Assessing the Impact of the 2007 Tax Reform on Poverty and Inequality in Uruguay

Abstract

In the context of a sharp rise in poverty incidence and increasing inequality since the end of the last decade, a major Tax Reform was enforced by the middle of 2007, with the explicit goals of promoting greater efficiency and equity in the Uruguayan tax system. Overall, the Reform substantially increased direct taxation on personal income with increasing marginal rates, lowered indirect taxes and direct taxes on firms, uniformed the employer contribution to social security across sectors of activity and eliminated some highly distortive taxes. We assess the joint effect of these main changes on macro balances, on labour market and on poverty and inequality using a top-down static CGE – microsimulation approach. We find that the full implementation of the Tax Reform has significant general equilibrium effects, which tend to reinforce the reduction of poverty incidence, poverty gap and severity of poverty exclusively due to the introduction of the personal income tax, without behavioural responses. Regarding poverty, the magnitude of the general equilibrium effects is significantly more important than the direct effect, but concerning inequality indicators, general equilibrium effects provoke a minor additional reduction of Gini indexes.