Assessing the impacts of a major tax reform: A CGE-microsimulation analysis for Uruguay

Abstract

In 2007, a major tax reform was put into place in Uruguay with the explicit goals of promoting both greater efficiency and equity in the tax system. Overall, the reform substantially increased direct income taxes by establishing higher and rising marginal rates; lowered indirect taxation; reduced the corporate tax; harmonized employer contributions to social security across sectors and eliminated some highly distortionary taxes. We assess the joint effects of these changes on macroeconomic and labor outcomes, poverty and inequality using a top-down static CGE microsimulation approach. Overall we estimate a 1% increase in GDP and a 2% increase in employment due to the reform. We find substantial general equilibrium effects of the full implementation of the reform that tend to reinforce the reduction of poverty indicators, exclusively due to the modifications of the direct personal income tax without considering behavioral responses. Regarding poverty, the general equilibrium effects are significantly greater than the direct effects. Overall, we estimate a one-point reduction of the Gini coefficient due to the reform.