San José, Costa Rica, since 1956

CAFTA Could Reduce Scanty State Income

Costa Rica will lose about $733 million across 15 years in foregone tariffs on U.S. imports if the country approves the Central American Free-Trade Agreement with the United States (CAFTA), according to an analysis done for The Tico Times by the Finance Ministry’s Statistics Department.

Finance Minister Guillermo Zúñiga, who says he hopes Costa Ricans will approve the U.S. free-trade agreement in the Oct. 7 referendum, described the loss as small and easy to compensate.

“Of course we are going to lose,” Zúñiga said. “(But) the total effect … would not even reach 0.4% of GDP … How are we going to compensate? By collecting taxes that this country has not collected.”

Economics Professor Henry Mora at National University (UNA) in Heredia, north of San José, who is vocally anti-CAFTA, acknowledges that the loss “won’t be great” and agrees “we can compensate with a few more taxes.”

Still, the state is strapped for cash and the legislature has been slow to pass reforms that would add income to state coffers. Every little bit of revenue counts for the Finance Ministry, which just last year announced, “We have the tax system of an undeveloped country and the spending aspirations of a developed country … For years we have been talking about a crisis.”

In the context of a larger revenue problem, losses under CAFTA would be an extra, though minor, squeeze on state finances. Some 60% of revenue last year came from internal taxes – for example, on income, merchandise sales and gas. Another 37% came from customs duties that importers must pay on items such as alcohol, soap and other general merchandise. CAFTA would affect only one type of customs duty, tariffs, which last year made up about 5% of state income.

Under CAFTA, 80% of imports from the United States would lose their tariffs immediately. Tariffs on products such as rice, refined oils, sugar, milk and ethanol would be phased out gradually over 20 years. The state would lose about $31.15 million the first year – a 2% decrease in projected revenue – and about $181 million over five years, according to an analysis by Rafael Madrigal, head of the Statistics Department at the Finance Ministry’s Customs Administration.

Costa Rica has long had to adjust to falling tariffs. When Costa Rica entered the General Agreement on Tariffs and Trade (GATT) in 1990, it had to substantially reduce tariffs on imported goods. The average tariff has since fallen from 50% to about 5%, said Customs officer Mario Ulate.

Zúñiga says the Ministry would have to work to compensate for a further reduction  in tariffs, but Vice-Minister of Finance José Luis Araya has a different idea. He thinks CAFTA will automatically generate more state revenue by promoting economic activity.

Some economists agree that CAFTA will increase exports, reduce prices of imported products and boost gross domestic product (GDP) growth. The state’s tax revenue could increase through sales taxes on imported products, income taxes and other local taxes.

“Firms will come to Costa Rica attracted by the conditions here,” said Trade Professor Patricia Rodríguez of the University of Costa (UCR). “(They) will hire people with high salaries … This will allow the state to collect more money because people with good jobs buy houses, pay property tax, pay income tax.”

Mora of UNA, said that argument is pure  speculation.

“You really can’t make a clear argument that the free-trade treaty will boost the economy and thus compensate for fiscal losses. It will be very difficult to isolate the treaty’s effect,”Mora said. “We don’t know.”

A Way Out?

With three tax reform bills crawling through the Legislative Assembly, the Finance Ministry has taken matters into its own hands. It recently granted the U.S.-based management and technology consulting firm BearingPoint a two-year $20 million contract to develop and implement a new tax system for Costa Rica. The goal is to improve revenue flow through more efficient collection of taxes, help reduce tax fraud and give Costa Ricans electronic access to their tax records. The Comptroller General’s Office is now deciding whether to give the project the green light.

The Finance Ministry has been cracking down on tax evasion, and expects to collect about $4.4 billion in taxes in 2008 – an 18% increase from this year. That means taxes will make up 15.8% of GDP, which is high for Costa Rica, but low compared to other developed Latin American countries, Zúñiga said.

If the state continues to collect taxes at the same rate as this year Zúñiga continued, it could comply with constitutional requirements for spending up to 2011. But to fund President Oscar Arias’ National Development Plan, which calls for increased spending on education and other social programs, the state would have to substantially increase its revenue (TT, Jan. 26, 2007).

Three bills that would allow the government to collect more taxes have been in various legislative commissions for more than a year, said Ministry advisor Carlos Vargas. One would create a tax on houses worth more than about $240,000, to be used to eradicate the country’s substandard housing (TT, June 1). A second bill would charge an annual $200 fee for corporations.

A third bill would apply a 13% sales tax to nearly all goods and services. (It now applies to most goods but only a few services.) Vargas said the Ministry would present more bills to reform the income tax and potentially tax financial transactions.

The tax system has not seen a major reform since 2003, Vargas said. A controversial nine-bill package proposed by the Abel Pacheco administration (2002-2006) was approved in early 2006 after years of debate. But it was archived after the Constitutional Chamber of the Supreme Court (Sala IV) ruled that the way it was debated violated the Constitution.


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