A few weeks ago, in this same space, I wrote about the problems that could arise in the area of public policy if we fall in love with the instruments and leave aside the objectives. That became tremendously evident this week after the approval of a third withdrawal of AFP funds, but, as if that were not enough, it is also behind another proposal of our creative parliamentarians.

This is the VAT reduction for basic necessities. Already the concept of "basic necessities" raises suspicions, because it is based on a subjective evaluation. We may agree on some of them, but it is still subjective. For example, I do not see that we want to lower the price of bicycles, their spare parts and accessories, or the crayons that my children use to draw. You may think I am being frivolous, but within the list of basic necessities included in the bill[1] are aesthetics and beauty services and flowers. Also restaurants, such as those offering snacks, but also international fast food chains and, of course, Boragó.

In addition to the subjectivity of the goods and services that would fall into the category, we have the distortions that such a measure generates in the economy. In Chile, fuels are taxed with a specific tax, justified in the negative externalities that their use causes in society (and not to rebuild roads, as erroneously thought). Well, fuels would also receive this VAT reduction. A marvel: on the one hand, we tax them more, but on the other hand, we lower them.

Along the same lines, price changes produce changes in behavior. It was commented that what a person will stop spending on one product (due to the eventual drop in price), he/she could spend on another, thus reducing the impact on tax collection. As El Chavo would say, "what a brute, put it zero". In this case, by lowering the price of a product, two economic effects are produced: if I do not change my consumption of that good, I will have more resources available to spend on others (income effect), but since it is relatively cheaper, without changing the consumption of others, I would like to consume more of that good (substitution effect).

Another distortion that occurs refers to the suppliers. It is well documented that, in economies with exemptions or differentiated taxes, many try to pass themselves off as subjects that should receive the benefit, when in fact they should not. And mind you, I am not talking about illegal practices (which also exist, no doubt) but about some perfectly within the law that only use the mechanisms created by the legislator. As if that were not enough, imagine the headache that the implementation of this measure would be for accountants and, above all, for auditors.

I wanted to save the tastiest part for last. Well, you will have a lot of problems, but at least people will see a drop in prices, right? right? Well, not necessarily. We did a calculation to project the maximum impact this could have on the monthly CPI variation the month this measure is eventually implemented: -3.3 pp, a brutality. However, an important assumption of this calculation is that it suggests that, in the short term, consumer and supplier behavior will not be affected, which we know is not true in reality. In some markets we will see significant price reductions, while in others we will see no change in price, which has nothing to do with abuse or bad intentions, but simply with the changes in behavior described above[2].

Therefore, it is not on a whim that economists prefer this type of taxation to be flat for all, since it is the best way to avoid generating distortions, which is widely corroborated in the literature. Moreover, at a time when more resources are needed to finance social needs, these types of proposals only point in the opposite direction, generating exemptions at a time when the proposal is to start eliminating them. Finally, if the idea is to help the poorest people, it is much better to provide direct transfers and let them decide what they need and what they do not. Such a policy does not generate distortions, ambiguities, unions claiming to believe they are more necessary than others, nor more social and political conflict, of which we already have enough.

[1] Products to which VAT would be reduced from 19% to 10%: a) Fuels, applicable to the import or sale of automotive gasoline, oil, diesel, liquefied petroleum gas for vehicle consumption and compressed natural gas for vehicle consumption, which will be applicable only to persons who are not transporters, nor engaged in the transportation of cargo or passengers. b) Food used for human or animal nutrition, not including alcoholic beverages, as well as animals, vegetables and other products used for the obtaining of food. c) Sanitary products, material, equipment or instruments used to prevent, diagnose, treat, alleviate or cure diseases or ailments of man or animals that are on sale to the public. d) Hotel, camping and spa services, restaurants and, in general, the supply of food and beverages for local consumption. e) Sanitary and dental assistance that do not enjoy exemption. f) Aesthetic and integral beauty services. g) Sports services and establishments. h) Flowers and ornamental plants. i) Services offered by funeral companies.

Products to which VAT would be reduced from 19% to 4%: a) Basic products such as bread, flour, eggs, milk, cheese, fruits, vegetables, legumes, tubers and cereals. b) Books, newspapers and magazines that do not contain only or mainly advertising. c) Medicines for human use, as well as medicinal substances and intermediate products used to obtain them. d) Prosthesis, orthosis and internal implants for handicapped persons. e) Tele-assistance and home help services.

[2] This is what economists call "price elasticity".

Nathan Pincheira

Chief Economist, FYNSA