Pandemic Encourages Low-Tax Paraguay to Build Its Welfare State

(Bloomberg) -- The coronavirus pandemic is forcing Paraguay President Mario Abdo Benitez to expand welfare in one of the countries with the lowest tax incomes in South America.

For that, the government wants to convince as many as 770,000 workers to leave the shadow economy and start paying taxes, according to Finance Minister Benigno Lopez. Formalizing more of the workforce would also make it easier for the government to help people in future crisis, he said.

“The plan as we envision is to have a large part of those people formalized at the end of the administration” in 2023, Lopez said in a telephone interview. “It will have an important tax impact.”

According to a bill that will be sent to lawmakers as soon as this month, informal workers who register with the government would receive four monthly payments of 500,000 guarani ($73) under a $250 million program. Participants would eventually have to pay taxes or contribute to social security agency IPS in exchange for health care and pension benefits, Lopez said, adding that the government is also studying the creation of an unemployment insurance system.

Paraguay’s March decision to close borders, impose a strict lockdown and pour money into social programs and underfunded public hospitals protected it even as neighboring Brazil became a global epicenter of the pandemic. The International Monetary Fund estimates the Paraguayan economy will contract 5% this year, one of the smallest recessions in the region.

Still, getting financial aid to workers and small businesses operating off the books remains a challenge. Data compiled by statistics agency DGEEC suggests about 63% of the country’s 2.8 million non-farm workers were informal last year. The status of the other 657,300 employed people isn’t clear.

Tax Impact

The government might succeed in formalizing several hundred thousand people, but the hand-to-mouth existence of most informal workers and the social security agency’s weak finances are challenges, said Fernando Masi, a senior researcher at local think tank Cadep.

“It’s good to formalize the economy,” he said. “But if we are going to formalize via the social security agency IPS without reforming it, we could be adding to its existing problem,” he said, warning the agency could run short on money.

Welfare states are expensive and Paraguay has historically struggled to generate revenue, in part due to low tax rates and its vast shadow economy. Tax revenue as a percentage of GDP was among the lowest in South America at just 14% in 2018, according to an Intra-American Development Bank report.

Any further changes to the tax system after a major reform approved last year will have to wait until after the economy is back on its feet, Lopez said.

The government has already borrowed more than $1.2 billion this year to fund its crisis response. It still needs to borrow about $350 million from multilateral lenders, the local debt markets or both to top off the recovery plan that will channel $2.5 billion into public works, social programs, and loans through the end of 2021, Lopez said.

With the fiscal deficit set to exceed 6% of GDP this year, the government will ask Congress to approve a new deficit law next month with a view to reach 1.5% within four years, Lopez added.

©2020 Bloomberg L.P.