Public Sector and Taxation

The public sector is a term used to describe the three entities—general government, nonfinancial public enterprises, and public financial institutions—through which governments carry out public policy. General government, made up of central, state (provincial, regional), local (municipalities, school boards), and supranational authorities, and social security schemes, forms the core of the public sector and has been the most important entity used by Latin American governments to formulate and implement public policy. Through its branches of public administration and defense, general government has directly determined the nature and transformation of collective, semicollective, and, indirectly, individual commodities (goods and services) produced in each Latin American country.

PUBLIC SECTOR FORMATION IN POSTCOLONIAL LATIN AMERICA

Collective Services

Collective services satisfy the collective (public) needs for public order and safety, defense and conduct of foreign affairs, protection of life and private and public property, political and economic freedom, equal treatment by government, and social harmony and environmental protection. These services guarantee to citizens the enjoyment of fundamental human, political, and economic rights, and free and equal participation in governance, production, and exchange. Collective services are said to be nonrival and nonexcludable in consumption: Consumption of collective services by one agent (person) does not reduce the availability of such services to someone else.

In the aftermath of independence, from 1820 to 1930, the primary task for governments was national reconstruction—the establishment of a postcolonial institutional framework that would enable the production of collective services. Much of the nineteenth century was taken up in the pursuit of this elusive goal. Endemic violence between 1830 and 1850, especially in the small Central American countries and Colombia; boundary disputes; and internal conflicts between competing factions delayed establishment of independent and democratic legislative, executive, and judiciary branches, which constituted the vital foundations of procedural democracy and civil society. With the exception of Chile, control of government remained largely in the hands of military dictatorships, which did not produce services satisfying these collective needs.

Semicollective Services

From 1820 to 1930 all Latin American governments made major efforts to increase the supply of semicollective services—education, health and sanitation, social security and welfare, and recreation and culture. Governments raised educational standards and made education available to more people at all levels—primary, secondary, vocational, and university. Mortality rates began declining, especially among infants. Argentina and Uruguay led the way in providing such services. In other countries, success was achieved mostly in urban areas and among the upper and middle classes and organized labor. The distribution of publicly and privately produced semicollective services remained highly unequal. More than a century after independence, the poorest 60 percent of households in Brazil, Bolivia, Guatemala, Mexico, Peru, Honduras, Ecuador, Venezuela, and elsewhere still had minimal or no access to educational, health, welfare, and other semicollective services.

Individual Commodities

Individual (or rival) services are defined as commodities whose consumption by one agent precludes consumption of the same unit by another. Individual commodities, which satisfy individual needs for food, clothing, shelter, and so forth, are normally produced by private- or state-owned enterprises in agriculture, manufacturing, mining, or services (personal, business) for sale in a market at a price expected to cover their cost of production.

In addition to relying on central, state, and local authorities, Latin American governments have always utilized government-owned or government-controlled (i.e., public) corporate and quasi-corporate, nonfinancial enterprises as instruments for the formulation and execution of public policy. Following independence, national governments continued to use such government monopolies as tobacco, salt, liquor, matches, the post office, mining, and agricultural products, which were inherited from the Spanish and Portuguese crowns and their followers, to generate revenues to support the production of collective services by the public administration and defense activities. Between 1820 and 1860 many of these enterprises were privatized, that is, ownership and control were transferred from the state to private entities, in an effort to raise revenues, reward the leaders of the wars of independence, fulfill popular liberal philosophies, or simply to benefit those in power. State ownership or control and privatization were not always implemented to promote the common good; fraud and outright theft were not uncommon.

Following the consolidation of political power and establishment of political stability, Latin American governments increasingly ventured into production of individual commodities. They assumed ownership and control of enterprises in public utilities, such as gas, water, and electricity, in an effort to satisfy the needs of growing urban populations. They often assumed ownership of railroads to facilitate public transportation or to maintain employment when the railroads were abandoned by private owners. They also relied on monopolies to raise revenues.

Although the nonfinancial enterprise segment of the public sector was important, even before 1930, in public utilities, including transportation, and selected monopolies, it rarely played a leading or dominant role in industry, agriculture, mining, trade, and construction. Furthermore, public policy, as defined by the collective services produced by general government, was generally friendly to private enterprise, foreign capital, and free trade. Overall, there was a high degree of recognition and satisfaction of the collective needs for freedom of internal and external trade, and safety, security and protection of national and foreign private property

Monetary and Financial Institutions

Monetary and financial institutions constitute the third major pillar of the public sector. Following independence, governments made concerted efforts to develop and control the first segment of monetary institutions, or institutions whose liabilities are money: the monetary authorities. These consisted of monetary agencies, currency authorities, and, since the 1920s, central banks. Governments also actively promoted, although generally they did not own and control, the second segment of monetary institutions: banks whose liabilities include deposits payable and transferable on demand, often referred to as deposit money banks. Governments attempted to create and expand the money and capital markets to advance private property and the efficient use of resources.

Public Sector Finances

Public sector finances were precarious in much of Latin America between 1820 and 1930. More often than not, public sector expenditures exceeded ordinary revenues. Current expenditures, which included wages and salaries of government employees, purchases of supplies, and transfers, rose significantly; they exploded during periods of external or internal conflict. Capital expenditures on public buildings, ports, railroads, canals, roads, schools, and so forth increased. Public sector revenues also increased, often spectacularly.

Public sectors generated both ordinary and extraordinary revenues. Following independence, general government in all Latin American countries relied heavily on such ordinary revenues as customhouse duties, land, property and excise taxes, trade and professional license receipts, tithes, bridge tolls, mint receipts, and surpluses generated by state monopolies selling tobacco, salt, liquor, and even opium (in Peru). As international trade expanded between 1860 and 1930, export and import duties increasingly became a major, even primary, source of tax revenues. Whenever trade-based taxes declined, sales and income taxes were introduced. During crisis periods, such as war, severe depressions, and trade collapse, general government relied heavily on such extraordinary revenues as government issue of paper money, sale of bonds in domestic and international capital markets, issue of treasury notes, and sales of public land and properties confiscated from the crown and its followers. Increasingly, governments also relied on inflationary finance (printing of money) from monetary authorities and deposit money banks to cover public sector deficits.

Rising, often rigid, expenditures, including subsidies to state railroads and public utilities, on the one hand, and excessive dependence on volatile, foreign-trade-based taxes and lack of broad-based, progressive income taxes, on the other hand, weakened the capacity of most governments to pursue the public policies needed to achieve economic, social, and political development. Instead, public policies between 1860 and 1930 either reinforced or created unsustainable and inequitable middle- and upper-class entitlements. Collective, semipublic, and even individual goods and services were produced by the state largely, often exclusively, for the minority middle and upper socioeconomic groups. In addition, often massive but volatile tax revenues from agriculture, mining, and foreign trade were used to reduce taxes and prices paid by the privileged minorities rather than to deliver more and better services to the underprivileged, needy, poor, rural, indigenous majorities.

Despite significant progress by 1930, Latin American governments and collective markets had not delivered the critical mass of collective services that could satisfy the complementary collective needs for political freedom (the foundation of electoral democracy); safety, security, and protection of life (the quintessential pillar of civil society); universal safety, security, and protection of private property (the precondition for efficient allocation of resources through free and competitive markets); equal treatment by government; social harmony; and environmental protection. They had not produced the collective (political, social, and economic modernization and justice, efficient markets, price stability) and semipublic (education, health, and welfare) services needed to achieve sustainable growth and equitable distribution. According to many, public sector policies and the complex forces that shaped them, have been largely responsible for the failure to transform the transitory, often fabulous, eras of prosperity between 1860 and 1930 into permanent ones.

AFTER 1930: EXPANSION OF THE PUBLIC SECTOR AND THE INTERVENTIONIST TRANSFORMATION OF COLLECTIVE MARKETS

The Great Depression of the 1930s, which precipitated a collapse in foreign trade, capital inflows, and immigration, had an immediate, profound impact on the public policy goals of Latin American governments and the instruments used to pursue them. The public sector, which was already large and complex in many countries before 1930, became larger and assumed even greater strategic significance in shaping the political, social, and economic evolution of Latin America.

Since 1930, Latin American governments have continued to face the formidable task of producing collective services recognizing and satisfying the seven complementary collective needs for political and economic freedom; safety, security, and protection of life and private property, equal treatment by government; social harmony; and environmental protection. Satisfaction of these needs would guarantee basic human, political, and economic rights and freedoms on a sustainable and equal basis to all citizens. However, beginning with the Great Depression of the 1930s, recognition and satisfaction of the collective need for freedom of external as well as domestic trade was increasingly reduced by a recognition and satisfaction of the collective need for barriers to internal and external trade. Progress in the satisfaction of the collective needs for political freedom and social harmony was achieved whenever democratic governments were in power. Basic political rights and freedoms were neglected, even suppressed, however, during the prolonged reign of dictatorial political regimes in Argentina, Bolivia, Brazil, Chile, Cuba, the Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Nicaragua, Panama, Peru, Uruguay, and Venezuela. Satisfaction of the collective need for political freedom was reduced, often to minimal levels. Stable, sustainable democracies have been rare and largely overshadowed by prolonged dictatorships. With the exception of Cuba, however, the production of collective services satisfying the seven fundamental collective needs that underlie procedural democracy and civil society, thus promoting basic rights and freedoms, improved considerably whenever parliamentary democracies were restored. Even in procedural democracies, however, provision of the collective services that satisfy the aforementioned seven collective needs, thus advancing the basic political, social, human, and economic rights and freedoms of the poor, both urban and rural, often indigenous populations, has left much to be desired. Endemic political and economic crises undoubtedly weakened the ability of governments to produce enlightened collective services for the poor and needy.

Despite improvements in semipublic services after 1930, with resultant population increases (from 103 million in 1930 to 436 million in 1990 and 556 million in 2006), public and private delivery of semipublic services has frequently been inadequate, and distribution of these services has remained highly unequal. Middle and upper socioeconomic groups and organized labor have benefited greatly, but delivery of services to the rural and urban poor and the indigenous populations in Bolivia, Brazil, El Salvador, Guatemala, Honduras, Peru, and elsewhere has been minimal to nonexistent. In most of Latin America, public policies have failed to eradicate endemic poverty and inequality. As a consequence, in 1989, according to World Bank statistics, 131 million people, or 31 percent of Latin America's population, lived in poverty, with incomes of less than $60 per month.

After the Great Depression, Latin American governments implemented a radical shift in public policy goals. As a result, the size of the public sector and of government involvement (participation) in economic affairs increased. The governments' immediate goal was restoration of income and employment to pre-Depression levels, with parallel goals of economic development, full employment, balance-of-payments equilibrium, and economic independence. Argentina, Brazil, Chile, Colombia, Cuba, Jamaica, Mexico, Peru, Nicaragua, Venezuela, and other countries transformed the nature of collective services produced by public administration and defense (i.e., the mesoeconomics of government) by increasing the direct use of nonfinancial state enterprises and public financial institutions in carrying out public policy; at the same time, they initiated an unparalleled increase in government intervention in production, exchange, and distribution.

Public Production of Individual Commodities

The component of collective services promoting the role of the state as lender to and owner, operator, and manager of enterprises increased, often sharply. The public sector grew, in many countries spectacularly, as the state expanded its direct involvement in the production of individual commodities beyond public utilities, railroads, and revenue-generating monopolies, into agriculture, industry, mining, communications, banking, commerce, and health. Nonfinancial public enterprises emerged not only in industry, mining, and construction, but also in agriculture, forestry, fishing, transport, communications (newspapers, magazines, radio, TV stations), wholesale and retail trade, hotels, restaurants, real estate, and business services.

Governments established public enterprises to pursue a multiplicity of policy goals. Expulsion of foreign capitalists from Chile under Salvador Allende, from Cuba under Fidel Castro, and from Nicaragua under the Sandinistas, aimed at wresting sectors, even economies, from actual or perceived foreign control. Land reform, including expropriation of large estates, and widespread nationalization of banks, mines, factories, newspapers, radio stations, and other large-scale private enterprises aimed at severing the national, private elites from their economic base and creating a new, sometimes Marxist, political, social, and economic order. State ownership and control of enterprises was also motivated by the desire to save jobs, stem capital outflow, rescue failing firms, and increase saving, or was simply accidental.

A further change in the nature of the public sector materialized after 1930 as governments increasingly relied on public financial institutions to finance the budget deficits of the nonfinancial public sector, that is, of general government and state-owned enterprises. From 1930 to 1980 financial institutions, especially central banks, in Argentina, Brazil, Bolivia, Mexico, Peru, Nicaragua, Uruguay, Venezuela, and elsewhere were assigned the role of transferring enough resources from the private sector to cover the deficits of the public nonfinancial sector. Shortages of domestic and foreign savings forced central banks to print money to finance skyrocketing deficits. The ensuing galloping inflation, which, according to the Economic Commission for Latin America and the Caribbean, reached an annual rate of 1,185.2 percent in 1990 and 416.8 percent in 1992, caused profound political, social, and economic damage and chaos. In an attempt to control destructive hyperinflation, beginning with Chile in the 1970s, most governments reassigned to financial authorities, in particular the central bank, the role of maintaining price stability and a sound, private financial system. Central banks were even constitutionally prohibited, as in Chile, from printing money to cover public sector deficits. By 1995 aggressive control of inflation was evident.

Increased Regulation

In pursuing their public policy goals, Latin American governments also increasingly relied on pervasive regulation and interventionist institutions. During the 1950s and 1960s, the complex web of rent, food, fuel, foreign exchange, interest, credit, and other price controls and regulations coincided with accelerated growth. By the 1970s and 1980s, however, the picture had changed. The implicit taxes associated with these controls had discouraged production, trade, and formal activities. The implicit subsidies established by these controls had created entitlements that the privileged public sector employees, the urban middle classes, and organized labor refused to give up. Efforts to establish a level playing field through deregulation, liberalization, and privatization were largely successful in Chile and Argentina but encountered stiff resistance in Venezuela, Brazil, and Ecuador.

The size of the public sector increased between 1930 and 1990, whether measured in terms of the magnitude of its expenditures or revenues. Its formidable size and growth from 1970 to 1985 is revealed by the time series statistics of spending by the consolidated nonfinancial public sector as a percentage of gross domestic product (GDP) in Argentina, Brazil, Chile, Peru, and Venezuela (see table). The nonfinancial public sector was also very large in Cuba, the Dominican Republic, Nicaragua, Uruguay, and elsewhere. The total public sector, which includes the public financial institutions, was even larger.

As the size of the public sector increased almost continuously between 1930 and 1990, the aggregate deficit of the public sector also reached, in some periods and countries, unprecedented levels. The nominal deficits of the nonfinancial public sector rose (to, for example, 83 percent of GDP in Brazil in 1989) because its expenditures, including those on interest due to rising public debt, were flexible upward but rigid downward, and generally significantly higher than its unstable, even declining, current revenues. The nominal deficits of the financial public sector also increased, as a result of numerous fiscal expenditures, such as the assumption of private debt, that these institutions, in particular the central banks, had to take upon themselves.

For the most part, the public sector revenues structure has remained highly inflexible and regressive since 1930. General government revenues, which consisted primarily of regressive indirect taxes and social security contributions, and only marginally of progressive income taxes, were adversely affected by rampant tax evasion, accelerating inflation, capital flight, and informalization of economies. Sales, the primary revenue of state enterprises, suffered as price controls turned these enterprises into distributors of implicit consumer subsidies. Finally, heavy dependence on revenues from internal and external borrowing increased expenditures on interest and the debt burden of all segments of the public sector. It also contributed to inflation by forcing central banks to print money and, ultimately, precipitated the widespread suspension of debt payments in the 1980s. The fundamental collective need for safety, security, and protection of private property was neither sufficiently appreciated nor adequately satisfied by the majority of Latin American governments.

With the exception of oil-exporting countries, indirect taxes have been the primary source of central and general government revenues since 1930. Within the indirect tax category, production and

sales taxes, which include all general sales, value added, and turnover taxes, and all other taxes and duties levied on the production, extraction, sale, leasing, and delivery of goods and rendering of services were the main sources of central government revenues (again, except in oil-exporting countries). During prolonged periods, indirect taxes contributed more than two-thirds of central government current revenues in the Bahamas, Bolivia, Costa Rica, El Salvador, Guatemala, Haiti, and Honduras. In much of Latin America, within the indirect tax category international trade taxes—which include all taxes on international trade and commercial transactions in the form of both specific and ad valorem import and export duties raised for purposes of revenue mobilization and for protectionism—have been the second-most important source of central government current revenues.

Nontax revenues, which have comprised non-compulsory current revenues arising from government ownership of property, enterprises, financial assets, land, and intangible holdings, in the form of dividends, interest, rents, royalties, and entrepreneurial income, have been an important source of central or general government current revenues since 1930 in Argentina, Chile, the Dominican Republic, Haiti, Mexico, Panama, Paraguay, Suriname, and Venezuela.

AFTER THE 1970s: REDUCTIONS IN THE PUBLIC SECTOR AND LIBERAL TRANSFORMATION OF COLLECTIVE MARKETS

Since the 1970s governments in Argentina, Brazil, Chile, Jamaica, Mexico, Peru, and elsewhere have once again drastically transformed their public administration and defense. The component of collective services promoting the role of the state as lender to and owner, operator, manager, and controller of enterprises was sharply curtailed. Increasingly, most governments recognized and tried to satisfy the collective needs of their populations, though often failing to ensure political freedom. The public sector shrank, especially in the 1990s, as state-owned enterprises in agriculture, industry, telecommunications, newspapers, and transportation (railroads, airlines) were privatized, often at unprecedented speed. Government regulation also was drastically curtailed. The component of collective services facilitating private enterprise; free, competitive, and efficient markets; overall price stability; and free trade was increased drastically. This phenomenal withdrawal of governments from ownership and control of enterprises engaged in production of individual commodities was motivated by a desire to reduce huge public sector deficits, harness skyrocketing inflation, improve efficiency of production, increase foreign trade, repatriate capital, and, above all, use the limited resources and energies of the state in the production of better and more equitable collective and semipublic services.

Traditional indicators of the economic impact of government include, first, its claim on GDP as measured by general government consumption as a percentage of GDP (see Table 2) or by central government expenditure as a percentage of GDP (see Table 3). General government consumption has ranged between a low of 2.9 (Dominican Republic, 1990, domestic prices) and a high of 33.9 (Nicaragua, 1990, purchasing power parity [PPP] prices, which take into account differences in price levels among countries) (see Table 2). Central government expenditure as a percentage of GDP ranges between 7.2 (Nicaragua, 1990) and 42.7 (Saint Vincent and the Grenadines, 1990) (see Table 3). The second indicator is the amount of taxes collected by different levels of government. As shown in Table 4, central government tax revenues as a percentage of GDP ranged between a low 2.93 (Nicaragua, 1990) and a high 27.72 (St. Lucia, 1990). The third and fourth indicators of government impact on the economy are regulation and state ownership of corporations. These have greatly varied over time among Latin American countries.

To achieve price stability and satisfy the collective need for safety, security and protection of private property, governments increasingly offered constitutional guarantees for the institutional independence of central banks. Furthermore, since 1980 production by general government, through collective markets, of the collective services satisfying the collective needs for economic freedom, social harmony, and environmental protection also has significantly increased. It remains to be seen, however, whether Latin American governments can, on a long-term basis, achieve sustainable democracy and economic growth. Venezuela under President Hugo Chavez and Bolivia under President Evo Morales have been subjected to significant curtailments of political and economic freedoms, suggesting that great difficulties lie ahead in turning the Latin American economic failure into a success through the establishment of both sustainable democracy and economic growth. The public sector must become both smaller and much more efficient if the policy goals of sustained development and improved distribution are to be achieved. In the face of persistent poverty and inequality, the need for a leaner and better public sector grows ever more urgent.

See alsoEconomic Development; Income Distribution; Privatization; Public Health; Service Sector.

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                                  Markos J. Mamalakis