A possible solution to Costa Rica’s ballooning fiscal deficit was presented to the Legislative Assembly on Tuesday, and after months of internal disagreements, lawmakers agreed to put the latest tax reform proposal on a fast track to a December vote.
With a vote of 43 to 10 during a full session of the assembly, the latest version of reform, known as the “tax solidarity bill,” took an important step towards ratification.
Included in the proposed reform are new taxes on Costa Rica’s wealthiest citizens, purchases of “luxury” automobiles and on properties. The plan would also add a value-added tax (VAT) at 14 percent. Several other tax changes are included (see box on Page 9).
According to the bill, taxpayers earning more than ₡4 million ($8,000) per month would be taxed 20 percent on income. Vehicles with a price tag of more than ₡18 million ($35,000), which lawmakers labeled “luxury,” would be taxed 50 percent.
The plan also calls for an increase in the tax on property transfers from 1.5 to 3 percent, except for homes valued at less than ₡50 million ($98,000).
The bulk of increased revenue that would be generated from new taxes would come in the form of a VAT on services. A 14 percent VAT would replace the current 13 percent sales tax structure, and would apply to all sectors where a discernible service is provided, such as lawyers, doctors, nurses, personal trainers and other occupations. A VAT of 2 percent would also be applied to private education and health services. Currently, these industries are exempt from paying taxes on services.
Each of the three separate fiscal reform proposals the government presented this year include a VAT.
“The third version of the tax solidarity law [would] increase Costa Rica’s tax burden by 2 percent of the GDP,” said Boris Segura, an economist and Latin American specialist at Nomura Holdings Inc. “Most of the increased taxation is to come from conversion of the current sales tax into a proper value-added tax, and from the increase of its rate to 14 percent from the current 13 percent.”
The goal of the latest fiscal reform package, which was authored by government heads and the Citizen Action Party (PAC), is to cap and reduce the national deficit, currently estimated at 5.2 percent of the gross domestic product, about $2.4 billion. Approval of a tax reform is one of President Laura Chinchilla’s most pressing goals. Last month, Second Vice President Luis Liberman and Finance Minister Fernando Herrero hinted that failure to reform tax policy before 2014 could have dire consequences for the economy.
“If debt continues to grow, it will be partnered with increases in interest levels for everyone and every company that has debts in the country,” Liberman said. “Everyone that has a loan on a house, a car or credit card will see hikes in interest rates. And that is something we do not want to happen.”
According to a report by Segura, the VAT could rake in an additional 1.38 percent of the GDP, or $550 million. The Finance Ministry projected that the new tax overhaul could rake in an estimated $850 million in one year.
Playing Nice in Congress
Many view the decision to approve an expedited voting process for the new fiscal reform bill as an important step for a Legislative Assembly that has been at odds for much of the year. A large cause of the dissention stemmed from an inability to agree on a new tax regime.
“Today’s vote of 43 legislators from six different parties demonstrates the possibility that this country can agree on items of great importance, such as a fiscal reform,” said Presidency Minister Carlos Benavides. “It is evident that there is a willingness of this government to negotiate and reconcile to achieve objectives that we have established. We will continue to work together to construct a better country.”
While reform measures could mean higher taxes for the wealthy, low-income taxpayers would catch a break. If the bill passes, workers who earn less than ₡4.8 million ($9,600) annually will not be required to pay income tax. The current cutoff is ₡2.8 million ($5,600).
“PAC is committed to voting for a fair and unifying reform that taxes the sectors with the largest incomes and does not affect the most vulnerable groups of the country,” said PAC legislator Manrique Oveido Guzmán. “We completely support the new measures of the new reform.”
Though the overwhelming majority vote is a good sign for Congress, public acceptance of new taxes could be an uphill battle.
“The tax reform proposal is likely to have its first vote by mid-December. As it is becoming a norm in Costa Rica, whoever loses democratically will likely turn to the Sala IV [Constitutional Court] to try to overturn the decision of the majority,” Segura said. “The pro-tax reform alliance needs to proceed carefully throughout the legislative debate of this proposal. A feasible final date for approval of this bill would be early 2012.”
New Tax Proposal
A new tax reform bill would result in the following changes to national tax structure:
Value Added Tax
A 14 percent value-added tax (VAT) would replace the current 13 percent sales tax. Additional services would also be taxed, including services by doctors, nurses and lawyers, among others. Private education and health services would be taxed 2 percent. Basic services such as water and electricity, public transportation, libraries and farming goods would not be subject to a VAT.
Income tax for corporate offices and institutions remains at 30 percent. Income earned by salaried employees and small businesses would be taxed 15-25 percent, according to income level.
Taxpayers earning salaries of more than ₡4 million ($8,000) per month would be taxed an additional 20 percent on income.
Tax on property transfers would increase from 1.5 to 3 percent, except for homes valued at less than ₡50 million ($98,000).
Purchases of “luxury” vehicles sold at more than ₡18 million ($35,000) would incur a 50 percent tax.
Breaks for Middle and Lower Incomes
Workers that earn less than ₡4.8 million ($9,600) annually would not be required to pay income tax. Currently, that figure is ₡2.8 million ($5,600).