Colombian Fiscal Policy: A Limited

Tool for Long-term Development

and Short-term Recovery

OECD &DeFiNe Meeting

Mara Anglica Arbelez

Fedesarrollo
September, 25th, Paris
 Main Issues
Colombia has lacked fiscal discipline
The fiscal policy has not been a tool for economic
stabilization (short-term perspective)
Not enough room for anti-cyclical measures
The social contract
The impact of social spending has been limited
Infrastructure spending has not been growth-
enhancing
Taxes: an erratic policy, with narrow effect on income
redistribution and growth-enhancing
Fiscal legitimacy is poor
It is not a matter of the lack of reforms but of their
quality, depth and scope
Recommendations
Colombia has lacked fiscal discipline
 The fiscal situation has continuously deteriorated over the last 15
years, particularly due to the Central Government imbalance

Non-Financial Public Sector Balance, 1990-2008 (% of GDP)

GC Rest of NFPS NFPS

4.5
4.1
3.3 3.6
3.1
2.1 2 2.1 2.3 2.3 2
1.62.3 1.8 1.7 1.6 1.9
1.6 1 0.7
0.1 0.4
0.1 0.2 0.4
-0.1 -0.3
-0.6
-0.2 -0.9 -1 -1 -1.2
-0.8 -0.7 -1.4
-1.7 -2.7
-2.2 -3.1
-2.9 -3.2 -3.7 -3.8 -3.6 -3 -3.2
-4.2
-4.1
-5 -5 -4.8
-5.8 -5.5 -5.8 -5.5 -5.5

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: Ministry of Finance and Public Credit and authors calculations
The imbalance was the result of three factors:
The Constitutional reform of 1991, by which a percentage of CG current revenues were to be
transferred to the regions (decentralization)
The pension reform
The increase in military expenditures
 Spending grew much faster than revenues

Central Government Tax Revenues and Expenditures, 1981-2008 (% of GDP)

23
21,8
21
20,7
19

17
16
15

13 13

11 9,7
9

7 8,3
Tax Revenue Total Expenditure
5
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: Ministry of Finance and Public Credit and authors calculations

 The increasing spending was largely financed
with debt
Balance and Debt Central Government,
60
1981-2007 (% of GDP)
1 53,6
47,5 50
1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
-1
40

-3
30

-5
20
16,5
-7 10

Current Banlance Total Balance Debt (Right Axis)

-9 0
Source: Ministry of Finance and Public Credit and authors calculations

In 2002, Colombia had to start running a permanent primary surplus of at least 1.8% of GDP for public
finances to be sustainable. The CG has reached a primary surplus, however still low.
The fiscal policy has not been a tool for
economic stabilization (short-term perspective)
 Fiscal policy indiscipline has caused macroeconomic
conditions for development to deteriorate
The boost in domestic debt resulted in a deep crowding out
since the mid nineties, that caused a rising in interest rates
and a slump in private investment
High current spending was partly responsible for real
exchange rate revaluation
The large deficit caused international investors risk
perceptions to deteriorate, which increased spreads
The boost of the external debt, which reached 25.5% of
GDP in 2002, increased the vulnerability of fiscal
performance to external shocks and exchange rate changes
Colombia lost its investment grade in 1999 and has not
been able to recover it
 Fiscal policy has been pro-cyclical
The CG spent more during booms and less during slumps

0.20
Expenditure and GDP Cycles 0.15
1980-2008 (% of GDP)*
0.15

0.10
0.10

0.05
0.05

0.00
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
0.00
-0.05

-0.10
-0.05

-0.15
Expenditures Cycle
-0.20
GDP Cycle (Right Axis) -0.10
* Log scale
Source: Ministry of Finance and Public Credit and Olivera, Pachn, and Perry (2008)
There were no fiscal savings during either the mid-nineties or the recent boom of
2004-2007 (in 2007 the economy grew 7.5%)
 Smaller fiscal impulse when output
gap is negative
0.05

0.04 1997
1995

0.03 2005 1996

1998
0.02 1994
Output Gap (logs)

0.01 1990 1982

1992
2004
0.00 1987 1988
1993 1991
-0.01 1989
1986
2003 1983
-0.02 1984
2000
-0.03 1985
2001
2002
1999
-0.04

-0.05
-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0
Fiscal Impulse (% del PIB)
 During the recent downturn there has been more room
for counter-cyclical policy, in contrast to the crisis of
1999
Real Expenditures Growth versus Output Gap
29.0% - Current Account deficit was
Investment large (around 4-5% of GDP in
Total without debt
Output Gap * 1998), so it was necessary to
19.0%
adjust spending, while it was
2.5% in 2008
9.0% - Central Government deficit was
around 5-6% of GDP in 2000,
while it was less than 4% in 2008
-1.0% -External public debt was around
20% of GDP in 1999-2000, while
it was 15% in 2007-2008.
-11.0% - Between 2008 and 2009, public
spending (excluding debt service)
rose from 18% to 20.2% of GDP,
-21.0%
and investment from 4.6% to
5.9% of GDP
Source: Ministry of Finance and Public Credit and Fedesarrollos calculations
 In the downturn (2008 and 2009), fiscal policy has been counter-cyclical
To compensate for the fall in demand, expenditures have been expanded
through the acquisition of new debt (instead of the decumulation of assets,
e.g., through stabilization funds)
Expenditure stimuli are oriented toward infrastructure, Social Protection
(strengthening social programs and coverage such as Familias en Accin, Red
Juntos), and subsidized financial credit lines and housing (Bancoldex, Fondo
Nacional de Garantas, Microcditos, Finagro).
However, the level of debt, still high and needs to remain on a sustainable
path, does not allow for maintaining the increased pace of expenditures in
2010
Central Government Balance, 2009-2010 (COP Billon)
2009 (% PIB) 2010 (% PIB)
Total Revenues 16.1 14.5
Tax revenues 13.6 13.0
Nontax revenues 0.1 0.1
Capital Ressources 2.2 1.2
Others 0.2 0.2
Total Expenditures 19.8 18.8
Interest 3.2 3.3
Operation 14.5 13.9
Investment 2.1 1.6
Net Loan 0.1 0.1
Deficit -3.7 -4.3
CRSF 0.2 0.1
Deficit to finance -4.0 -4.4
The social contract (long term impact on
development)
The impact of social spending has been limited
Infrastructure spending has not been growth-
enhancing
Taxes: an erratic policy, with narrow effect on
income redistribution and growth-enhancing
 Spending composition: Capital expenditures represent around
7% of total expenditures, Current Transfers 55%, Operational
Expenditures 18% and Debt Service 20%
Central Government Expenditures 1981-2008 (%GDP)
25.0 Central Government Transfers, 1990-2008 (% of GDP)
7.00 14.00
Total Expenditure Regional Transfers
Current Expenditure 13.00
6.00 Pensions
20.0 Capital Expenditure
Current Transfers Other 12.00
Operational Expenditure 5.00 Total Transfers (Right Axis)
Debt Service 11.00
15.0 10.00
4.00
9.00
3.00
10.0 8.00

2.00 7.00

5.0 6.00
1.00
5.00

0.00 4.00
0.0

1999

2006
1990
1991
1992
1993
1994
1995
1996
1997
1998

2000
2001
2002
2003
2004
2005

2007
2008
1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

Source: Ministry of Finance and Public Credit and Olivera, et al, 2008

Current Transfers and Debt Service exhibited the largest increase.

Current transfers grew due to regional transfers and pensions
 The provision of high-quality public expenditures has been
limited
Social expenditures have increased, but the effectiveness has been
partial
Social spending grew during the nineties above the regions average: 11.2% of GDP
in 1994 to 14.7% in 2006
Education has had the greatest increase, but the rate of coverage has increased
more slowly than expenditures
Some social indicators have improved slightly and poverty has shrunk, but less than
proportional to social spending efforts
Income distribution inequality remains practically unaltered
Public policy has not been growth-enhancing in key areas, such as
infrastructure
Public investment in public works and transportation is low, and decreasing over the
last fifteen years. Fiscal adjustments have been made at the expense of such
investment
Around 3% of GDP in the mid-nineties, 1% in 2003, has recovered in the recent
years mainly due to investments in the oil sector. The most pronounced decline has
been in public works and transportation (road works)
Some indicators show that the quality of infrastructure in Colombia is still very poor
 Taxes: an erratic policy (not as redistributive and not
growth-enhancing)

8
Central Government Tax Revenues, 1981-2008 (% of GDP) 16
VAT Relies more on indirect taxes
Income Tax
7 (VAT, tariffs and transaction taxes)
Tariff
Financial Transactions Tax
14 than on direct taxes (income
6 Net wealth Tax taxes and wealth taxes)
Total Tax Revenues (Right Axis) 12 Income tax and VAT have the
5
largest shares. Financial
4 10
transaction taxes and wealth
taxes together have the same
3 participation as tariffs.
8
Since 1990, there have not been
2
any structural reforms, but only
6 reforms aimed at increasing
1
revenues in the short
0 4
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

Source: Ministry of Finance and Public Credit and Olivera, et al, 2008
Fiscal legitimacy is limited
 Fiscal legitimacy is limited
Budget Transparency Index, components, 2007
2003 2005 2007
Budget participation
Civil Society Participation 15 35 13
Functions and powers of the legislative body 40 45 38
Budget Drafting
Information about macroeconomic criteria 43 60 45
Changes on the Budget 37 47 44
Budget Allocation 31 33 31
Budgetary Control
Budgetary Overseeing 40 52 38
Capacities of the external control body 40 57 41
Evaluation of the treasury inspector's office 4 21 25
Accountability
Reporting 24 36 26
Control over public officials 36 48 29
Responsibilities at different levels of the government 34 25 34
Source: ndice Latinoamericano de Transparencia Presupuestaria, 2007
It is not a matter of the lack of reforms but of
their quality, depth and scope
 It is not a matter of the lack of reforms but of their
quality, depth and scope
Fiscal Reforms
1990-2008
Tax Expenditure Decentralization Pension
Reforms Reforms Reforms Reforms
Decrees 3 3 0 0
Laws 12 3 6 3
Constitutional Reforms 0 0 3 0

Tolal 15 6 9 3
Source: Olivera, Pachn and Perry, 2008

1. Tax laws approved were of the quick fixes or piece meal type (increases in tax
rates, establishment of new distortionary taxes on financial transactions and net
wealth). Most Government initiatives were dominated by revenue objectives and
disregarded efficiency considerations. Overall, tax revenues increased, but by much
less than the increase in expenditures
2. Decentralization-related reforms indebtedness and expenditure controls and
regional transfers for subnational entities were quite successful, as they achieved a
significant reduction in transfers/GDP ratios after 2001 and led to aggregate
surpluses in sub-national balances during the boom period
3. Only one expenditure reform (the Fiscal Responsibility Law of 2003) was approved by
Congress during the period. This reform required the use of medium expenditure
frameworks, though it did not include enforcement instruments
Recommendations
 Long-term perspective
Improve the institutional framework and arrangements in order to:
improve fiscal discipline and the consistency of spending and revenue
policies with macroeconomic stability
budget allocations according to policy priorities (by sector, regions)
and efficiency and evaluation of expenditures (see, Olivera, 2008)
Adopt structural tax reforms aimed at:
reducing tax exemptions and carefully reviewing their impact and the
source of financing
making the income tax more progressive and increasing the taxable base
(reducing the rate for corporations)
increasing the scope in terms of goods subject to the VAT and reducing
the number of rates
eliminating distortionary taxes that were transitory and have became
permanent (Transaction Tax, Wealth Tax)
and improving the tax administration (see Fiscal Reform in Colombia:
Problems and Prospects, 2005)
 Short-term stabilizer
Design institutional mechanisms to improve its capacity to
implement counter-cyclical fiscal policies
rules that guarantee that spending will evolve in line with long-
term fiscal revenues, encouraging fiscal savings when revenues
increase beyond their long-term trend, and de-saving when they
grow below their long-term path
Fiscal authorities should improve the automatic stabilizers
the adoption of social support programs with clearly defined
entry and exit clauses (unemployment insurance instead of
programs such as Familias en Accin),
the definition of budget expenditures based on permanent, not
transitory, revenues
Stabilize mining and energy income
by strengthening the existing funds such as the FAEP
Projections of long-term growth and oil prices, for example,
should be made by experts who are independent from the
government
Colombian Fiscal Policy: A Limited
Tool for Long-term Development
and Short-term Recovery

OECD &DeFiNe Meeting

Mara Anglica Arbelez

Fedesarrollo
September, 25th, Paris