Achieving development agendas while also maintaining fiscal sustainability requires that the countries of Latin America and the Caribbean (LAC) improve the way they spend their resources, collect taxes and manage public debt. Spending in LAC is currently insufficient, disproportionately focused on short-term expenditures and not optimally allocated. The public sector has a strategic role to play in financing crucial public services and goods for attaining the sustainable development of the region. However, low tax revenues in most LAC countries limit the state’s capacity to strengthen institutions and to provide more and better public services. Given the region’s heterogeneity, different combinations of policies tailored to each country will be required to improve tax collection and the progressivity of tax systems. But current debt levels in the region limit fiscal space for investment, and high debt service costs reduce spending capacity.

This chapter begins by examining the main trends of public spending in LAC and the need for more and better spending. It presents an analysis of current taxation systems in the region, highlighting the need to achieve fairer, more efficient and simpler designs. It explores possible actions to improve public debt management and promote the use of innovative and sustainable debt tools and examines the importance of developing a tax-paying culture in the region. It concludes with key policy messages.

Central government expenditure as a percentage of gross domestic product (GDP) has grown in LAC over the past 30 years, but it remains relatively low, is biased towards the short term and tends to be pro‑cyclical. In 2023, central governments in LAC allocated a simple average of 25.5% of their GDP towards expenditure, compared to 19% in the 1990s (ECLAC, 2023[1]). Of this, a significant portion went to current spending, which accounted for 82% of total public expenditure across LAC in 2023. However, there is considerable heterogeneity. In Dominica, for example, government expenditure reached 56.9% of GDP in 2022, driven significantly by income from its Citizen by Investment (CBI) programme, which confers citizenship on foreigners who invest in the country. Other Caribbean nations, such as Antigua and Barbuda, Grenada, Saint Kitts and Nevis, and Saint Lucia, also received a substantial financial boost from CBI programmes. Public expenditure as a proportion of GDP was much lower in Paraguay, at 17.3%, and Guatemala, at 14%, in 2023. The composition of current versus capital expenditure also varies markedly in the region (Figure 2.1).

Another aspect of public expenditure in LAC is its cyclical nature. As in other developing regions, countries in LAC tend to decrease public spending during economic downturns and artificially increase current expenditure during upswings (Ardanaz and Izquierdo, 2017[2]) and pre-electoral periods up to 1% of GDP, highlighting their financial restrictions, short political timelines and weak institutions (Nieto Parra and Santiso, 2009[3]). During the COVID-19 pandemic, most LAC economies responded with increases in health spending and economic support measures for households and businesses, but these varied widely in size and type (IMF, 2020[4]). The composition and timing of public expenditure are important in assessing the effect of fiscal stimulus on economic growth (Ilzetzki, Mendoza and Végh, 2013[5]). During downturns, cuts in public investment have a more harmful effect on growth than cuts in public consumption, potentially reducing output by USD 1.3 for every cut of USD 1 in public investment compared to USD 0.4 for public consumption (Ardanaz and Izquierdo, 2017[2]). In Peru, government current expenditure demonstrates multipliers ranging from 0.3 to 0.7, while capital expenditure exhibits multipliers ranging from 1.0 to 1.15 (Restrepo, 2020[6]; Raga, 2022[7]). These figures underscore the importance of strategic allocation in budget planning to maximise the impact of public spending.

Public expenditure in LAC can also promote the reduction of poverty and inequality (Lustig, 2018[8]). In 2024, 26.8% of LAC’s total population lived in poverty, 10.6% in extreme poverty and the Gini coefficient reached 0.45 (Chapter 1). Despite the greater multiplier effect of capital compared to current expenditure, the latter remains high. Therefore, the efficiency in government spending on basic but transformative goods and services, such as education, is essential for citizens’ well-being, and thus for the sustainable development of the region (AFD, 2024[9]; Lustig, 2018[8]).

National budgets help align sustainable development priorities with available public expenditure. To ensure the best possible alignment, governments need to understand the importance of each strategic sector and the cost of developing them (Chapter 1). Many national budgets in LAC are not aligned with development agendas and have inconsistencies between sustainability objectives, the funds assigned and the efficiency of their implementation. For example, fossil-fuel subsidies have been rising in LAC since 2015, as will be discussed below (Figure 2.3) (UNCTAD, 2024[10]). A properly designed budget should not only fund the development agenda but also ensure that the amounts calculated for each objective are properly executed. Improved budget design and implementation and data availability can ensure that each priority is adequately funded and protected from unexpected cuts throughout the fiscal year. In 2021, on average, only 80% of the assigned budget was executed in LAC. Most of the countries executed between 60% and 80% of their budgets, with exceptions like Chile, which executed its entire budget (100%). Nicaragua exceeded its assigned budget with an execution rate of 110% (IDB, 2023[11]).

Co‑ordination among public agencies and jurisdictions is key in aligning objectives designed nationally but financed locally. In recent years, subnational governments in LAC have taken a central role in the administration of public funds in some countries. Subnational governments have accounted for more than 30% of total general government expenditure in countries such as Argentina, Brazil, Colombia, Mexico and Peru, compared to 15% or less in nations like Chile, Costa Rica, Ecuador, Panama, Paraguay and Uruguay (OECD, 2022[12]). Multilevel governance and effective co‑ordination among government levels are essential to ensure alignment between the objectives for sustainable development set at the national level and spending at the local level. Mechanisms and tools such as Programme Budgeting and Budget Trackers aim to prevent spending duplicity between national and local governments that does not achieve public policy objectives. There are many other variables that policy makers should consider when designing and implementing their budgets. The OECD has developed a set of recommendations on budgetary governance that might serve as a reference (Box 2.1).

In LAC, public expenditure in education illustrates that it is not only about how much is spent, but also how well it is spent (OECD/CAF/ECLAC, 2015[14]) (OECD et al., 2019[15]). LAC governments have consistently invested a higher proportion of their GDP in education (4.5%) than other developing regions, but there is strong heterogeneity across the region. Investment per student ranges from 22.2% of per capita GDP in Jamaica to 9.9% in the Dominican Republic (World Bank, 2023[16]). In 2022, LAC recorded a lower average PISA mathematics score for 15-year-old students (373) than the OECD average (472) (Figure 2.2). The comparison between educational outcomes of countries with comparable per capita GDP spending on students highlights how an efficient investment can promote better performance and results for the same amount of funds. Although the data suggest a positive correlation between government expenditure on education and academic performance, it is crucial to understand that it should not be taken as a causal effect, and other factors should be considered in the equation – such as education quality, curriculum effectiveness, different resource availability in rural and urban areas, teacher training, and the socio-economic conditions of both teaching staff and students. Understanding these drivers is necessary for targeted policy interventions that improve educational equity and quality across different countries and regions. By adopting the OECD’s spending efficiency standards, countries could maintain current levels of education expenditure while simultaneously improving outcomes. For example, ceteris paribus, following the OECD’s average performance, with current levels of investment Jamaica could achieve a PISA mathematics score of 501 if the funds were properly spent, while Costa Rica could reach a score of 475.

The rationalisation and sequential phase‑out of fossil fuel subsidies could free up funds for other uses. However, to safeguard inclusivity in the transition to cleaner energy, it is crucial to pair subsidy phase-outs with policies that protect the most vulnerable against fuel price volatility (OECD et al., 2024[18]). Financing fossil fuel subsidies in LAC accounted for 7.4% of GDP in 2021 (Figure 2.3, Panel A). At the time, governments across the region were supporting customers and businesses in light of the global increase in energy prices, and many subsidies tended to be poorly targeted (OECD, 2023[19]). In 2023, Suriname allocated the highest proportion of GDP to fossil fuel subsidies, at 19.5%, followed by Bolivia (14.4%). The LAC countries with the lowest percentages of GDP dedicated to fossil fuel subsidies were Uruguay (1.5%), Barbados (1.4%) and Belize (0.4%) (Figure 2.3, Panel B). Oil remains the most subsidised fossil fuel in LAC (OECD et al., 2022[20]). In Colombia, all fossil fuel subsidies were allocated to the oil sector in 2022, and the same was true for most fossil fuel subsidies in Bolivia and Ecuador. Other LAC countries have diversified. For example, Argentina allocated 42% of its subsidies to oil, 21% to electricity and 37% to gas, while Mexico granted 46% to both oil and electricity, 5% to coal and 3% to gas.

In this context, well-designed budgets are crucial instruments for fostering sustainable and inclusive development models. Inclusiveness can be enhanced with targeted funding. For example, socially inclusive budgets can boost overall energy transition policies by reducing regressive subsidies, which sometimes benefit rich households and increase inequality, and by prioritising funding for compensatory policies for the most vulnerable groups, which can help to avoid setbacks and social unrest (OECD et al., 2022[20]).

For the majority of countries in LAC, funds raised through taxes serve as the primary and most stable revenue source for governments, enabling effective planning and budgeting, and facilitating the funding of vital public services, infrastructure projects and social welfare programmes. In most LAC economies, there is potential to increase tax revenues and improve the progressivity of the tax system. Given the region’s heterogeneity, different policies are needed. Policies should focus on rebalancing the tax structure, rationalising tax expenditures, exploring additional revenue sources such as property, health and environmental taxes, and improving tax administration.

Despite increased tax collection over the last three decades, tax revenues1 in LAC remain insufficient to finance increased public spending. Tax revenues for the LAC region stood at 21.5% of GDP in 2022, well below the OECD average of 34.0%. Levels varied greatly, from 33.3% in Brazil to 10.6% in Guyana (Figure 2.4, Panel A). The tax-to-GDP ratio has steadily increased, from 14.6% in 1990 to 21.5% in 2022, but the gap with OECD economies persists. The increase in the tax-to-GDP ratio in LAC has been mainly driven by increases in revenue from taxes on income and profits, and by value-added tax (VAT) (OECD et al., 2024[22]) (Chapter 1).

Equivalent Fiscal Pressure (EFP) can serve as a complementary measure to the tax-to-GDP ratio. EFP includes mandatory contributions to private social security and non-tax revenues from the exploitation of natural resources (Morán and Solera, 2023[23]; OECD et al., 2024[22]). As such, EFP can assist in evaluating the dependency of LAC countries on natural resources, their vulnerability to price fluctuation and the importance of private social security contributions (SSC) (i.e. non-tax compulsory payments) in the mobilisation of resources. EFP is particularly relevant for countries like Chile and Mexico, where private SSCs and non-tax revenues from natural resources play a significant role. In 2021, these revenues contributed an additional 5.9% of GDP to the traditional tax-to-GDP ratio in Chile, reaching a total of 28.1% of GDP (Figure 2.4, Panel B). In Mexico, they contributed an extra 5.5% of GDP. These contributions accounted for more than 3% of GDP in Bolivia, El Salvador, Panama and Uruguay, while in Argentina, Colombia, the Dominican Republic and Peru they slightly exceeded 2% of GDP. In contrast, in Belize, Guatemala, Jamaica and Nicaragua, non-tax revenues from natural resources and private SSCs are practically non-existent (Morán and Solera, 2023[23]). With the exception of Guyana and Trinidad and Tobago, where non-tax revenue from oil production and exploitation are high, many other Caribbean countries rely significantly on non-tax revenue sources from Citizen by Investment (CBI) programmes and grants (ECLAC, 2024[24]).

The tax structure in the region is characterised by a low contribution of direct taxes and a high reliance on indirect taxes. In 2022, personal income tax (PIT) and SSC accounted for 26.7% of total tax revenue (5.7% of GDP) in LAC, compared to the OECD average of 48.4% of total tax revenue (16.9% of GDP) (Figure 2.5). In contrast, corporate income tax (CIT) contributed more to tax revenues in LAC than in OECD countries. CIT accounted for 16.3% of total tax revenues (3.4% of GDP) in LAC, compared to 12.0% of total tax revenues (3.9% of GDP) in OECD countries. Taxes on goods and services represented 48.4% of total tax revenues (10.4% of GDP) in LAC, compared to less than 32% of total tax revenues (10.6% of GDP) in OECD countries. In LAC, VAT accounted for most of the revenue from goods and services, contributing 28.3% of total tax revenues and 6.1% of GDP (OECD et al., 2024[22]).

Indirect taxes, including VAT and import duties, tend to be regressive if measured against current income and proportional or slightly progressive when measured as a percentage of current expenditure. When poorly designed and targeted, these taxes can place a disproportionate burden on low-income populations. For instance, fiscal incidence analysis across ten countries in the LAC region showed that VAT is regressive, but that its impact on the current income of poorer households was mitigated by high levels of evasion and informality (Pessino et al., 2023[25]). In addition, substantial tax expenditures aimed at making VAT less regressive often primarily benefit the wealthy (the group with the highest levels of consumption) in absolute terms. In other words, a lack of household-level targeting of tax expenditures leads to higher-income households benefiting the most (Pessino et al., 2023[25]). To improve the progressivity of VAT, tax expenditures should be rationalised and designed in such a way as to minimise regressive effects and revenue losses, in some cases compensating poor households for their loss in purchasing power from paying VAT. It has been shown that social transfers (targeted benefit schemes or even universal transfer schemes) can deliver greater benefits to poorer households than reduced VAT rates or exemptions for the same fiscal cost in developing countries (Warwick et al., 2022[26]). Social programmes must be better targeted and designed to help lift households out of poverty (Chapter 1) (Núñez and Lasso, 2024[27]).

Low levels of personal income tax collection and inefficient tax expenditures weaken the ability of tax systems in LAC to promote equity and sustain long-term development. Factors contributing to low PIT collection include: i) high tax reliefs (such as personal deductions and income exemptions); ii) a narrow tax base that is comprised primarily of wages (since tax privileges are often granted to returns on capital); and iii) high levels of tax evasion (OECD et al., 2024[22]). Tax relief often includes provisions such as deferrals and allowances that limit potential tax revenue. In some cases, deductions and exemptions mainly favour taxpayers with higher incomes (Núñez and Lasso, 2024[27]). Enhancing and reassessing the design of PIT holds promise for increasing progressivity and revenue generation in the region. For instance, a reassessment could favour targeted tax relief measures for low-income individuals over more general tax benefits, such as broad-based deductions or credits that disproportionately benefit higher-income earners. Finally, it is imperative to overcome the political challenges associated with reforms that affect higher-income sectors. Achieving a balance between administrative simplicity, distributive equity and revenue sufficiency is crucial (ECLAC, 2023[28]).

The potentially positive impact on inequality and poverty of direct taxes suffers from the effect of SSCs, which is relatively high in LAC and tends to make taxation less progressive and thus to increase poverty (Pessino et al., 2023[25]). In addition, tax expenditures for both PIT and CIT are regressive in the region, averaging 0.8% and 0.4% of GDP respectively. Improving the targeting of tax expenditures is essential to improve the progressivity of direct taxes (Pessino et al., 2023[25]). Taking the analysis a step further requires considering the redistributive impacts of the net fiscal system – that is, the combined effect of taxes and transfers on inequality.

As tax evasion significantly impacts the equity and efficiency of tax systems in the region, combating evasion of both direct and indirect taxes is essential. In 2018, CIT evasion in LAC reached an average of 2.9% of GDP and PIT evasion 1.5% of GDP (Pessino et al., 2023[25]). High levels of evasion of SSCs also persist, although official estimates are scarce (OECD, 2019[29]). For indirect taxes such as VAT, estimates indicate an average evasion rate of 2.2% of GDP, representing about 30.0% of total tax evasion (Rasteletti and Saravia, 2023[30]). Evasion is examined in greater detail in the section on tax morale below.

Relatively high tax rates on corporate profits in the LAC region could deter competitiveness and investments. Average statutory CIT rates were 25.0% in LAC in 2021, above the OECD’s 21.5%. However, revenue levels and statutory tax rates (STRs) do not show differences across jurisdictions regarding several important features, such as fiscal depreciation rules as well as other tax provisions. These provisions include allowances for fiscal depreciation, deductions for interest payments and equity financing. Because these provisions can significantly affect tax liabilities, their generosity is key for the correct measurement of effective taxation across tax systems.

LAC countries have relatively high forward-looking average and marginal effective tax rates (ETRs). They are a useful tool for best gauging the effective tax burdens on investment projects (Hanappi et al., 2023[31]; OECD, 2022[32]). This methodology is based on assumptions about the financial returns of hypothetical investment projects, to which existing tax provisions are applied to determine the amount of tax owed and do not require information from tax returns. In 2021, the effective average tax rate (EATR)2 for a given investment project in the 21 LAC countries analysed3 averaged 23.9%, compared to 21.9% in OECD countries and 17.1% in the remaining countries in the sample, which includes data from emerging Europe, Middle East and Central Asia, emerging Asia and Sub-Saharan Africa. In the case of effective marginal tax rates (EMTR), the average rate was 13.8% in the LAC region, almost double the average of 7.6% in OECD countries and 7.8% in the remaining countries (Figure 2.6). At the country level, Argentina, Brazil and Chile had the highest EATR of the 89 jurisdictions analysed. In the case of EMTR, Argentina, Bolivia, Chile, Jamaica and Peru were in the top ten (Hanappi et al., 2023[31]).

The forward-looking high ETRs in LAC countries are mainly explained by the region’s high statutory CIT rates, but also by ungenerous tax provisions that in some cases can even increase ETRs. The effect of tax provisions on ETRs can be observed by analysing the difference between STRs and EATRs. This difference is on average only 0.2 percentage point (p.p.) in LAC, while it reaches 1.7 p.p. in OECD countries and 0.8 p.p. in the remaining countries in the sample. However, the LAC figure is skewed by important outliers that present large decelerating tax treatment of capital expenditure. These countries are Argentina, Bolivia and Chile, where the tax treatment of acquired software drives high EATRs (Hanappi et al., 2023[31]).

Incentives or preferential tax treatment in specific activities, sectors and locations affect CIT revenues and effective rates. Tax incentives provide a more favourable tax treatment compared to the standard treatment and are targeted to specific taxpayers. Incentives are often implemented to stimulate investment or support other policy objectives, like sustainable development goals. However, incentives may be of limited effectiveness when poorly designed and may provide windfall gains to projects already planned without incentives. They can also result in foregone government revenue, create economic distortions, erode the principle of equity and increase administrative costs (Celani, Dressler and Wermelinger, 2022[33]). The region needs more and better analysis of the costs and impact of incentives, which in some cases may need a redesign (OECD, 2022[34]). Such analysis is particularly important in view of new international agreements on the global minimum effective corporate tax rate (GMT). The GMT can have a significant impact on the effectiveness of certain tax incentives and may require a careful reconsideration of the design and implementation of tax incentives in the region (Box 2.2).

Tax incentives are a common feature of many CIT systems, including in LAC. In 2021, foregone revenue from CIT incentives averaged 3.7% of GDP in LAC countries, equivalent to 19% of central government tax revenues (OECD et al., 2023[35]).

Existing evidence and policy guidance emphasise that tax incentives can increase investment but that such effects are uncertain and heterogeneous and depend on incentive design, firm and asset characteristics, and the economic context. The risk of tax incentives being ineffective, in addition to their associated costs, raises questions regarding their role in a country’s policy toolbox. Existing policy guidance cautions against their use and promotes few design and implementation principles (IMF et al., 2015[36]), for example favouring expenditure-based (e.g. tax allowances and credits) over income-based incentives (e.g. reduced rates and tax exemptions) to boost investment while limiting revenue costs. It also recommends regularly monitoring and evaluating incentives to ensure they are fit for purpose, publishing revenue loss estimates in tax expenditure reports, transferring the oversight of all incentives to a single organisation (normally the Ministry of Finance), and ensuring effective co-ordination and clear mandates amongst government stakeholders.

Analysis is crucial to understanding the effectiveness of corporate income tax incentives in achieving policy objectives and their costs. A useful first step is to map the many different designs of CIT incentives available across countries and calculate their effect on corporate effective tax rates. The OECD Investment Tax Incentives Database (ITID) compiles quantitative and qualitative information on the design and targeting of investment tax incentives available across economies, using a consistent data collection methodology. It focuses on incentives that are provided through the CIT system and that are only available to a specific group of corporate taxpayers, based on the taxpayers’ sector, activity, location or other investor- or project-related characteristics (i.e. targeted provisions) (Celani, Dressler and Wermelinger, 2022[33]). The 2022 version of the ITID finds that, among 52 emerging and developing economies, almost 90% of economies use at least one tax exemption, while 69% and 65% of the economies use reduced rates and tax allowances respectively (OECD, 2022[37]).

More data and analysis on the use, design and impact of tax incentives are needed given their widespread use in the region. CIT incentive analysis can shed light on areas for improvement in the design of incentives and yield recommendations to make them simpler, more transparent and conducive to quality investment and reduce their costs. As part of a fiscal co‑operation project with the Spanish Agency for International Development Co‑operation (AECID), at least eight LAC economies4 will be included in the ITID and relevant ETR measures evaluated by the end of 2024. The purpose is to help LAC policy makers make smarter use of tax incentives and rationalise and reform costly but inefficient ones.

As in many other countries, LAC countries tend to grant targeted tax incentives or preferential tax treatments that reduce ETRs in specific activities, sectors and locations. To illustrate how the tax incentive analysis can be used, ETRs were calculated for selected tax incentives in three economies in the region (the Dominican Republic, Ecuador and Paraguay) and three industries (textile, metals and tourism) (Figure 2.7). While the Dominican Republic and Ecuador have a 25% standard ETR, they offer sector-specific tax incentives that substantially lower effective taxation in two of the industries. For example, ETRs can be as low as 0% in textiles in the Dominican Republic and be 45% lower than standard taxation in the Ecuadorian metals industry (13.7% compared to 24.8%). While Paraguay does not use CIT incentives, it applies a relatively low standard CIT rate, resulting in the lowest ETR in the metals and tourism industries across the three countries.

Recurrent taxes on immovable property can help reduce inequality, yet their potential in the region has not been fully realised. Recurrent taxes on immovable property accounted for 0.4% of the region’s GDP on average in 2022, well below the OECD average of 1% (Figure 2.8). However, there is great heterogeneity in property tax collection across the region, ranging in 2022 from 1.8% of GDP in Barbados to 0.1% in the Dominican Republic. Recurrent taxes on immovable property remained largely unchanged between 2014 and 2022 in most LAC countries, with slight decreases in some cases. In Barbados, revenues from these taxes fell from 2.1% of GDP in 2014 to 1.8% in 2022, marking the largest decline in the region. Argentina, Guyana, Panama and Saint Lucia also saw a reduction of 0.1% of GDP. Fully leveraging property taxes on immovable property by updating current systems to simpler, more taxpayer-friendly valuation methods could potentially generate additional revenues of 1.5% to 2.0% of GDP (Ahmad, Brosio and Jiménez, 2019[41]).

Most countries and municipalities in LAC use value-based approaches for property taxation, which are often difficult and costly to administer due to limited administrative capacity and the unpopularity of such taxes in certain regions (Ahmad, Brosio and Jiménez, 2019[41]). A value-based approach assesses taxes based on a property’s market value, using either assessed or cadastral values, or a combination of both. They also require very precise information that can be hard to obtain in countries or municipalities with limited administrative capacity. To make the system more taxpayer-friendly and address issues of complexity and unpopularity, simpler alternatives include self-assessment, an area-based system and a banded system. In the case of the self-assessment system, property owners estimate their own property's value. Depending on the local context (e.g. the level of administrative capacity), area-based taxation can be implemented, where taxes are based on property size or characteristics, and taxpayers participate in determining the tax base. The area-based system, in particular, could generate significant revenue and reduce inequality, especially if the funds are directed toward social programmes (Ahmad, Brosio and Jiménez, 2019[41]). The banded system, which groups properties into categories to simplify tax calculations, could complement either approach (self-assessment or area-based) (Ahmad, Brosio and Jiménez, 2019[41]). Countries and municipalities in LAC should aim to progressively adopt valuation systems that simplify the tax process, improve transparency, and involve taxpayers in determining their tax liabilities.

While urban land constitutes the primary component of the tax base for recurring property taxes, it is crucial to also assess the potential revenue contribution from rural land. Special attention must be taken to avoid setting tax rates too high, as this could have negative economic effects, such as discouraging investment or burdening rural communities. On average, rural property makes up a notable 20.8% of the total property value recorded in the cadastre across the LAC region. Residential property constitutes the largest share at 64.2%, followed by vacant sites at 21.9%, and non-residential property at 4.6% (Lincoln Institute of Land Policy, 2014[42]).

Improving recurring property tax administration in the region is essential (Choga and Giwa, 2023[43]). For countries and municipalities with established value-based systems, it is essential to further enhance this capacity by investing in data collection and management systems (e.g. multipurpose cadastre), training personnel, and improving administrative infrastructure. For countries with numerous rural or hard-to-reach areas, exploring simpler methods such as self-assessment or area-based approaches may be more beneficial. Furthermore, to ensure the progressivity of recurring property taxes, it is essential to balance accurate property value assessments with managing administrative costs, while also ensuring that taxes are fair and contribute to the funding of essential services (Ahmad, Brosio and Jiménez, 2019[41]).

Health taxes offer advantages for governments by simultaneously curbing the consumption of unhealthy products, generating additional tax revenue and potentially lowering long-term healthcare costs (Sassi et al., 2023[44]). By promoting healthier lifestyles, these taxes can also enhance long-term labour productivity (PAHO, 2023[45]). Across developing countries, health tax reforms remain relatively limited (OECD, 2023[46]). Most have focused on increasing excise duties on tobacco (and alternatives) and alcohol, while fewer have introduced taxes on sugar-sweetened beverages (SSBs) (OECD, 2023[46]).

Although health taxes on tobacco, SSBs, and alcohol have been implemented in LAC, there is still room to expand them. For example, revenues from tobacco taxes could be increased by raising the tax rates, and these tax increases could also reduce cigarette use (OECD/The World Bank, 2023[47]). Studies in 31 LAC countries indicate that a 50% excise tax increase on a pack of cigarettes can increase tobacco tax revenue by 32%, representing an additional USD 7.1 billion for the region (Goodchild, Sandoval and Belausteguigoitia, 2017[48]). At the same time, 21 countries in LAC have implemented some type of SSB tax. However, many countries' tax policies are misaligned with health goals as they continue to tax bottled water but not certain high-sugar beverages (PAHO, 2022[49]). In 2023, Colombia became one of the first countries in the world to tax ultra-processed products when it introduced a health tax on such products and SBBs. The tax started at 10% and will rise to 20% by 2025 (OECD, 2023[46]). In Mexico, a study showed that an excise tax on SSBs that resulted in a 10% drop in consumption could save the country USD 983 million in health care costs, while a drop in consumption of 20% could save USD 1.9 billion in health care costs (Sánchez-Romero et al., 2016[50]). As for alcohol taxes, 28 LAC countries applied taxes to beer and spirits as of 2018, while 26 did so for wine (PAHO, 2022[49]).

A comprehensive fiscal policy approach to health taxes in LAC is crucial. These taxes should not be seen merely as tools to reduce the demand for unhealthy products, but also as instruments to promote and enable longer, healthier lives (Sassi et al., 2023[44]). They serve as important sources of information for both consumers and producers. For consumers, these taxes offer insights that help individuals understand their rationale and make more informed health choices, beyond just the financial impact. For example, for producers, particularly in the case of SSB taxes, the information helps them reformulate their products – a key intended outcome of such taxes (Sassi et al., 2023[44]). Health taxes frequently attract criticism for their potentially regressive financial effects, amplified by their high visibility and divisive nature (Sassi et al., 2023[44]). Policy makers need to establish a consistent policy framework and narrative to address and counter these critiques effectively (Sassi et al., 2023[44]). On the supply side, governments must regularly modify the design of health taxes to maintain their effectiveness in the face of evolving market structures and strategic reactions (Belloni and Sassi, 2023[51]). Therefore, it is important to consider industry responses, as these can impact tax revenue collection. For example, in the United Kingdom, a health tax on SSBs led to product reformulation and a shift in advertising towards non-taxed or lower-taxed products. While this outcome was successful in terms of product reformulation, the SSB tax generated only 0.03% of total tax revenue (Belloni and Sassi, 2023[51]).

The adoption of environmentally related taxes in LAC countries has been slow, with a heavy reliance on fuel taxes. Environmentally related tax revenues (ERTR) can help to increase revenues in the short to medium term while pursuing environmental and social objectives. These measures should be implemented with the understanding that they may generate progressively less revenue over time if they successfully lead to changes in behaviour as the green transition advances. In 2022, ERTR in LAC averaged 0.8% of GDP, below the OECD average of 1.8% of GDP (Figure 2.9). In LAC, these values ranged from 0.1% of GDP in Belize to 2.0% in Costa Rica. Costa Rica’s ERTR is the only one in LAC that surpassed the OECD average. In Costa Rica, fuel taxes are higher than in many other Latin American countries, while subsidies remain lower (OECD, 2023[52]). Several countries, such as Barbados, Honduras, Nicaragua, and Peru, source their ERTR almost exclusively from energy, with amounts ranging from 1.4% of GDP in Honduras to 0.4% of GDP in Peru. In contrast, Brazil and Trinidad and Tobago rely almost exclusively on transport for ERTR.

Countries such as Chile, Colombia and Mexico have undertaken significant green tax reforms, reflecting their commitment to environmental protection. The impact of these reforms is reflected in the wide variation of environmentally related tax revenues across the region (OECD et al., 2024[22]). For instance, in 2014, Mexico implemented a Special Tax on Carbon, replacing previously ineffective fuel subsidies with impactful fuel taxes. This green tax, aimed at mitigating emissions from fossil fuels, especially gasoline and diesel, led to a substantial increase in fiscal revenues, transitioning from a cost of MXN -300 billion (Mexican pesos) to a revenue of MXN +300 billion (AFD, 2022[53]).

Further developing explicit carbon pricing mechanisms can help to increase revenues in LAC. On average, carbon pricing instruments have the potential to increase government revenues by up to 2.0% of GDP in the region (OECD et al., 2022[20]). In some LAC countries, these revenues could be as high as 4.2% of GDP, as observed in Ecuador, or as low as 0.3% of GDP for Costa Rica, when considering both carbon pricing and subsidy reforms. Governments can increase carbon prices through the introduction of new carbon taxes, increases in carbon tax rates, the phasing out of carbon tax reductions or exemptions, or increases in the stringency of minimum standards for carbon price benchmarks (OECD, 2023[54]).

Carbon taxes, emissions trading systems (ETS) and carbon credits are different carbon pricing methods that hold the potential to reduce emissions while generating additional revenues. Carbon taxes put a price on emissions. An ETS caps emissions and enables trading. Carbon credits involve trading emission reductions. In LAC, explicit carbon taxes are emerging, with countries like Argentina, Chile, Colombia, Mexico, and Uruguay adopting them (Table 2.1). For instance, in its latest tax reform (Law 2277 of 2022), Colombia expanded the base for the carbon tax. However, in most countries carbon taxes have only recently gained traction and are still being implemented at low rates with limited coverage (OECD, 2023[54]). ETS can generate significant revenues through allowance auctions of permits, which, if well designed, can support key sustainable development objectives. In the European Union, ETS auction revenues are used to spur investments in clean technologies (IEA, 2020[55]). As of March 2024 in LAC, only Mexico had implemented an ETS pilot policy, with legal and political hurdles still affecting the implementation of ETS in Brazil, Chile and Colombia (Table 2.1) (OECD et al., 2022[20]). The establishment of a carbon credit market can also open new avenues for revenue collection, such as taxes on transactions or administrative fees for the registration and transfer of credits. Since the LAC market is growing and maturing, these revenues can be significant (OECD, 2023[54]). LAC stands as the world's second-largest source of carbon credits, contributing approximately 20% of all global carbon credits generated in 2020 and 2021 (World Bank, 2023[56]). However, only Chile and Colombia have developed their own carbon credit mechanisms, which operate in conjunction with a carbon tax or an ETS policy (Table 2.1). To ensure the effectiveness of these credits in high-impact green projects, it is essential that environmental benefits are fully realised, fair distribution among local communities is guaranteed, and alignment with the national carbon finance strategy is achieved.

Environmentally related taxes should be accompanied by protection schemes for vulnerable households. Developing and improving compensation and mitigation measures, such as cash transfers, in-kind support, active labour market policies and entrepreneurship programmes, are essential to cushion social costs and strengthen social protection systems. For instance, gasoline taxes have a direct impact on middle- and high-income households through private transportation costs. But, more importantly, gasoline taxes indirectly impact low-income households through public transportation and the transportation costs incorporated into the prices of goods and services they purchase, including food. Recent studies indicate that the increase in indirect tax pressure on poor households associated with gasoline taxes can even reverse the poverty-reducing effect of direct transfers (AFD, 2022[53]). This makes implementing gasoline taxes even more challenging during periods of high energy prices. Countries in the region can develop better support mechanisms to help households adapt to higher energy costs through technological changes and public transport development. More precisely targeted mechanisms using carbon tax revenues for income support policies are necessary to address distributional consequences. Compensation policies should be complemented by programmes facilitating relocation, retraining and the promotion of decent work (OECD et al., 2022[20]).

Well-designed presumptive tax regimes, hold the potential to bolster tax compliance and promote business formalisation. Presumptive tax regimes offer a practical solution, for example by applying taxes on an assumed income base, making them more straightforward and efficient than standard methods. This approach not only facilitates the formal registration of businesses but it could also aid in broadening the social safety net by subsidising social security contributions for micro firm workers (Azuara Herrera et al., 2019[57]; Mas-Montserrat et al., 2023[58]). By reducing compliance costs and imposing lower tax rates compared to standard tax systems, they primarily target micro and small businesses in both the formal and informal sectors. Though not primarily aimed at immediate revenue generation, these regimes can significantly enhance long-term tax compliance, yielding positive revenue effects over time (Azuara Herrera et al., 2019[57]).

For presumptive tax systems to be effective, their design should include identifying specific target groups, establishing clear and verifiable eligibility criteria, reducing compliance costs for taxpayers and enforcement costs for the tax administration, providing an incentive to formalise, and ensuring that the system is affordable for the target group. It should also facilitate, rather than deter, migration into the standard tax system (Mas-Montserrat, Colin and Brys, 2024[59]; Mas-Montserrat et al., 2023[58]). Poorly designed regimes may yield adverse effects on revenue and equity and increase tax evasion. A presumptive tax regime focused solely on short-term revenue gains could deter taxpayers from joining the formal economy. Thus, gradual implementation is advisable to improve compliance. These regimes may also inadvertently foster tax evasion by creating discontinuities in the tax schedule, such as sudden changes or gaps in tax rates or thresholds. These discontinuities can provide opportunities for individuals or businesses to exploit loopholes or ambiguities in the tax system, thereby reducing their tax obligations or avoiding taxes altogether. Such distortions could ultimately hamper overall productivity and GDP growth (Azuara Herrera et al., 2019[57]). To combat tax evasion, it is crucial to further digitalise services, enabling tax authorities to verify compliance through digital means such as mobile phone or Internet-based tax returns and payments (Mas-Montserrat et al., 2023[58]). Digital solutions can simplify tax regimes and increase trust in governments through digital governance initiatives (see below on tax morale). A simpler, digitally enabled tax system encourages compliance and facilitates the tracking of payments, which in turn raises awareness and reduces evasion (Arsovska, 2021[60]).

Presumptive tax systems have the potential to expand social protection coverage and gradually increase revenue generation, especially when they incorporate social security contributions (OECD, 2024[61]). Under such a regime, small businesses could be allowed to pay a single tax that replaces as many taxes as possible, including social security contributions. By offering social protection access, these systems may encourage individuals to formalise their businesses. Specific cases in LAC demonstrate that simplified tax regimes can effectively reduce informality (Mas-Montserrat, Colin and Brys, 2024[59]). Uruguay now boasts the lowest level of informal employment in the region following implementation of the Monotributo regime (Mas-Montserrat, Colin and Brys, 2024[59]; Mas-Montserrat et al., 2023[58]). Introduced in 2001 and expanded in 2006, Monotributo offers a simplified framework by consolidating social security contributions and income tax into a single payment. It allows self-employed individuals to register as personal enterprises with one employee, as partnerships with two partners or as family businesses with a maximum of three partners and no employees (Azuara Herrera et al., 2019[57]).

Tax policy can contribute to gender equality and to governments’ efforts to reduce inequalities (OECD, 2022[62]). The payment of taxes can directly or indirectly exacerbate gender inequality, depending on how and on whom the tax burden is imposed, as well as its size (ECLAC, 2021[63]). While men and women are generally subject to the same tax regulations, gender inequalities within the tax system can inadvertently be perpetuated by social and economic differences, such as income disparities or varying levels of labour participation (OECD et al., 2023[38]). Identifying biases that perpetuate these inequalities is crucial for phasing them out and promoting gender non-discrimination in taxation. In LAC, countries must develop more gender-responsive tax systems. While some countries have made progress in reforming tax policies to enhance gender equity, further measures are necessary.

Identifying and addressing both explicit and implicit biases are essential for moving towards more gender-equal tax systems. Explicit biases are written into laws or seen in informal practices, while implicit biases lead to unequal impacts despite similar treatment. In direct taxation, biases arise from joint taxation, differential treatment by income source, tax allowances and the different relative share of women and men in different occupational categories. In the Dominican Republic, for instance, joint filing is standard unless a woman proves that she has independent income (ECLAC, 2021[63]). In indirect taxation, there may be implicit biases that can contribute to regressivity, as these biases may disproportionately affect lower-income women who spend a larger share of their income on taxed goods and services. Here, strengthening the progressivity of tax policies is key. While a progressive tax system does not equate to a gender-responsive one, it generally exhibits greater sensitivity to gender-specific impacts (ECLAC, 2021[63]).

Moreover, tax policy may contribute to gender-related inequalities in labour market outcomes, especially with respect to labour market participation. Studies indicate that tax burdens on households’ secondary earners (who are mostly women) can discourage their participation in the labour market (ECLAC, 2021[63]). Studies show that in some countries second earners face higher effective tax rates than single workers when they enter the workforce (OECD, 2024[64]). Additionally, tax-induced disincentives for second earners are more significant in countries that employ household-level taxation or in jurisdictions with individual-level taxation where tax benefits are calculated on a household basis (OECD, 2024[64]).

Formalising the care sector would significantly benefit women and potentially increase tax revenues. Through well-designed care policy packages that improve earnings and expand employment, countries in the region can unlock significant tax revenue potential (OECD, 2024[65]). Formalisation of this sector can help to expand tax bases and promote greater labour market attachment. In LAC, unpaid care work is equivalent to 21% of GDP (significantly above the OECD average of 15%), with women contributing three-fourths of this share (UNDP, 2024[66]). Globally, closing the care sector formalisation gap requires a 4.2% of GDP investment by 2035. However, this investment could be partially offset by increased tax revenue from a wider tax base due to formalisation. Estimates suggest that this could reduce the net funding requirement to 3.2% of GDP by 2035. Women would benefit significantly, holding 78% of the new jobs created, with 84% of these being formal positions (ILO, 2022[67]).

Gender-sensitive tax policies should also foster the development of women's entrepreneurship. Women face challenges in raising capital, and cultural norms and stereotypes often hinder their access to emerging technology and entrepreneurial industries. Although the financing gap for women-owned micro-enterprises in LAC remains significant, it is currently the smallest among developing regions due to concerted multi-stakeholder efforts. This demonstrates that co‑ordinated efforts among international co‑operation agencies, governments, civil society and the private sector can have a long-term positive impact, consolidating more gender-sensitive policies (Berg, Rubio and Laske, 2024[68]).

Public debt enables governments to finance human and physical capital investments, facilitating long-term economic growth. It helps to smooth macroeconomic fluctuations by providing fiscal stimuli during recessions to support economic activity. However, the benefits of public debt depend on the productivity and efficiency of its utilisation, the stage of the economic cycle and the level of financial market development (Ayhan, Ohnsorge and Sugawara, 2020[69]).

High debt levels may pose several risks for countries. First, high debt levels increase vulnerability to financial crises. Rising debt ratios may lead to an erosion of investor confidence and demand for higher risk premiums, potentially leading to a debt crisis when debt levels are considered unsustainable (Ayhan, Ohnsorge and Sugawara, 2020[69]). They may also constrain government responses during economic downturns, since resources to implement fiscal policy are constrained (Romer and Romer, 2018[70]). Furthermore, rising debt ratios have a negative impact on economic growth since they displace productive public expenditures, increase domestic interest rates and diminish private-sector investment (Powell and Valencia, 2023[71]). In LAC, debt levels have decreased since the COVID-19 pandemic, but the current global context has given rise to public debt sustainability concerns (Chapter 1).

Public debt levels relative to the size of the economy exhibit heterogeneity across countries in the region. For instance, Barbados’ public debt as percentage of its GDP stood at 140% in 2021, while figures for Colombia and Chile were 57% and 21% respectively. Heterogeneity persists across multiple dimensions of debt composition, including the currency of issuance (whether domestic or foreign), the legislative framework of issuance and the maturity profile. The composition of creditors can also vary, encompassing different levels of participation from the private sector and bilateral and multilateral banks. These diverse characteristics shape distinct debt profiles for countries.

There is heterogeneity in the composition of public debt across LAC economies (Figure 2.10). While domestic debt is predominant, with 74% of public debt in the region issued under internal legislation, external debt continues to serve as an important source of financing for some countries. For instance, in Brazil, Mexico and Costa Rica, domestic public debt accounts for 98%, 78% and 75% of total debt, respectively, while in Nicaragua, Paraguay and Panama, external debt makes up 90%, 90% and 81% of total debt, respectively. Issuing bonds under domestic legislation presents several advantages, including the use of national custody and settlement systems, lower required volumes per issue than in international markets and the resolution of any litigation in national courts with lower costs and less uncertainty (Powell and Valencia, 2023[71]). However, there are risks. For instance, domestic debt may be subject to higher interest rates than debt issued under external legislation. Moreover, sustaining domestic issuances relies on the level of financial market development, which tends to be low in the region. Countries face challenges related to liquidity and the creation of a broad and diversified investor base (Jonasson and Papaioannou, 2018[72]).

Although 69% of public debt in LAC is held in domestic currency, foreign currency issuances are significant in several countries, exposing them to exchange rate fluctuations. Allocation varies across countries. Debt in domestic currency represents 66% to 95% of the total debt of Brazil, Mexico and Chile (Figure 2.10). High local currency debt issuance reduces debt sustainability risks in the face of large exchange rate depreciations (OECD et al., 2020[73]). Although foreign currency debt is typically associated with external debt, certain countries in the region also issue domestic debt in foreign currency. Ecuador, El Salvador, Nicaragua and Panama hold domestic debt exclusively denominated in foreign currency. Countries such as Argentina, the Dominican Republic, Paraguay and Suriname hold sizeable issuances in non-domestic currency, amounting to 70% to 90% of their total debt. For these countries, debt service has the potential to increase significantly in national currency terms, creating pressure to mobilise additional resources or cut public spending to meet obligations (ECLAC, 2023[74]).

Historical trends in debt issued under domestic currency also exhibit heterogeneity. Between 2015 and 2021, a consistent share of total debt denominated in domestic currency was maintained by Brazil (95%) and Mexico (78%). In contrast, countries such as Belize, Guatemala, Guyana, Haiti, Honduras and Uruguay experienced notable increases in their domestic currency debt over this period. The share increased from 26% to 55% in Guyana, for instance, and from 18% to 34% in Belize. At the same time, significant declines were registered in Suriname (from 49% to 20%) and Paraguay (from 25% to 10%), indicating a shift towards debt denominated in foreign currency (IDB, 2021[75]).

An increase in the share of local currency debt has long been a policy objective in LAC. An excessive level of foreign currency debt has been associated with recurrent currency crises and debt defaults. Foreign currency debt increases financial vulnerability because the exchange rate would need to depreciate sharply after a negative shock, and this causes an automatic jump in the public debt-to-GDP ratio. Gains in the share of local currency government debt have resulted from a stronger macroeconomic policy framework in many economies in the region, and from a growing domestic institutional investor base (Powell and Valencia, 2023[71]).

A long-term structuring of external debt reduces exposure to financial market volatility. However, some countries face medium- and short-term obligations, rendering them vulnerable during periods of rising interest rates. The bulk of the region’s public debt is long-term (more than 5 years), followed by medium term (1-5 years), with a slight proportion of short-term debt (less than a year) (Figure 2.11). The average remaining maturity stands at 13 years. Longer amortisation profiles are associated with less exposure to financial market fluctuations (mainly interest rate shifts). Countries such as Argentina, Brazil and Suriname face obligations over the next five years, representing about 40% of their GDP.

External debt in Latin America is mainly held with private creditors. However, multilateral and bilateral lenders remain the main financing source for countries with constrained access to financial markets. External resources raised vary across the region. On average, the creditor structure of the region is composed of bonds (51%), multilateral banks (19%), bilateral creditors (13%) and commercial banks (11%) (Figure 2.12). Caribbean economies like Dominica, Haiti, and Saint Vincent and the Grenadines, and Latin America countries such as Bolivia, Guatemala, Honduras and Nicaragua, mainly rely on debt issued through multilateral and bilateral creditors. Countries that have traditionally had access to capital markets such as Argentina, Brazil, Colombia, the Dominican Republic, Mexico and Peru, mainly raise funds through bond issuances.

Credit quality improved in LAC in 2023 after deteriorating in previous years, with 14 more positive than negative actions by credit rating agencies (Figure 2.13). The credit outlook was revised upward for 11 countries in the region, and eight countries were upgraded: Argentina, Barbados, Brazil, Costa Rica, El Salvador, Guatemala, Jamaica and Uruguay. The outlook was revised downward for four countries, and five were downgraded: Argentina, Bolivia, Ecuador, El Salvador and Panama. Reasons for positive actions included completed distressed exchanges or debt restructurings, better economic conditions and resilient fiscal performance. Reasons for negative actions included heightened risks and vulnerability, political uncertainty and depletion of external liquidity buffers (ECLAC, 2023[77]). Moreover, in 2024, Paraguay's credit rating was upgraded, achieving investment grade for the first time. This was driven by sustained economic growth, enhanced fiscal stability, greater resilience to external shocks, and reforms that strengthened public institutions.

Debt service as a proportion of tax revenues has increased due to higher debt levels and interest rates, constraining fiscal space for development-oriented government spending and investment. Developing countries face higher borrowing costs in financial markets, even after considering default risk and market volatility. This results in many governments dedicating a high share of revenue to debt service payments that could be crowding out public spending (Gray Molina and Jensen, 2023[78]). Across the region, the ratio of debt service to tax revenue reached 12.2% in 2022, up from 9.8% in 2012 (Figure 2.14). Most countries in LAC have experienced increases, with the highest levels in 2022 seen in Mexico (30%), the Bahamas (23%), the Dominican Republic (20%) and El Salvador (20%). In contrast, countries such as Barbados, Chile and Jamaica have achieved significant reductions. Jamaica stands out as a notable case of debt reduction due to the adoption of well-designed fiscal rules and a partnership agreement that ensured the equitable distribution of adjustment burdens (Arslanalp, Eichengreen and Blair, 2024[79]) (Chapter 1).

Over the past decade, interest payments on debt have surpassed core government expenditures in several countries. For instance, in some cases, debt service has exceeded the spending on education and reached two times that on healthcare and capital investment. However, the differences in research and development are even more pronounced (Figure 2.15). At the same time, the weight of debt service relative to expenditure in other priority areas varies across the region. While countries such as Chile and Paraguay face lower debt service burdens, others like Brazil and Jamaica experience higher ratios. Debt service constitutes more than 25% of all government spending in some LAC countries (Martin and Waddock, 2022[81]).

Fiscal frameworks are an essential tool to preserve medium- and long-term stability. They establish rules that can help fiscal policy to be countercyclical, reduce discretionality of public spending and guarantee debt sustainability (Chapter 1). Within them, Medium-Term Fiscal Frameworks (MTFFs) focus on a 3- to 5-year perspective of fiscal aggregates, promoting fiscal discipline, guiding annual budgets and enabling governments to better manage risks and policy trade-offs (Curristine et al., 2024[83]). Fiscal frameworks can also help to protect public investments that are essential for the production transformation. Without fiscal frameworks, governments may find it easier to reduce public investment rather than cut current expenditures during episodes of fiscal consolidation due to political considerations (Ardanaz and Izquierdo, 2017[2]). This can affect economic recovery and impact long‑term growth. In contrast, protecting investment during a fiscal consolidation period can mitigate economic contraction and, in some cases, lead to an expansion (Arreaza et al., 2022[84]; OECD et al., 2023[38]).

Fiscal rules are a central component of the fiscal framework. They are designed to solve the temporal inconsistency of public finances and mitigate the accumulation of debt by establishing debt limits (Andrian et al., 2023[85]). By decoupling spending from the business cycle, fiscal rules prevent spending from rising during economic upturns and protect public investment during downturns (Ardanaz and Izquierdo, 2017[2]). Moreover, fiscal rules help to stabilise debt-to-GDP ratios, ensuring long-term fiscal stability. Additionally, they have the potential to alleviate the perception of sovereign risk (Gomez-Gonzalez, Valencia and Sánchez, 2024[86]). Sustainability depends not only on the existence of fiscal rules but also on their quality and on compliance. Quality rules are supported by institutions. They have robust legal frameworks, flexibility against economic shocks and monitoring and enforcement mechanisms. High quality fiscal rules stabilise debt growth and reduce its volatility (Galindo and Izquierdo, 2024[87]). Compliance is crucial, since periods of adherence correlate with fewer events of debt acceleration, lower bond spreads and higher credit ratings (Ardanaz, Ulloa-Suarez and Valencia, 2023[88]).

Fiscal rules are widely used in LAC. Most are concentrated in expenditure or budget balance rules, with some economies using a combination of these. For instance, Argentina, the Bahamas, Brazil, Colombia and Costa Rica are currently implementing expenditure rules that aim to set a limit on total, primary or current government expenditures. Similarly, the Bahamas, Brazil, Chile, Colombia, Costa Rica and Peru are using budget balance rules, while the Bahamas and Peru are using the debt rule. Some economies base their budget balance rules on fiscal balances that consider the (structural) cycle. Some also have clauses that aim to protect investment. For instance, Costa Rica included a golden rule in its framework according to which borrowing can be used only to finance investment spending (Hamid et al., 2022[89]; OECD et al., 2023[38]).

Fiscal rules must be flexible enough to accommodate exogenous shocks. The importance of flexible fiscal rules is evidenced by the fact that economies with no fiscal rules or with rigid ones can reduce their public investment by 10% in a fiscal consolidation amounting to 2% of GDP, while in countries with flexible fiscal rules, fiscal consolidation does not affect investment. This flexibility can take the form of cyclically adjusted fiscal targets, well-defined escape clauses or differential treatment of investment expenditures (Ardanaz et al., 2021[90]).

New fiscal pacts are key pillars to implementing social contracts in the region and they would allow to sustain long-term revenue mobilisation policies and reforms. Citizens are more inclined to pay taxes when they see the government using collected funds efficiently for quality public goods and services (Carrillo, Castro and Scartascini, 2021[91]). However, low tax revenues in LAC limit the state’s capacity to strengthen institutions and provide better quality public services. To create a virtuous cycle, countries in the region must reconnect with citizens and design taxation systems that both raise the needed revenues and spend them in a more progressive and transparent manner. This requires better tax administration and a broad consensus built through national dialogue and clear communication. It also requires the development of a tax-paying culture.

A tax-paying culture is a fundamental pillar of the fiscal pact. Strengthening tax compliance is not only a question of improving tax enforcement and “enforced compliance” but also of pursuing “quasi-voluntary compliance” by building trust, providing quality public services, and facilitating tax payments. This requires addressing persistent challenges in tax systems, such as unequal tax burdens, questionable interactions with tax officials and poor translation of revenue into service delivery. There is an urgent need in LAC for innovative technical strategies to boost revenue collection while fostering taxpayer trust, building political support for reform, and reinforcing social contracts (Dom et al., 2022[92]). It is therefore important to understand the drivers of voluntary compliance.

Tax morale is generally defined as the intrinsic motivation to pay taxes (Torgler, 2005[93]; OECD, 2019[29]). It is often measured using perception surveys and is frequently proxied by a question referring to the percentage of the population that declares that cheating on taxes is never justified. In LAC, tax morale has fluctuated over the last decade but seems to be deteriorating. After a period of increasing tax morale between 2008 and 2011, the trend reversed: the proportion of those saying that not paying taxes was justifiable rose from 45.5% in 2011 to 57.9% in 2023 (Figure 2.16, Panel A) (WVS, 2022[94]; OECD, 2019[29]).

Three determinants can help policy makers understand the low levels of tax morale in LAC: i) socio-economic factors that condition citizens’ perceptions of taxes and their capacity to pay them; ii) how institutions influence and promote tax payment; and iii) the quality of public services and goods, which can incentivise citizens to contribute via taxes (OECD, 2019[29]). These determinants are important because understanding the sources of a country’s tax morale is a first step to developing a tax-paying culture.

Socio-economic factors that can affect willingness to pay taxes include level of education, age, gender and religion. People with more education are generally more predisposed to pay taxes, as are older people, women and those who are more religious. As such, educational policies have the potential to raise tax morale. Policy makers can use targeted policies, like taxpayer education per socio-economic group. For instance, enforcement may be more effective if targeted at high-income groups, where evasion is higher, while facilitating compliance could be emphasised for lower-income groups (OECD, Forthcoming[95]). Similarly, women tend to have higher compliance at lower levels of tax liability, and the use of deterrence messages has been proven to be more effective with them (Lopez-Luzuriaga and Scartascini, 2023[96])

The quality of public services may directly affect willingness to pay taxes because it demonstrates how public funds are used (OECD, 2019[29]). Citizen satisfaction with healthcare and education declined in several LAC countries between 2011 and 2022 (Figure 2.16, Panel B). Declining satisfaction with public services has been accompanied by an erosion of tax morale in the region, as LAC citizens who believe that the government uses tax revenues efficiently to provide quality public goods are more likely to consider paying taxes as a civic duty (Castañeda, 2024[97]).

Taxpayers’ trust in government plays a fundamental role in tax morale. The interaction between citizens and institutions is marked by the institutional trap in LAC. As living conditions improved in LAC and the middle class consolidated, citizens’ expectations grew only to face the slow response of inequitable institutions and poor governance (OECD et al., 2019[15]). Trust in government could be strengthened by investing the higher tax revenues stemming from improved compliance in redistributive policies. This would strengthen the social contract, which fosters trust and collaboration between stakeholders by creating an inclusive framework for mobilising public and private resources towards financing development objectives, while also delivering on the sustainable development agenda (Chapter 1) (OECD et al., 2021[100]). Countries that spend more on social programmes tend to be more successful in reducing inequality, while inequality tends to increase in those that spend less (Lustig, Martinez Pabon and Pessino, 2023[101]). Efforts to strengthen tax morale should include businesses and various private-sector representatives. Multinational enterprises represent a considerable source of public revenue. Through responsible business conduct actions, they can play a transformative role in advancing the sustainable agenda and can help to spread a culture of compliance through their supply chains (OECD, 2022[102]). Moreover, communication strategies can significantly influence public perceptions of taxation. Providing information about fiscal reforms and their impact on inequality can enhance social acceptance of taxation, increase trust in the authorities and raise overall tax morale, while at the same time working to counter tax evasion and corruption (Ormeño Pérez, 2017[103]; Goenaga Ruiz de Zuazu, 2020[104]; Durán-Fernández and de las Mercedes Torres-Negrete, 2024[105]; Salgado and Ugarte, 2024[106]).

Transparency policies can strengthen citizens’ trust by helping governments better evidence how common funds are used and better account for their redistributive impact. Cases have shown that the positive impact of digital solutions can also have a positive impact on tax morale and trust. Digital programmes can enhance transparency, reduce both actual corruption and public perceptions of it, simplify the tax payment structure and provide citizens with more accessible, efficient and higher-quality public services at lower costs. For example, LAC countries such as Brazil, Chile and Colombia have integrated artificial intelligence (AI) systems into their tax administrations to enhance efficiency and compliance. Brazil’s Risk Analysis and Applied Artificial Intelligence System of the Tax Administration project utilises AI for advanced risk analysis in detecting tax fraud, while Chile’s Integrated Taxpayer Assistance System employs clustering algorithms to manage VAT taxpayer categorisation. Similarly, Colombia uses AI to enhance the identification of eligible recipients for its social programmes (Valencia and Camilo Díaz, 2024[107]). Similarly, participatory processes can help policy makers design policies that truly cover citizens’ perspectives and priorities (Box 2.4).

Public expenditure in the LAC region has expanded over the past three decades, accounting for an average of 25.5% of GDP in 2023. However, it remains predominantly short-term and pro-cyclical, with current spending constituting 82% of total expenditure. Given that 26.8% of the population is living in poverty in 2024, optimising public spending efficiency, especially in critical areas like education, and ensuring strategic budget allocation are crucial for fostering sustainable and inclusive development models.

Most LAC economies have the potential to increase tax revenues and improve the progressivity of the tax system. In the majority of economies, policies need to focus on improving the design of indirect taxes, raising more revenues from direct taxes, rationalising tax expenditures, formalising the economy, strengthening tax compliance, tapping into the revenue potential of international tax co-operation and exploring new revenue sources such as recurrent taxes on immovable property, health taxes and environmentally related taxes. Addressing gender biases in tax policies as much as possible is essential for promoting gender equality. As countries in the region face different challenges, tax reform or tax policy recommendations require country-specific analysis, design and implementation, as a one-size-fits-all approach does not exist.

Elevated levels of debt in LAC countries and its vulnerable composition constrain fiscal space for development-oriented spending and investment. High debt levels heighten susceptibility to financial crises and limit fiscal responses during recessions. Effective debt management is imperative to finance both human and physical capital, promote long-term economic growth and provide stability throughout the economic cycle.

Maintaining medium- and long-term fiscal stability hinges on robust fiscal frameworks that support countercyclical fiscal policies, curtail discretionary spending and uphold debt sustainability. Such frameworks safeguard essential public investments during fiscal consolidations, thereby bolstering economic recovery and paving the green and digital transitions. Fostering flexible fiscal rules, implementing effective compliance mechanisms and cultivating a robust tax-paying culture are vital for sustaining long-term revenue mobilisation for sustainable development, enhancing tax morale and bolstering public trust in governmental institutions.

The key policy messages for LAC on public finance for development are presented in Box 2.4.

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