aNALYSIS: Chile tax reform double-edged sword for Pinera

Reuters News

5/3/2012 4:14:52 PM - Reuters News

By Simon Gardner and Antonio De la Jara

SANTIAGO (Reuters) - Chilean President Sebastian Pinera's tax reform to help fund an education overhaul could help center-right hopefuls ahead of next year's presidential race, but it won't stifle protests and might backfire by spurring calls for even higher spending.

Pinera's reform proposal includes raising taxes on companies and lowering income tax for individuals. If approved, it would raise up to $1 billion a year in extra funding for education.

Pinera unveiled the reform last week in response to massive student-led protests demanding free education and better distribution of the profits from a long copper boom in Chile, the world's No.1 producer. The bill, or at least its key parts, is expected to ultimately pass with cross-party support.

The unpopular Pinera has been criticized by some inside his ruling coalition for caving in to protesters. On the other side, leftist lawmakers wanted far higher corporate taxes and complain that the biggest beneficiaries will be the rich because they will pay much less in income tax.

But the reform will likely take some political pressure off Pinera, possibly helping his coalition at municipal elections in October and at the presidential election in November next year. Under the constitution, Pinera cannot seek a second consecutive term.

"What it does is help position the government's candidates for the presidential race," said Ricardo Israel, a political analyst at Universidad Autonoma in Santiago.

Students and leftist groups led often-violent protests in 2011 to demand better and free education and greater economic equality. They helped drag Pinera's approval rating down to just 29 percent in March, according to pollster Adimark.

That makes him Chile's most unpopular leader since General Augusto Pinochet's dictatorship ended in 1990, although the same poll showed the center-left opposition bloc, the Concertacion, was even more unpopular with just 21 percent support.

Pinera ended two decades of Concertacion rule in 2010 and it is still in disarray, meaning the presidential election is still wide open.

Camilo Escalona, the Senate president and a leading figure in the Socialist Party, says he agrees with the tax reform in principle but he and other leftists are likely to use the debate in Congress to push for more concessions.

"I'm not going to boycott it, because I'm practical ... At least it covers the education deficit," said Escalona, although he added his coalition could reject some of the articles.

Escalona is close to former President Michelle Bachelet, who is still widely popular and seen by many as the Concertacion's best candidate ahead of next year's race.

BUSINESS BUY-IN

Pinera's reform bill raises the tax rate for companies to 20 percent from 17 percent, includes a variable tax rate mechanism to cushion consumers from oil price swings, and reduces income tax for individuals.

The government had previously hiked royalties on mining companies and raised a host of taxes to help finance reconstruction after a devastating earthquake in February 2010.

But Chile's corporate tax rates are still way below levels in regional peers like Argentina and Brazil. Business leaders have been sanguine in the face of both reforms.

"As the tax reform stands, emphasizing that all the (extra) money will go to education, we Chileans cannot fight it," said Eliodoro Matte, chairman of Chilean paper and forestry company CMPC.

He cautioned, however, that such reforms come at a cost. "Whenever you raise taxes on companies, there is a little less money to invest. That's a fact."

Most Chileans earn too little to be liable for income tax, so some argue the bill mainly benefits the wealthy.

"The proposal is completely insufficient," Gabriel Boric, who heads a student group that spearheaded mass protests, said on his Twitter account. "The proposed reform lowers taxes for the richest."

The students resumed protests last week, though they are not expected to draw as much popular support as they did in 2011.

"It does seem like things are more contained than they were last year," said Risa Grais-Targow, an analyst with the Eurasia Group consultancy.

Given Pinera's weak approval ratings, the presidential campaign is likely to kick off early. A host of center-right hopefuls have already emerged, including Public Works Minister Laurence Golborne, Defense Minister Andres Allamand and Economy and Tourism Minister Pablo Longueira.

Analysts say the discussion of tax reform and putting more money into education could push candidates into taking populist positions, particularly if those demanding higher spending are emboldened to step up their calls given the precedent that Pinera's tax reform sets.

"They're not going to be able to close this issue before the next presidential election cycle, and that's going to make it more difficult for everyone who wants to be fiscally responsible," said Patricio Navia, a political scientist at New York University.

"It's going to generate incentives for everyone to ask for more," he added. "And every time you discuss tax reforms in an election year, people feel the temptation to offer more than they should."

Pinera clearly believes his ratings should be higher, especially as the economy is likely to grow between 4 and 5 percent this year and unemployment is falling.

"I sometimes feel frustrated when voices pipe up on these issues. Some criticize us because the reform is too small, others because it is too big," Pinera said in a recent television interview.

He knows he needs the help of his center-left opponents who have a narrow majority in the Senate, and he has appealed to leftists and students to rally behind his proposed changes.

"No education reform will be successful without the ... support of the students," he said when he sent the bill to Congress, asking lawmakers to push it through quickly. "We have no right to tie ourselves up in Byzantine arguments."

Chile has for long been one of Latin America's most stable economies, thanks in part to the fiscal discipline shown by a series of governments.

The tax reform is unlikely to put off investors, particularly when compared with more volatile policies in neighboring Argentina and Bolivia as well as Venezuela.

"When you look at it from the optic of an external investor, you have to balance out the risk return profile of these measures. Chile is still a very significant commodity producer, it's a very open economy and a very well managed economy," said Enrique Alvarez, head of research for Latin America at IDEAglobal.

"I think (the tax measures) have to be seen as a necessary tradeoff in the overall environment to try and keep a stable investment environment on the ground in Chile."

(With reporting by Anthony Esposito, Moises Avila, Alexandra Ulmer, Fabian Cambero and Felipe Iturrieta. Editing by Kieran Murray and Andrew Hay)