Latin America and the Caribbean (LAC) face a structural challenge of low economic growth, which threatens the region’s long-term development prospects. The demographic dividend that supported growth over recent decades is fading, and now more than ever, the region must boost productivity and capital investment to sustain economic growth (see Figure 1).
As a result, increasing domestic and foreign direct investment (FDI) will be crucial. Unfortunately, the region is lagging. Total investment peaked in the 2010s at an average of 22% of GDP, but has since declined, approaching levels seen at the start of the century, according to our calculations[1]. FDI has also lost momentum compared to other emerging economies. While average inflows have decreased across the board so far this decade, the drop has been steeper in LAC compared to the rest of the emerging world.
What can governments do? Tax policy can be a powerful tool for attracting investment across the region and the IDB has been working with several governments in such reforms. By making tax frameworks more business-friendly and improving system efficiency, governments can foster a more competitive business environment while also enhancing the resilience of public finances—especially critical for countries still grappling with high debt levels. The following sections will explore policy options and assess their feasibility.
Figure 1: Growth decomposition, 2000-2024
(Latin America and the Caribbean, %)
Reducing the Tax Burden for Businesses
LAC has persistently high rates for the corporate income tax (CIT), with an average effective rates reaching 24% in the region compared with 22% for OECD countries and 17% in emerging economies. Additionally, the marginal effective tax rate on capital in LAC is nearly twice as high as in peer regions, raising the cost of capital and discouraging investment. This inefficient tax design introduces distortions, reduces the region’s attractiveness to foreign investors, and ultimately weighs on economic growth.
In a bid to offset this problem, many governments grant substantial exemptions, deductions, or special regimes. However, that has not been effective to reduce the tax burden for businesses. Figure 2 reveals that several countries combine high tax expenditures with relatively high effective CIT revenues as a share of GDP, raising questions about the actual effectiveness of these incentives in lowering the cost of capital or stimulating investment.
Figure 2. Income Tax Collection and CIT Effective Tax Rates
A simpler solution would be to reduce the tax rate. Our simulations[2] show that a 1 pp cut in the CIT rate leads to an increase in the return on capital, which in turn supports greater FDI, private investment, the market valuation of firms[3], and economic growth. On average, FDI and total investment increase by 0.4 pp (Figure 3 – Panel A – Blue line), with effects that persist for at least a decade. GDP growth also increases by approximately 0.2 pp in the early years (Figure 3 – Panel B – Blue line).
While this evidence points to potential gains in capital formation and productivity, it is crucial to weigh these benefits against the fiscal costs—especially in a region where public finances are already under pressure. CIT’s high share in revenue collection across LAC, combined with the region´s high debt levels and rigid spending commitments, such as wages, transfers, and interest payments, leave limited room for fiscal maneuvering, at least in the short term.
In this context, any cuts in corporate income tax rates or changes in incentives must be highly selective, well-targeted, and subject to rigorous evaluation to ensure its effectiveness and sustainability.
Enhancing Tax Certainty
Reducing uncertainty around future capital taxation can be as powerful—or even more so—than cutting CIT rates when it comes to stimulating investment and growth. Enhancing legal certainty and ensuring stable and predictable tax rules can improve the business planning horizon and stimulate investments.
Our simulations[4] indicate that clearly signaling no major changes to capital taxation can lead to a short-term increase of 1.5 percentage points in private investment, a 1 percentage point boost in foreign direct investment (FDI), and a 0.5 percentage point rise in GDP growth (see Figure 3 – red lines).
Figure 3. Effects of 1pp CIT reduction on FDI and Economic Growth conditional on fiscal certainty
In summary, frequent or unexpected changes in tax policy can discourage firms from investing, even when tax incentives are offered. Maintaining stable and transparent tax frameworks is therefore essential to fostering private investment and supporting long-term economic growth. In times of severe budget constraints, this approach is also appealing because it is likely to have a limited short-term impact on fiscal balances.
Lowering Compliance Costs
In LAC, 27.6% of firms report having to meet with tax officials—significantly above the OECD average of 16.7%—and they do so nearly three times on average, compared to just 1.7 times in OECD countries (Figure 4). These excessive interactions reflect a tax system with high administrative friction, consuming time and resources while increasing the scope for discretion. Unsurprisingly, 30% of firms in LAC view tax rates as a significant obstacle, and nearly 22% cite tax administration itself as a key constraint, well above the levels observed in advanced economies.
Figure 4. Selected Indicators of the Enterprise Surveys on Tax Administration
Moreover, in LAC, nearly half of the potential CIT revenue is lost due to non-compliance, evasion, weak enforcement, or administrative shortcomings, as shown in Figure 5. On average, the region forgoes 47% of its potential CIT collection, with countries such as Argentina, Peru, Brazil, and Panama experiencing inefficiencies of 60% or more, significantly exceeding the OECD average of 22%.
Figure 5. Efficiency loss in CIT revenues (% of potential collection base)
These figures underscore that fostering a business-friendly environment requires more than simply adjusting CIT rates. Before considering rate changes, there is substantial room to improve the efficiency, fairness, and transparency of the tax system. On one hand,streamlining procedures, embracing digitalization, and clarifying tax rules and incentives are essential to encourage private investment and economic growth. On the other, strengthening audit capacity, promoting formalization, closing legal loopholes, and simplifying tax processes can significantly boost revenues while reducing the compliance burden on firms.
Additionally, LAC countries need to look beyond their national borders when implementing these reforms and align their tax rules with the OECD’s Base Erosion and Profit Shifting (BEPS) initiative.
BEPS is implementing a global minimum income tax for multinational companies and applying rules that will prevent these companies from artificially shifting profits to low tax jurisdictions.
These agreements will reshape the future of corporate taxation by narrowing opportunities for large-scale avoidance and redefining fiscal competition. For LAC, this underscores the need not only for competitive tax regimes but also for alignment with emerging global standards to protect revenue and remain attractive to high-quality foreign investment.
An Opportunity to Boost Investment in LAC
Economic recovery hinges on increased private investment, especially during periods of fiscal consolidation. If investment remains subdued, the region risks a prolonged post-pandemic slowdown. To avoid falling into this trap, LAC should adopt a tax policy that supports a favorable investment climate, avoiding excessive burdens on capital and ensuring legal certainty.
Evaluating the effectiveness and efficiency of tax expenditures should become a cornerstone of fiscal reform. At the same time, revenue diversification is critical to reduce overreliance on corporate taxation. Modernizing tax administrations is also crucial for reducing compliance costs and increasing trust in the tax system. Ultimately, the goal is to establish a tax framework that is investment-friendly, resilient, and credible—one that provides firms with the confidence to commit to the region in the long term.
To learn more how the IDB is supporting countries to strengthen their fiscal policies and reform their tax systems, visit our fiscal management page.
[1] IDB staff calculations with data from the IMF-World Economic Outlook and the World Bank.
[2] We used a Dynamic Stochastic General Equilibrium model.
[3] As measured by Tobin’s Q.
[4] We also used the DSGE model Incorporating the approach of Fernández-Villaverde et al (2015) in Fiscal Volatility Shocks and Economic Activity for modelling fiscal uncertainty.
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