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Friday, June 02, 2006

Colombia's Window of Opportunity


By MARY ANASTASIA O'GRADY

Liberty lovers across the Western Hemisphere are cheering Colombian President Alvaro Uribe's second-term victory on Sunday. Colombians gave their president more than 62% of the vote. His closest competitor, the hard-left Carlos Gaviria, whose platform mirrored the ideology of Venezuelan President Hugo Chávez, earned only 22%. Pro-Uribe parties also won a majority in Congress.

The Uribe win is not only an endorsement of a worldview favoring security, the rule of law and global engagement for Colombia. It is also evidence of a backlash against the economic isolation and hostility toward private property preached by Mr. Gaviria and Mr. Chávez next door. As such it casts a ray of hope on the Andean region, which has been trending toward left-wing, authoritarian populism of late.


Now comes the hard part. To secure Colombian democracy, Mr. Uribe's second term will have to go beyond the success he managed in beating back guerrilla forces around the country and stabilizing the economy in his first term. Second-term success will require equal boldness in economic reform so that Colombia might attract more capital, bring underground economic activity into the legal sector, begin to grow at its potential and provide economic mobility.

The Colombian corporate tax regime may be the country's single most pernicious policy error. It is also easily correctable by introducing a single, low corporate rate, an idea that is spreading rapidly in Eastern Europe and has proven to stimulate growth and reduce corruption. Were Mr. Uribe to embrace it, he would score an early reform victory that would have a huge payoff. Failure to seize the moment will mean a missed opportunity that is not likely to present itself again. Just ask Mexican President Vicente Fox what happens when political capital is not spent.

A low corporate rate goes against the tired old saw that high taxes on entrepreneurs make society fair, even though this model has left Latin America in poverty. But bucking conventional wisdom is Mr. Uribe's trademark. When he was first a candidate for the 2002 elections, Colombia was overrun with guerrilla terror while the terrorists enjoyed a jungle safe-haven the size of Switzerland, courtesy of the government as an olive branch toward peace. The status quo favored this concession even though the rebels warred on, using the area to store weapons, hold hostages and organize assaults against the civilian population. Washington and Colombian "experts" counseled this perpetual "peace process," while the human carnage wrought by guerrillas was mounting weekly.

Mr. Uribe saw things differently and said so: Appeasement of terrorists was making things worse. That observation got him elected and when he took office he ended the safe-haven policy, beefed up the military and sent a message to the rebels that the Colombian people would defend themselves. Four years later, Colombia has not only regained lost territory but it has also recovered national confidence.

Now Mr. Uribe has the chance to do the same thing with the economy that he did with security: break with conventional wisdom and forge a new path. His economic team has already accomplished some microeconomic reform and Colombia was named one of the world's most-improved business environments by the World Bank two years ago. Improved security has paid off in increasing investment. Yet the massive underground economy remains, holding back the productivity gains essential for development. With GDP growth still averaging below 5% annually, much more has to be done to lower the cost of complying with the law so that entrepreneurs can afford to come out of the informal shadows.

The economic eyesore is tax policy, according to the bank's annual "Doing Business" report, which ranks Colombia at the bottom of the pile (148 out of 155 countries) in the category of "paying taxes." According to the report, full compliance for a medium-sized business involves an administrative burden of 432 hours and 54 payments annually. The survey further finds that "total tax payable" amounts to more than 75% of gross profit.

That's not nearly as bad as Brazilian or Bolivian tax policy but it's a world away from Estonia -- where compliance means 11 payments a year taking 104 hours and costing less than 40% of gross profit -- or Ireland where there are eight payments annually that take 76 hours at a cost of just over 45% of gross profit.

How can the lower costs in Ireland and Estonia be explained? Easy: Both have low, flat corporate rates. Ireland's is 12.5%; Estonia's is zero on retained profits. Compare this to Colombia's 35% rate and its mishmash of loopholes. Simplification means fewer filing headaches and less corruption. Tax revenues have soared in flat tax countries as businesses invest more and comply more readily. The economic effect is more employment and more funding for infrastructure and social programs serving the truly needy.

Ireland, which for more than a century lived one of the world's most tragic emigration stories, is now experiencing net immigration and is a richer country than the United Kingdom. Estonia has one of the most competitive business environments in Europe and from 2001-2004 its average per capita growth rate was 6.7%.

Of course, any attempt at such a free-market tax policy will meet with a lot of reasons about why it can't work. Mr. Uribe could prepare for this by listening to former Estonian Prime Minister Mart Laar who won the Cato Institute's Milton Friedman Prize in April for his role in breaking the regulatory and tax shackles on his country and making it one of the world's superstar economies.

The humble Estonian has plenty of horror stories about living under Soviet rule. But he also notes that once the reformers came to power, economic freedom faced a different enemy. "The Western experts," he says, often advised his economic team against deep and rapid liberalization.

It is likely that Mr. Uribe is also encountering naysayers. The State Department is famous for its arm-twisting bureaucrats who push steeply progressive tax schedules. But Mr. Laar has the moral authority and his counsel is clear: Do it and do it fast and don't let "experts" talk you out of it.

The battle for security will continue but as Colombian economist Mauricio Cardenas said recently, "It's a mistake to think that the conflict must first be resolved for the economy to grow. We need economic growth in order to resolve the conflict." To meet that goal there may be no single policy as powerful as the corporate flat tax.

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