President Laura Chinchilla’s defining moment in her first years in office will likely come down to a vote in the Legislative Assembly on fiscal reform.
As Costa Rica’s fiscal deficit approaches $7 billion, a victory on tax reform could generate an additional $850 million annually in badly needed government revenue.
Tax reform has eluded the previous three administrations and would be a political victory for the president, who has yet to show significant progress on many of her campaign promises.
Lawmakers will vote on the controversial reform package next month. In the lead-up to that vote, this week Chinchilla and members of her Cabinet negotiated with various business sectors to allay fears that new taxes could cause production costs and consumer prices to skyrocket.
Over two days, members of the Chamber of Industries, the Food Industry Chamber, the Association of Engineers and Architects, the Costa Rican Construction Chamber, farmers groups and the Agriculture and Livestock Ministry reached separate agreements with Chinchilla’s administration, promising to support the plan in exchange for a reduced value-added tax, or VAT. Initially, the plan called for a universal 14 percent VAT.
“The government has openly listened to our concerns in the industrial sector about the effect the VAT would have on industrial products and basic consumer prices,” said Marco Meneses, president of the Chamber of Industries. “After a process of constructive dialogue, the impact of the tax proposed in the original plan has been significantly reduced to meet the demands of the chamber.”
Under the new agreements, the VAT for raw materials and production equipment in the industrial sector would be reduced to 2 percent. The VAT on food items and household products included in the country’s basket of consumer goods was reduced to 3-4 percent.
“The original proposal was drafted in a way that would have been a large hit to the wallets of national consumers and could have severely damaged several vital production sectors,” said Marco Cercone, the chamber’s president. “Thanks to the government’s attention to and acceptance of our requests, this potential disaster was averted.”
On the Losing End
Despite this week’s gains, opposition to the reform package remains strong. On Tuesday, 200 workers from six free-zone companies protested in front of the Legislative Assembly, shouting “¡Zonas francas!” (Free zones!) as lawmakers entered the building.
Free-zone companies have been the most vocal in opposing the reform plan. If the overhaul passes, foreign companies that begin operations in Costa Rica’s free zones after 2015 will be taxed 15 percent on earnings. Legislators from the Citizen Action Party (PAC), which drafted the plan with Chinchilla’s government, have said that free-zone companies already located in Costa Rica would not be subjected to the tax if they reinvest after 2015.
But according to Gabriela Llobet, general manager of the Costa Rican Investment Promotion Agency, those promises are not in writing.
“Free-zone businesses are asking for a text that clearly states that businesses already located in free zones are not going to be affected by the 15 percent tax after 2015,” Llobet told The Tico Times. “PAC, the government and the Finance Ministry are yet to add text to the law. … If the law is passed and makes existing companies pay 15 percent income tax on reinvestments, they will definitely not consider Costa Rica as an option for reinvestment.”
Llobet urged lawmakers in the assembly’s fiscal reform commission to put those changes in writing this week, before the bill goes to the assembly floor for discussion.
Some companies have already put investments on hold. Aegis, a technology outsourcing company in Tilarán, in the northwest Guanacaste province, is delaying plans to build a Spanish-language call center that would employ up to 400 workers.
Tilarán Vice Mayor Mauren Ugalde said the decision to delay construction of the center has caused uncertainty and disappointment among residents.
“We took all the steps to bring foreign investment into our town. When Aegis announced that they intended to build a large project in Tilarán, we were ecstatic,” Ugalde said. “There was great expectation from the community and for the town’s youth. … Now, with such uncertainty about the investment, residents are losing hope for potential jobs.”
German Herrera, production manager at Panduit, a free-zone company in the Central Valley town of Grecia, also cited job loss fears as a reason for attending Tuesday’s protests.
“I’ve worked in free zones for 20 years. I started as an uneducated employee; my company funded my education, and now I am a manager,” Herrera said. “I hoped my children would follow the same path. If the reform is approved, that future will be in jeopardy.”
Chinchilla has visited the United States three times this year to attract investment. Led by Foreign Trade Minister Anabel González, Chinchilla’s administration hopes to attract $9 billion in foreign investment by 2014. Last year, foreign investment totaled $1.5 billion, and the goal for 2011 is $1.9 billion.
On Nov. 4, González, who accompanied Chinchilla during the U.S. visits, told members of the legislative commission studying reform that she opposes the president’s proposed tax structure.
“For an investor, stability in a country’s legal framework is very important. It provides confidence for investments not only in the short term, but for future investment planning in the country,” González said. “A change in the current legislation could put further investment at risk, which is a very worrying prospect for the country’s economic sector.”
This week, Llobet and other critics of the plan noted the mixed signals that tax hikes on potential foreign investors would create.
“It seems like a contradiction to say that we are a government that wants to promote foreign direct investment, while at the same time we are going to risk the stability of the business environment that we worked so hard to create,” Llobet said.
Luis Guillermo Solís, a political analyst and member of PAC, said that the tax rate is only part of the decision-making process of company managers looking to invest in Costa Rica.
“The amount of income tax in a country isn’t the only factor that companies consider when choosing a country to invest in,” Solís said. “It is one piece of the whole package, which includes things like quality of living, education level, infrastructure, competitiveness and more. A tax isn’t the most important factor considered.”
Lawmakers have already filed more than 2,000 motions against the reform plan, which is scheduled to reach the assembly floor next week. Commission president Edgardo Araya said he expects a vote on the bill by the end of the year.
“It seems that even with a plan that [has] deficiencies and limits, support is rallying behind it, because it is understood that it will put the country in a better place financially than it is now,” Solís said. “There is no option that exists that will please both sides, but I think that if the plan passes, the president will be very happy with the achievement.”