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Wall Street Journal: Latin America Model for Asia?

Wall Street Journal: Latin America Model for Asia?

Posted by Juan Gavasa on April 16, 2014

For years, the fast-growing Asian tigers have been held out as the model for economic development. Now, as inequality becomes a greater focus for policy makers, Asian countries facing a widening wealth gap are being urged to look at Latin America, where tax and spending programs are narrowing the difference between rich and poor.

But can Asia move toward Latin American-style budgets without slipping to Latin American-level growth?

A poor residential district and squatter colonies are overlooked by high-rise residential and commercial buildings in Taguig, Metro Manila. Reuters

The Asian Development Bank, in its latest regional economic outlook, rings the alarm bells about rising inequality. While forecasting a relatively robust 6.2% expansion rate for developing Asia this year, up a tick from 2013, the report also notes “widening income gaps” throughout the region, particularly in the three largest countries: China, India, and Indonesia.

Of course, Asia’s runaway growth in recent years has lifted tens of millions out of poverty. Latin America still has higher levels of inequality. But its ratio has been decreasing fast due to redistributive policies. Asian inequality, meanwhile, has worsened as measured by the distribution of household consumption. The ADB thinks, left to fester, inequality could lead to social instability – already an issue in Thailand – and lower growth as potential workers are sidelined.

“Developing Asia lags other regions in fiscal spending to promote equity,” the Manila-based institution said in its report. The ADB highlights that Latin American governments spend 12% of gross domestic product on “social protection” programs, which include education and health outlays, twice the level of developing Asia.

The ADB recommendation: raise public spending, funded by higher taxes. In the report’s language, Asia’s “legacy of fiscal prudence,” has given the region “the fiscal space to finance government programs that mitigate poverty and equality,” with policies to “expand and strengthen its comparatively limited fiscal resource base.”

As evidence, the ADB report notes that developing Asia’s gross government debt and tax levels are both considerably lower than those of Latin America — and suggests Asia could afford to tax and borrow closer to Latin American levels.

Echoing the ADB’s theme, the World Bank posted an essay on its website April 11 titled “Latin American no longer views Asia with envy.” These days, Latin America “has an advantage over the Asian ‘teacher’ in many aspects of development, such as the increase in per capita income and reduction of poverty and inequality,” says the essay, which summarizes a panel discussion of experts from each region.

Still, the World Bank article notes that the “swiftness of Asian growth remains an enviable goal.” It says growth in Latin America is forecast to slip to 2.3% this year — less than half the pace of developing Asia.

Numerous factors explain the growth gap. But contrasting economic policies likely play some role. And ADB officials acknowledge the difficult juggle in their new push for higher taxes and spending in Asia.

The IMF this year also has gotten behind redistribution of wealth to reduce inequality. But the fund has stressed it doesn’t want taxes that minimize incentives to work save and invest – potentially hurting growth.

So what taxes work best? The IMF estimates less than 15% of income in developing nations is covered by personal income taxes due to bureaucratic inefficiencies and avoidance. A number of Asian nations are bringing in value-added taxes, which are easier to administer.

ADB economist Joseph Zveglich also said “the value-added tax tends to be a non-distortionary tax,” meaning it doesn’t affect investment and other decisions in an economy. But VAT also is highly regressive, since poor people tend to spend a higher portion of their income than the rich, and so would end up paying a higher effective tax rate. The ADB report suggests that “earmarking new VAT revenues to increase public social spending can make this regressive tax progressive on balance.”

Higher investment taxes would narrow the wealth gap, since the wealthier have bigger portfolios. But “overly emphasizing capital gains taxes would be growth-inhibiting,” said Mr. Zveglich in an interview after presenting the report in Tokyo.

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