the growth of a number of domestic manufacturing industries, however, and a somewhat different solution was chosen this time to meet the needs for revenue. Rather than redressing the drop of almost 40 per cent in imports and customs receipts by increasing the tax or customs rates on remaining imports, the Government decided to bring the output of the domestic manufacturing industry into the revenue base. By Decree No. 1361 of June 6, 1942, a tax of 3 per cent was imposed upon the domestic sales by textile factories (producing yarn or cloth of cotton, wool, or silk), sugar mills, breweries, and cement factories. Payment of the tax was to be based upon declarations of sales filed within 15 days after the close of each calendar quarter.

Because of the concentration of manufacturing production in a relatively few industries (in marked contrast to later stages of development), the imposition of this limited consumption tax—in effect, selective excise levies on a very few products—promised to provide coverage of a large portion of total manufacturing production and to be comparatively easy to administer. Production in these four industries (textiles, sugar, beer, and cement) accounted for 40 per cent of total manufacturing production in 1940 and, together with the tobacco and liquor industries (already taxed through departmental excises and liquor monopolies), represented 64 per cent of the total. (The corresponding figures for production in these industries in 1963 were 23 per cent for these four branches of manufacture and 27 per cent if distilled liquors and tobacco were included (see Table 1).)

Table 1.

Colombia: Relative Importance in 1940 and 1963 of Manufacturing Industries Taxable Under Decree 1361 of 1942 and of Those Covered by Excises and Fiscal Monopolies

(Production in thousands of pesos)

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Sources: For 1940: Departamento Administrativo Nacional de Estadística (DANE), Anuario General de Estadística, 1940 (Bogotá, 1941), p. 52. For 1963: DANE, Anuario General de Estadística, 1963 (Bogotá, 1965), pp. 612 and 662–84.

The ease with which this broad coverage could be obtained was increased by the relatively small number of large firms which predominated in the sugar, beer, textile, and cement industries. The 66 taxpaying firms in these four industries accounted for 69 per cent of income tax payments by all manufacturing companies in 1940 (see Table 2), while 9 of the 40 textile firms included in this number were responsible for nine tenths of all textile production.6

Table 2.

Colombia: Income Tax, Net Wealth Tax, and Excess Profits Tax Contributions by Various Manufacturing Industries, 1940

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Source: Contraloria General De La RepúBlica, DireccióN Nacional de EstadíStica, EstadíStica Fiscal Y Administrativa, 1942–1943, Anexo al Informe Financiero Del Contralor General De La RepúBlica (Bogotá, 1945, hereinafter Cited As EstadíStica Fiscal Y Administrativa), Pp. 43–57.

Difficulties arose because of the regressivity of the tax, however, as the composition of the 1942 domestic manufacturing base imposed a markedly regressive character upon any tax that it could support. This regressivity reflected the effects which import substitution had exerted on the distribution of the tax burden. Because goods with a mass market were the first to attract domestic manufacture, the substitution of nontaxed domestic production for imports had reduced a part of the revenue system which had rested primarily on the poorer classes. To some extent, of course, this lighter burden might be offset by the higher prices charged by less efficient domestic manufacturers enjoying tariff protection. The return of these mass-consumed articles to the revenue base—through the taxation of domestic manufacture proposed in 1942—had corresponding regressive implications for the distribution of the tax burden.

Dissatisfaction was quick to appear. By October 1942, the Government presented a new fiscal and economic plan to Congress, which soon approved it. This plan rescinded the taxes created by Decree No. 1361 “which bear so heavily upon the popular consumption,” with the exception of that on beer, which was raised to 5 per cent and was transferred to the Departments. In place of these taxes, mandatory bond purchases were imposed upon exports and incoming capital, and income, stamp, and inheritance taxes were increased.7 Income tax collections, enhanced by this addition (and augmented since 1936 by surcharges for net wealth and excess profits), soon surpassed customs revenues to become the Government’s leading source of revenue (see Table 3). Sumptuary excise taxes on beer, liquor, and tobacco, the major source of departmental revenues, dropped from 22.5 per cent of consolidated current government revenues in 1940 to 16.0 per cent in 1963, as the shrinking importance of alcoholic beverages and tobacco in national manufacturing production weakened departmental finances (see Table 4). The remainder of Colombia’s manufacturing industry, meanwhile, was to remain free from a broad sales levy for another 23 years.

Table 3.

Colombia: Customs, Income Tax, and Total Current Revenues of the National Government, 1915–65

(Amounts in thousands of pesos)

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Sources: For 1915–25: Charles A. McQueen, Colombian Public Finance (U.S. Department of Commerce, Washington, 1926), pp. 20 and 24. For 1926–43: Estadística Fiscal y Administrativa, 1942–1943 (Bogotá, 1945), pp. ix-x. For 1944–48: United Nations, Department of Economic Affairs, Public Finance Information Papers: Colombia, ST/ECA/SGR.A/2, March 1950, pp. 28–31. For 1949: Estadística Fiscal y Administrativa, 1949 (Bogotá, 1951), pp. 3–8. For 1950–65: Dirección Nacional del Presupuesto, Boletín No. 53 (Bogotá, December 1966), pp. 89–99.

Including surcharges.

From 1936, including taxes on net wealth and excess profits.

Table 4.

Colombia: Composition of Consolidated Current Government Revenues, 1925, 1940, and 19631

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Sources: For 1925: Charles A. McQueen, Colombian Public Finance (U.S. Department of Commerce, Washington, 1926), pp. 24–31, 80, and 88. For 1940: Estadística Fiscal y Administrativa, 1942–1943 (Bogotá, 1945), pp. 2–7, 64, and 155–233; for municipalities, DANE, Anuario General de Estadística, 1941 (Bogotá, 1942), p. 169. For 1963: Data from the Treasury and the Banco de la República.

Consolidated to eliminate intragovernment transfers. Current budget revenues of national or local decentralized agencies or enterprises were adjusted for cost of operation, except for municipalities in 1925 and 1941.

1925–26 for Departments.

1939–40 for Departments and 1941 for municipalities.

Includes Col$30 million in taxes collected by other decentralized agencies.

1965 8

When a sales tax was enacted, late in 1963 to take effect at the beginning of 1965, it was under the pressure of rising development expenditure needs, a cyclical decline in real customs receipts, and the reduced growth of income tax collections under the liberalized exemptions provided by the revenue-sacrificing reform that had been adopted in 1960, at the cyclical peak of imports and customs revenues. To meet the resulting revenue needs, the legislature voted on August 20, 1963 to increase stamp and inheritance taxes, require government bond purchases by banks, levy a surtax on the income tax for 2 years, and institute a general sales tax.9 Under the new law the President was authorized “to establish national taxes on the sales of finished articles by manufacturers or importers at rates varying between 3 and 10 per cent … with exemptions for food items of popular consumption, school books, drugs, and exports.” (Law 21, Article 1 (6).) The resulting general sales tax at the manufacturers’ and importers’ level was established by Decree No. 3288 of December 30, 1963, to go into effect a full year later, on January 1, 1965.10 In January 1965 opposition to the sales tax culminated in threats of a general strike, leading the Government to refer the problem to a Grand Commission of Inquiry, which was set up to consider a number of tax and economic questions, and to issue a revised regulatory decree, No. 377, on February 25, 1965. This was to stand with little change until mid-1966, when several changes in procedures and rates were decreed.

Under these regulations the tax was levied upon the sale or exchange11 of finished articles (defined as those which are the result of an industrial process and are ready for use or further processing), including capital goods but excluding services, food, medicine, school books, exports, gasoline (which is taxed separately), and—to give full scope to the exemption of food—insecticides, fertilizers, seeds, and animal feed. Taxable articles were divided into four rate categories carrying rates of 3 per cent, 5 per cent, 8 per cent, and 10 per cent.12While a number of imported articles were taxed at higher rates than similar products produced domestically, imports from countries in the Latin American Free Trade Association—which accounted for 8 per cent of all Colombian imports in 1965 13—were taxed as though produced domestically. With effect from July 1, 1966, the 8 per cent and 10 per cent rates were raised to 15 per cent, and the 5 per cent rate to 8 per cent, while the 3 per cent rate remained unchanged.14

Under Decree No. 377, finished articles sold to other manufacturers for subsequent processing or to exporters for export were exempted from the tax, upon presentation to the seller of a statement on intended use. In mid-1966, however, this exemption was restricted to exporters and manufacturers of exempt products.15 Other manufacturers were required to pay the tax but were permitted to take a credit for the tax paid on purchases of materials physically incorporated in the products, though not for other materials or capital equipment. On goods sold to persons or firms economically related (by marriage, consanguinity, or 50 per cent common ownership), the tax could be delayed until sale to third parties or could be paid, at the seller’s option, and deducted from the tax liability on the later sale. In either instance, the sale or transfer was to be reported on the bimonthly sales declaration.16

All importers and manufacturers were required to register and to submit declarations of their sales (or lack of taxable sales) and taxes due, along with payment. In July 1966 this requirement was extended to manufacturers of exempt goods as well, and declarations were required for all sales periods even if there were no sales or sales only of exempt products.17 At first, sales declarations were due within a month and a half after each bimonthly sales reporting period; later they were due a month after the end of the period. The tax on imports was generally collected not at customs but upon subsequent sales by the importer, with some exceptions, such as direct importation by non-registered firms or individuals.18 Exemptions from customs duties did not imply exemption from the sales tax. After some initial ambiguity, sales of domestic liquor, lotions, and colognes produced by departmental monopolies were exempted from the sales tax.19

Implementation of the sales tax began with only minimal enforcement efforts during the first year, and an unexpectedly small number of registrants was recorded. Compared with a total of 8,230 nonfood manufacturing establishments reported by the Statistics Department in 1962,20 registrations of both importers and manufacturers who were subject to the tax reached only 5,137 by the end of 1965; further enforcement efforts, however, increased registrations to 8,250 by September 31, 1966.21 In mid-1965, data for four major regional offices showed that only about two out of three registrants were filing the required sales declaration (see Table 5). Data for the Bogotá region alone for the full year 1965 showed that some 77 per cent of registrants filed reports, but this included late filing through August 1966 (see Table 6).

Table 5.

Colombia: Registrations and Sales Tax Declarations Due on June 15, 1965 and Filed on Time or Between June 16 and July 31, 1965 in Four Major Regional Offices

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Source: Data from Ministry of Finance, Division of National Taxes.
Table 6.

Colombia: Taxpayers, Registrants, and Sales Tax Collections by Type of Manufacture and Importat Bogotá Tax Administration, 1965

(Collections and payments in thousands of pesos)

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Source: Ministry of Finance, Division of National Taxes and Budget Office.

Despite early problems in securing compliance, collections of the sales tax for the first year (covering sales in the calendar year 1965 and payments through February 1966) totaled Col$392 million, equivalent to about 10 per cent of national government revenues in 1965. Some 63 per cent of collections, and 78 per cent of the base, was at the rate of 3 per cent. At an average rate of 3.73 per cent, the tax was collected on a base of Col$10.5 billion—18 per cent of Colombia’s gross domestic product (Col$58.8 billion) for 1965 (see Table 7). Data for collections in Bogotá—roughly half of the national total—for July-August 1965 indicated that 30 per cent of the collections came from importers and 70 per cent from domestic manufacturers. Imported merchandise was more heavily represented in the high tax rate categories, however, as imports constituted roughly 60 per cent of the sales in the 8 per cent and 10 per cent categories (see Table 8). Collections at the 5 per cent rate were almost exclusively from domestic manufacturers, reflecting in part the dominant position of payments for beer, which alone accounted for 21 per cent of collections in the Bogotá region during 1965 (see Table 6). Data on the size of tax payments in Bogotá indicate an extreme degree of concentration of collections. While two thirds of the sales taxpayers accounted for only 5 per cent of total collections, 47 per cent of all the collections in Bogotá came from the 20 top firms (see Table 9). Though the Bogotá collection data cover only half of the national total, include both imports and domestic manufactures, and are affected by the rate of the tax as well as the base, they roughly resemble the pattern of concentration that is evident for the domestic portion of the tax base represented by manufacturing production in 1962 (see Table 10 and Chart 1).

Table 7.

Colombia: Collections and Implied Sales Base of Sales Tax by Rate Category, 1965 and First Half 1966

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Source: Ministry of Finance, Division of National Taxes.

Exclude fines and interest.

Includes collections through February 1966, covering sales during the calendar year 1965.

Total Collections divided by Total Implied Sales Base.

Includes collections from March through August 1966, covering sales during January–June 1966.

Table 8.

Colombia: Base of Sales Tax Payments by Importers and Domestic Manufacturers, at Bogotä Tax Adminstration, July–August 1965

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Source: Finance Ministry, Division of National Taxes and Budget Office.
Table 9.

Colombia: Distribution of Sales Tax Payments in Bogotá Tax District, 1965

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Source: Finance Ministry, Division of National Taxes and Budget Office.
Table 10.

Colombia: Distribution of Production Among Manufacturing Establishments Ranked by Number of Employees, 1962 1

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Source: DANE, Anuario General de Estadística, 1962 (Bogotá, 1964), p. 760.

Includes only establishments with annual production of Col$24,000 or more.

Chart 1.
Chart 1.

Colombia: Distribution of Production Among Manufacturing Establishments Ranked by Number of Employees, 1962, and of Bogotá Sales Tax Collections, 1965

Citation: IMF Staff Papers 1968, 001; 10.5089/9781451956221.024.A002

Per Cent of Manufacturing Establishments, 1962, or of Bogoti Sales Taxpayers, 1965

During 1966, sales tax collections increased sharply, totaling Col$644 million. This gain reflected primarily the rise in imports—particularly automobile imports—to a 6-year peak and the generally higher tax rates on imports. This was apparent in the rate distribution of collections during the first half of 1966, when the share of collections in the 8 per cent and 10 per cent rate categories was approximately double that in 1965 (see Table 7). Higher collections were attributable also to the statutory rate increases enacted in mid-1966 and to more effective measures for enforcing the tax.

II. Changes in the Base of a Possible Sales Tax

Between the imposition of the consumption tax in 1914 and the inauguration of the sales tax in 1965, important changes were taking place in the Colombian economy—changes which altered the size, composition, and accessibility of the base upon which a tax system could be imposed. Part II of this paper departs from the actual development of the tax system to examine the changes which occurred in the economic base underlying a possible sales tax.

To measure only economic changes in the base for a sales tax, rather than the effects of definitional differences in tax legislation, the base considered for the entire period is essentially that defined in the sales tax inaugurated in Colombia in 1965. The base studied comprises all expenditures except those for food, medicine, and services. While this differs from some sales taxes adopted in other countries, it is not an uncommon tax base definition. Food is often excluded by sales tax legislation for reasons of equity, and services are often excluded because of the administrative difficulties that they entail.

The base studied differs somewhat from the base for the 1965 sales tax, which includes some double counting of machinery and materials not physically incorporated in the final product. Under the 1965 law these items are taxed on purchase by manufacturers and again when included—without offsetting tax credit—in the taxable value of manufacturers’ sales. There are differences, too, in the exact dimensions of the tax base studied when it is examined from various points of view. The tax base relevant to an examination of private consumption expenditures, excluding business expenditures, comprises retail sales, or the aggregate of the value added at all levels through the retail stage. The tax base examined from an aggregate, national production point of view, including business expenditures, falls somewhere between the value of sales by manufacturers and by wholesalers (as does the 1965 sale tax base). It embraces the value added in industry at the manufacturers’ sales level and the value of some imports, which may be closer to the wholesale level. A tax base at the retail level, to be sure, is larger by the amount of the retail markup than one at the wholesale level, and a base at the wholesale level exceeds that at the manufacturers’ level by the amount of the wholesale markup. In general, however, though divergencies may result from differences between the wholesale and retail markups of different products or over the course of development, the analyses of the base measured at one level are applicable to the base measured at other levels as well.

For the 40 years 1925–65, changes in four aspects of the hypothetical sales tax base are examined: (1) its elasticity, or growth in relation to changes in total income or expenditures; (2) the distribution of the base and the resulting regressivity or progressivity of a tax on it; (3) the adequacy of coverage of the base through the customs house; and (4) the accessibility of the base to possible tax collection at the manufacturers’, wholesalers’, and retailers’ levels. While the context of this study remains that of Colombian development over the past 40 years, evidence from other countries is adduced where necessary to fill in the outlines of tax base changes in Colombia.

Elasticity

A number of elements suggest that the base of a general sales tax covering all expenditures but food, medicine, and services does not constitute the same percentage of either personal expenditures or gross national income throughout the development process. At the lowest levels of development, a significant portion of the population is engaged in subsistence living, that is, much of their consumption consists of goods that they produce themselves. An important part of consumption, therefore, does not pass through the regular marketing mechanism and remains outside the hypothetical sales tax base. While in a developed country the sales tax base of rural families is proportionately smaller because of home-grown food, which is of no consequence if the sales tax exempts food,22 in a developing country rural consumption of nonmarket goods extends to many nonfood items as well. In Colombia in 1953–54, for example, rural per capita consumption was about one third that in urban areas,23 but per capita retail sales outside the departmental capitals—in effect, in the rural areas—was only about one sixth the level inside the capital cities, and nonfood retail sales were only one eighth.24

Besides the effects of subsistence living upon the flow of goods through market channels, the relative size of the sales tax base is affected by changes in the composition of consumption as per capita income rises. The portion of total personal consumption expenditures which is devoted to each category of consumption, such as food or clothing, varies with the level of income and affects how much of total consumption is to be inside or outside the sales tax base. This is true not only of families but also of countries at different levels of per capita national income.

The influence of income levels upon the portion of personal consumption expenditures that is within the sales tax base may be examined by applying the definition of the tax base used here—excluding food and services, medicine being rather difficult to segregate—to consumption patterns in a cross section of countries with different income levels. (This comparison does not affect, of course, that part of the tax base which comprises business expenditures rather than personal consumption expenditures.) The results of such an examination suggest that the percentage of private consumption expenditures embraced by this sales tax base rises appreciably as per capita national income rises.

Using data for the 1950’s compiled by Professor Simon Kuznets from UN sources for 27 countries arranged in four groups, consumption categories have been classified as predominantly inside or outside the tax base (see Table 11).25 This classification indicates that the portion of private consumption expenditures included within the sales tax base rises with increases in income, going from 27.0 per cent in the group of countries with an average per capita net national product of US$116 a year to 37.6 per cent in countries with an average of US$1,110. This increase in the percentage of consumption expenditures that is within the sales tax base as per capita income rises may be viewed in terms of the two major exemptions, food and services. Food consumption decreases as per capita income rises, from more than 60 per cent of the personal consumption expenditures in the very least developed countries to less than 30 per cent in the wealthiest countries. The long-run income elasticity of the food-consumption function is about 0.7, so that as income rises by 10 per cent, food expenditures would rise by only 7 per cent.26 Services, on the other hand, represent a more heterogeneous collection of expenditures with less clear-cut behavior in the aggregate. Between the lowest and highest income categories in Table 11, however, the services component—tax-exempt categories other than food—shows a rising trend, with an income elasticity of consumption of about 1.2, so that service expenditures rise by 12 per cent for each 10 per cent increase in per capita income. The combination of these two components brings a decline in exemptions as incomes rise, the food component declining more rapidly than the service component grows. This is so because food expenditures are far greater than service expenditures in the lower income category and because the elasticity of food consumption is further below 1 than the elasticity of service consumption is above it. (1.0–0.7=–0.3; 1.2–1.0 = 0.2.) As incomes continue to rise, however, the percentage of food in total expenditures grows steadily smaller, and the services percentage grows steadily larger. Increasingly, therefore, the rise in the service component offsets more and more of the decline in the food component. The decline in exemptions as a percentage of consumption becomes progressively smaller, and, at the highest levels of per capita income, exemptions should actually rise. Assuming constant income elasticities for these categories of consumption, the turning point comes when

Table 11.

Percentage of Personal Consumption Expenditures Taxable Under a Hypothetical Sales Tax Exempting Food and Services in Countries at Various Income Levels During the 1950’s

(In per cent of total personal consumption expenditures)

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Source: Simon Kuznets, “Quantitative Aspects of the Economic Growth of Nations: VII, The Share and Structure of Consumption,” Economic Development and Cultural Change, Vol. X, No. 2, Part II (January 1962), p. 24. Based on data for 27 countries, grouped as follows. Group 1: Australia, Belgium, Canada, Sweden, United Kingdom, United States. Group 2: Finland, France, Netherlands, Norway, Austria, Ireland, Puerto Rico. Group 3: Italy, Panama, Union of South Africa, Dominican Republic, Jamaica, Japan. Group 4: Ceylon, Ecuador, Ghana, Honduras, Peru, Rhodesia-Nyasaland, Taiwan, and South Korea.

Automobiles distinguished from other transportation expenditures on the basis of more detailed data for 12 countries, United Nations, Yearbook of National Accounts Statistics, 1965 (New York, 1966), and estimates based on passenger cars per capita for other countries, United Nations, Statistical Yearbook, 1965 (New York, 1966).

SF=(1eF)eS1

when S=services, F=food, eF=income elasticity of the food consumption function, and es=income elasticity of the consumption function for services.27 With income elasticities of consumption of 0.7 for food and 1.2 for services, the tax base would cease rising and begin to decline as a per cent of total expenditures when services reached 1.5 times the value of food expenditures. This point is already reached in the United States, for which the services-to-food ratio for 1950–59 is 1.67, using adjusted Kuznets data.28

Another influence on the growth of the sales tax base may be the importance of nonpersonal expenditures in gross national product (GNP). With a sales tax restricted to personal expenditures (which is not the case in Colombia or with the base studied here), the declining share of personal consumption expenditures in GNP tends to reduce the sales tax base as a per cent of GNP in the highest income category (see Table 11).

These influences of personal consumption expenditures on the sales tax base are reflected in the elasticities calculated for the base over the full income range. Between the lowest and highest income categories in Table 11, the income elasticity of the sales tax base is thus 1.15 and the elasticity of the tax base with respect to expenditures is 1.22.29 Both income and expenditure elasticities level off as income rises, falling to about 1.00 as they reach the highest income categories. The elasticities between categories, derived from Table 11, are as follows:

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If the comparison of consumption patterns in countries at different income levels offers a valid indication, the growth in per capita income within a country may be expected to produce a rise in the sales tax base which is more than proportionate.

This expectation appears to be confirmed by data for Colombia over the past 40 years. These data, however, focus not on changes in personal consumption patterns over this period but on the relationship between income and nonfood imports and production. Two sets of data for income and production are available for this period, one covering the period 1925–54 prepared by the UN Economic Commission for Latin America (ECLA) and the other covering the years from 1950 onward prepared by the Colombian central bank. From these data it has been possible to calculate a reasonable approximation of the hypothetical sales tax base by adding the value of nonfood imports to the value added by nonfood manufacturing industry within Colombia. Though this figure for the sales tax base includes the value of medicine and excludes the value of nonfood domestic raw materials used by the manufacturing industry, it is believed to offer a fairly good approximation, on the whole, of movements in the hypothetical sales tax base over the period 1925–63.30

Use of a time series to examine long-term changes in the sales tax base, however, reveals an important element that is not apparent from the cross-section analysis of countries at different income levels. This is the effect of shorter, cyclical fluctuations on the percentage of income that is included in the sales tax base. In Colombia such cyclical variations in the hypothetical sales tax base have been quite pronounced and have been restricted to the import component (see Table 12 and Chart 2). Influenced by the depression in the 1930’s, World War II, and postwar variations in coffee export receipts and foreign credits, Colombian imports—as a per cent of gross domestic product (GDP)—have reached periodic peaks since 1925 at intervals of 10 years, 10 years, 7 years, 6 years, and 6 years. Whether through income generation, monetary expansion and contraction, or direct trade restrictions and controls, the sporadic requiting of pent-up demand for imports of capital goods and of durable consumer goods has been a regular feature of the Colombian economy. Though a part of these fluctuations was no doubt absorbed by inventory changes, there has also been appreciable cyclical variation in actual final expenditures as well.31 The import component of the hypothetical sales base, in consequence, shows wide fluctuations, somewhat dampened since World War II, around a level trend line of about 10 or 11 per cent of GDP (see Tables 13 and 14 and Chart 3).

Table 12.

Colombia: Total Imports and Import Components as Per Cent of Gross Domestic Product, 1925–64

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Sources: GDP for 1925–49 calculated from GDP in 1950 pesos and annual GDP deflators, ECLA, Analyses and Projections of Economic Development, III: The Economic Development of Colombia, Statistical Annex (in Spanish, Geneva, 1957, hereinafter referred to as Statistical Annex), Tables 4 and 32. GDP for 1950–64 from Banco de la República, Cuentas Nacionales, with 1964 a preliminary estimate. Composition of imports for 1925–49: Statistical Annex, Table 30. Composition of imports for 1950–57: Departamento Administrativo de Planeación y Servicios Técnicos, Informe al Congreso Nacional, 1961–1963, Table 6 A, p. 135. Composition of imports for 1958–64: Based on data from Departamento Administrativo de Planeación y Servicios Técnicos. To obtain comparability between the two GDP series used, ECLA data for 1925–49 have been increased by 15.77 per cent, their average shortfall for the 5-year period (1950–54) during which the two series overlap.
Chart 2.
Chart 2.

Colombia: Components of Imports as a Per Cent of Gross Domestic Product, 1925–66

Per Cent of GDP

Citation: IMF Staff Papers 1968, 001; 10.5089/9781451956221.024.A002

Table 13.

Colombia: Components of Hypothetical Sales Tax Base—Value Added in Nonfood Manufacturing and Nonfood Imports, 1925–63

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Sources: Value added in nonfood manufacturing, 1925–53: Based on data from ECLA, Analyses and Projections of Economic Development, III: The Economic Development of Colombia (Geneva, 1957) and Statistical Annex. Value added in total manufacturing: From Statistical Annex, Table 1; for value added in food manufacture, ratio of value added to production for each branch of food manufacture in 1953 (Analyses and Projections of Economic Development, III: The Economic Development of Colombia, p. 419) was used and weighted by changing composition of food production each year 1925–53 (p. 421) to calculate ratio of value added to production for all food manufacture. This was applied to the index of the quantum of food production, Statistical Annex, Table 131; values were converted to current pesos using deflators in Statistical Annex, Table 32. Value added in nonfood manufacturing, 1954–63: Based on Banco de la República, Cuentas Nacionales. Nonfood imports: From data in League of Nations, Memorandum on International Trade and Balances of Payments, 1926–1928, Vol. III (Geneva, 1930), p. 75; League of Nations, International Trade Statistics, 1931 and 1932 (Geneva, 1933), p. 72; League of Nations, International Trade Statistics, 1933 (Geneva, 1934), p. 72; Contraloria General de la República, Dirección Nacional de Estadística, Anuario de Comercio Exterior (Bogotá, various years); United Nations, Yearbook of International Trade Statistics (New York, various years).
Table 14.

Colombia: Changes in Hypothetical Sales Tax Base as Per Cent of Gross Domestic Product and in Per Capita Gross National Income, 1925–63

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Sources: Cols. 2, 3, and 4: Tax base from Table 13 and GDP from Table 19. Col. 5: For 1925–49, from Statistical Annex, Table 4. For 1950–63, from Banco de la República, Cuentas Nacionales. Conversion to 1953 dollars based on average import rate shown in Joint Tax Program of the Organization of American States and the Inter-American Development Bank, Fiscal Survey of Colombia (Baltimore, 1965, hereinafter referred to as Joint Tax Program, OAS/IDB), p. 164. To obtain comparability, ECLA data for GDP and GNI were expanded by their average shortfall from Banco de la República data during the 5-year period (1950–54) during which the two series overlap.
Chart 3.
Chart 3.

Colombia: Domestic and Import Components of a Hypothetical Sales Tax Base as a Per Cent of Gross Domestic Product, 1925-63

Per Cent of GDP

Citation: IMF Staff Papers 1968, 001; 10.5089/9781451956221.024.A002

The domestic component—value added in nonfood manufacturing—shows a quite contrary pattern, moving steadily upward from about 4 per cent of GDP in the 1920’s to roughly 15 per cent in the early 1960’s, with interruptions only in the depression and war years (see Chart 3).32 The total hypothetical sales tax base shows the effects of the wide fluctuations in its import component, so that on a year-by-year basis no relationship exists between the rise in per capita gross national income (GNI) and the hypothetical sales tax base as a per cent of GDP (see Chart 4).

Chart 4.
Chart 4.

Colombia: Per Capita Gross National Income in 1953 U.S. Dollars and Hypothetical Sales Tax Base as a Per Cent of Gross Domestic Product, 1925–63

Citation: IMF Staff Papers 1968, 001; 10.5089/9781451956221.024.A002

Over the long run, however, and abstracting from the influence of short-term import fluctuations, increases in Colombian per capita GNI were accompanied by increases in the hypothetical sales tax base as a per cent of GDP. To remove the influence of import cycles from the data, a moving average was taken of both per capita income and the tax base, varying with the length of the import cycle.33 The moving average of the tax base showed a continuous upward trend over the period, from 13.8 per cent of GDP in 1925–34 to 25.1 per cent in 1957–63, while per capita GNI rose from US$122 to US$216. A chart of both moving averages since the 1920’s showed parallel growth between per capita income and the tax base as a per cent of GDP (see Chart 5). While the averages moved at about the same pace through the early 1930’s, the tax base rose more steeply through the remainder of the 1930’s, and per capita income rose more steeply in the postwar decade. Variations may be attributable to the pace of industrialization or to the shift of population to the urban centers or to other factors. In any case, the removal of cyclical fluctuations from the data for Colombia over the past 40 years seems to point quite clearly to the same concomitant increase in per capita income and in the ratio of the sales tax base to GDP that is evident in a cross-section analysis of countries with various per capita incomes.

Chart 5.
Chart 5.

Colombia: Moving Averages of Hypothetical Sales Tax Base as a Per Cent of Gross Domestic Product and Per Capita Gross National Income, 1930–60

Citation: IMF Staff Papers 1968, 001; 10.5089/9781451956221.024.A002

These movements may be compared with those calculated for the cross section of countries in different income brackets. Using moving averages for the sales tax base and GDP,34 the income elasticity of the sales tax base emerges as 1.30 from 1925–34 to 1945–54, the full period for which ECLA data exist, and as 1.36 for the period as a whole.35

These longer run elasticities are somewhat higher than the elasticity of 1.21 calculated for the cross section of countries in the per capita income range of US$116 to US$232 and may reflect a number of differences. The cross-section data are based on family expenditures, and therefore represent personal expenditures at the retail level. The hypothetical sales tax base calculated for Colombia over the past 40 years is based on the value of goods passing through customs and on the value of goods leaving the factory. It is not clear whether retail and manufacturing values may diverge, as the margin or value added in the distribution channels may or may not remain relatively constant over the period. The production measure of the tax base, finally, includes not only personal expenditures but also nonpersonal expenditures, which are covered by the 1965 Colombian sales tax and may have grown more rapidly than nonexempt personal expenditures. Other influences at work may include a steeper rise in urbanization in Colombia than in the cross section of countries used and the possibly quite significant differences between historical developments in consumption patterns and those revealed by comparison at one point in time.

Incidence

Quite distinct from the size of the hypothetical sales tax base and its growth relative to income is the distribution of the base and the resulting incidence of a tax upon it. The taxation of the domestic manufacturing base alone at the earlier stages of development, as examination of the 1942 Colombian experience noted, was no doubt regressive in character because of the basic mass consumption on which such industry must concentrate to find a large enough market. Whether a tax on all sales excluding food, services, and medicine would be regressive, however, is quite a separate question, depending upon whether the tax is passed forward to the consumer and, if so, upon what proportions of consumers’ total expenditures and income are subject to the tax—and at what rates—in various income brackets.

Whether a general sales tax is passed forward to consumers, absorbed by the seller, or shifted backward to the factors of production remains an unsettled issue. Predominant opinion is rather critical of any general backward shifting of the tax to factors of production.36 As regards the import component of the sales tax base, moreover, the relatively small size of the Colombian market would give little chance of any backward shifting of the tax abroad. The forward shifting of the tax burden to consumers hinges upon the interaction of market forces, that is, the demand and supply elasticities at work in the Colombian economy. While no analysis is attempted here of this question, there are a number of elements on the Colombian scene—heavy tariff protection, quantitative import controls, periodic upward price adjustments, and imperfections in market structures—which would seem to facilitate forward shifting. It would appear reasonable to accept as a working hypothesis at least, therefore, the distribution of a sales tax burden which forward shifting would entail.37

Incidence of the tax would depend in the first place upon the composition of expenditures by the consumers to whom the tax would be passed.38 Fortunately, rather complete, though not recent, data on the consumption patterns of urban families are contained in Colombia’s 1953 consumer expenditure study, upon which the cost of living index is presently based. Separate consumption patterns are calculated for two classes of urban families: the lower-class worker families, with a median income in 1953 of 350 pesos a month derived primarily from wages, and the more middle-class employee families, with a median income in 1953 of 650 pesos a month derived mainly from salaries.39 These two groups are believed to maintain different consumption patterns, and separate indices are calculated for their cost of living and for their income from employment in manufacturing industries.

To approximate the distribution of the hypothetical sales tax base, expenditures for the tax-exempt categories—food, services, and medicine—have been examined for each income bracket for both employee and worker families, using a weighted average of data for the seven cities in the sample. The results are presented in Tables 15 and 16.

Table 15.

Colombia: Per Cent of Family Expenditures (Based on 1953 Consumer Expenditure Survey) Comprising Food, Medicine, and Services by Income Brackets1

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Source: DANE, Economía y Estadística (Bogotá), November 1958, pp. 178–205.

Weighted average of seven cities.