Most countries in the region suffer from low fiscal legitimacy as a result of the limited role their tax systems play in reducing inequality and delivering high-quality public services.

People have little trust in government's ability to collect and spend fairly, and this creates a vicious circle: Poor-quality fiscal policy hinders the generation of tax revenues, frustrates public expenditure —

Fiscal policy is not a purely technical matter: Politics shapes the success or failure of fiscal reform — and consensus must be reached through an open and transparent public debate.

and further undermines fiscal legitimacy.

According to Latinobarómetro, less than 25% of Latin Americans believe that their taxes are being well spent. Even allowing for some volatility or measurement error in those opinion surveys, there can be no doubt of the low orders of magnitude of fiscal legitimacy in most countries in the region.

An important explanation for this lack of trust in fiscal policy is that, in contrast to an important effect of fiscal systems in most OECD countries, taxes and transfers play little or no redistributive role in most Latin American countries. When taxation fails to help bridge the gap between the rich and the poor, the credibility of the fiscal system suffers.

Fiscal reforms in the 1980s and 1990s made significant progress and produced positive, albeit insufficient, results. Brazil, for instance, collects and spends a lot nowadays. At about 35% of GDP, its tax revenues are close to the average for OECD countries — and far above the average of 17% for Latin America as a whole.

However, more does not necessary translate into better — and Brazil does not outperform other Latin American countries on numerous social indicators that reflect the effectiveness of public spending.

Mexico, for example, whose tax revenues are below 15% of GDP, scores

When taxation fails to help bridge the gap between the rich and the poor, the credibility of the fiscal system suffers.

as low as Brazil on numerous measures of human development and the quality of public goods.

At opposite ends of the regional spectrum in terms of their tax-revenues-to-GDP ratios, Brazil and Mexico, like many other countries in Latin America, illustrate that collecting more is only part of the equation.

Improving the quality of public expenditure is the most pressing issue for fiscal systems in Latin America. So far, taxes and transfers have failed to reduce inequality in one of the most unequal regions in the world.

Levels of income inequality in Europe and Latin America are quite similar, but while European states manage to reduce inequality substantially through public transfers and taxes, the fiscal-policy induced reduction in inequality is eight times smaller in Latin America than in Europe.

According to the Latin American Economic Outlook 2008, taxes and transfers reduce inequality 15 Gini points in OECD countries, but only two Gini points in Latin America.

The explanation of this alarming figure is provided by the limited size of transfers — and their poor targeting to reduce inequality and address social needs. Indeed, fiscal expenditures even show a regressive nature in many

Local think tanks' independent monitoring of public spending and fiscal policy-making can strengthen a sense of public ownership over democratic processes.

Latin American countries. In key sectors, wealthier households tend to benefit more from public expenditures than poorer ones.

Social-insurance programs, in particular, are notably regressive throughout the region. The richest segment of the population received over 16% of all social spending in social security payments alone.

That is more than what the poorest fifth of the population received in education, health and social security spending altogether.

Extensive evidence also suggests that public spending in health and education is at best mildly progressive, and can be strongly regressive, as it is in higher education.

Conditional cash-transfer programs, such as Bolsa familia in Brazil or Oportunidades in Mexico, on the contrary, are very progressive. Nevertheless, they are still relatively minor in size.

The most promising path for Latin America’s fiscal reforms to succeed is by strengthening democratic governance. People will support fiscal reform — including tax reform — if they see results.

First, as pointed out above, public spending should be targeted better. The region needs better, fairer and more public spending, certainly on health and education — but also on infrastructure and innovation.

In terms of tax reform, a major pending challenge is to make collection systems fairer and more balanced through the elimination

Brazil and Mexico, like many other countries in Latin America, illustrate that collecting more taxes is only part of the equation.

of special exemptions from direct and indirect taxes. Such reforms will operate as a disincentive for tax evasion and increase revenues, thus broadening the tax base.

Revenues from indirect taxes, value-added taxes (VAT) in particular, play a large role in tax collection. Tax structures can only be balanced by increasing the share of revenues coming from direct taxation.

An open debate on fiscal policies will also be critical for its improvement. Expectations are growing for measures that can help strengthen accountability mechanisms and bring official policies closer to the population and public scrutiny.

Local think tanks can play a very important part here. Their independent monitoring of public spending and fiscal policy-making can strengthen a sense of public ownership over democratic processes.

New ways of empowering local governments in the area of taxation need also to be explored. After all, decentralization can strengthen accountability and democratic governance by reinforcing the capacity, authority and accountability of subnational governments, especially through direct taxation.

Overall, transparency should reinforce citizens’ perceptions that they are getting value for their money — and that taxes are being well spent.

Levels of income inequality in Europe and Latin America are quite similar, but European states manage to reduce inequality substantially through public transfers and taxes.

In their efforts to enhance fiscal legitimacy and reinforce democratic governance, Latin American countries need to bring politics back into tax and fiscal policy.

Fiscal policy is not a purely technical matter: Politics shapes the success or failure of fiscal reform — and consensus must be reached through an open and transparent public debate.

Any attempt to carry out and implement the necessary transformations Latin America needs in terms of fiscal policy should consider the political economy of reform.