The Costa Rican government’s proposal to the IMF will exacerbate the economic contraction because it has a clear regressive fiscal and budgetary bias

LATINDADD TECHNICAL NOTE ON THE NEGOTIATION BETWEEN THE REPUBLIC OF COSTA RICA AND THE IMF

The Costa Rican government’s proposal to the IMF will exacerbate the economic contraction because it has a clear regressive fiscal and budgetary bias

The Government of Costa Rica presented to the IMF a proposal to start the negotiation of an “Extended Fund Facility” (EFF) to access funds for $ 1,750,000,000.00 (One thousand seven hundred and fifty million dollars), a proposal that contains a strong fiscal and economic adjustment mainly oriented to the reduction of public expenditure and the creation of new taxes to increase revenues.

Given this, Latindadd points out:

A. Budgetary austerity, sale of state assets and reforms in public institutions

1. It proposes strictly following the Fiscal Rule contained in Law No. 9635 approved in 2018, which implies an indefinite freezing of remunerations in the public sector, strong budget contraction and the merger or closure of various institutions and public bodies.

2. It transfers parafiscal charges established by the Law of Public Banks that today finance various institutions, to the Treasury, without establishing the destination of said resources or what will happen to the affected entities.

3. It promotes public works in infrastructure under the figure of Public – Private Partnerships (PPPs), without considering that in several countries of the region these mechanisms have led to disproportionate costs and socio-environmental conflicts.

4. Sale of state-owned assets (National Liquor Factory and International Bank of Costa Rica). That is, privatizations.

B. New tax burden with regressive and economic contraction content 

1. A permanent increase of 300 percent in the municipal real estate tax rate, which will represent a serious blow to the family finances in mid-income sectors, by not making any type of distinction nor exemption. This is a serious blow to small and medium-sized traders and farmers at a time when these suffer the impacts of the economic crisis caused by the pandemic.

2. A two-year increase in Income Tax rates (2.5 percent, 5 percent and 10 percent) for individuals and legal entities. A measure that initially could be thought as progressive becomes regressive, first because less than a year ago a tax rate increase came into effect. Second, because in the current pandemic context, a good part of mid and high level salaries in the formal sector are the main financial support of households given the very high unemployment rates observed (24.4 percent). And third, because this increase in the midst of a serious economic recession (-4.3 percent of GDP in the first half of 2020) will affect small and medium producers and traders, implying an excessive increase in costs when they have not even recovered their former levels of sale revenues or production.

3. A new tax for 4 years of (0.3 percent for the first 2 years and 0.2 percent for the following two) on electronic banking transactions, which means an increase in costs for all economic agents and a reduction in the families´ consumption capacity. Likewise, it increases costs in the productive sector by taxing its transactions and exacerbates the regressive bias of the tax by not making any type of differentiation either in the amount or in the type of transaction. In a different context, this measure could have been discussed in terms of whether was relevant or not, but what is true is that it is very far from the international debate on taxing large financial transactions and speculative capital flows in particular.

4. Although it could be said that the idea of including Global Income from 2023 goes in the right direction, the figure of World Income was not included mainly due to lobbying actions by the corporate sector that resists a measure that would help decisively in the fight against illicit financial flows derived from foreign trade and the financial sector.

C. Tax privileges and corporate tax evasion / avoidance remain intact

1. Although the proposal indicates its intention to “eliminate Tax Expenditure”, it actually seeks to eliminate components of the expenditure referred to labor income, by eliminating exemptions of Income Tax (ISR) on the school salary (0.12 percent of GDP) as well as family Income Tax credits for the spouse and children under 25 years who study (0.03 percent of GDP). Additionally, it eliminates the tax exemption for lottery prizes (0.07 percent of GDP) as well as the exemptions of Income Tax for Cooperatives (0.06 percent of GDP).

2. In contrast, the Tax Expenditure related to the highly influential corporate sector remains unchanged. Exemptions of the Value Added Tax (VAT) and ISR in free zones are not modified, which represent 1.01 percent of GDP in terms of ISR and 1.0 percent of GDP in terms of VAT. No changes are considered either in the exemption of ISR for passive income from the financial market (0.36 percent of GDP) and the exemption of income tax on gains in real estate transfers (0.15 percent of GDP). Tax Expenditure in general has a serious impact on the national economy since it represents 5.57% of GDP.

3. There is no concrete and effective measure in the proposal to combat tax evasion and avoidance. Only the implementation of the “Hacienda Digital” (Digital Treasury) project is mentioned as a mechanism to reduce evasion. It should be noted that only in ISR and VAT, evasion represents 8.22 percent of GDP. On the other hand, tax evasion and avoidance derived from International Trade (False Billing and Transfer Pricing Manipulation) represent 5.50 percent of GDP.

D. A policy that deteriorates the working conditions and wages in the public sector

1. The public employment Reform project is endorsed, which universalizes the «Single Salary» notion without any type of «salary supplement», thus deteriorating the composition of salaries in the public sector. It also relaxes and deregulates redundancy conditions and introduces major changes in hiring alternatives and job stability.
2. It seeks to eliminate the seniority salary supplement labeled «annuity» from the entire public sector payroll for four years.

3. It promotes a program of «labor mobility» or retirement of 7,000 (seven thousand) public officials.

4. It promotes a legislative project that aims to eliminate the eight-hour working day, and replace it by a twelve-hour working day instead.

In light of the above, Latindadd concludes that:

• The government proposal to the IMF shows an intention to promote a severe adjustment in terms of expenditure reduction:
  • emphasizing a strict policy of budgetary austerity based upon a Fiscal Rule,
  • promoting a hard policy of freezing remunerations,
  • a policy of freezing and deregulating labor contract conditions, and
  • the closure and merger of public institutions.
• It dangerously includes the sale of state-owned assets as a way out, something that Latin America´s experience showed can have serious adverse consequences. Similarly, the promotion of Public-Private Partnerships in public infrastructure has shown important weaknesses and risks, as documented by several studies.
• It promotes a set of new temporary and permanent taxes, which are highly regressive due to the way in which they are collected and due to the current context of economic crisis, severely hitting mid-income sectors and small and medium-sized entrepreneurs who have suffered the most in terms of the economic consequences of the pandemic. This package of new taxes will have a counterproductive effect on the national economy, exacerbating the current recession.
• The proposal does not address two key aspects that tend to deteriorate public finances, such as Tax Expenditure and Tax Evasion and Avoidance, as it relies mainly in the removal of tax exemptions of labor income, leaving those of the corporate sector unchanged. Also, it does not propose a single measure to address the serious problem of corporate tax evasion and avoidance.
• The proposal has a clear anti-labor bias with a set of measures aimed at deteriorating working conditions and salaries in the public sector.
• A fundamental and structural weakness of the proposal presented by the Government is that it does not address a critical problem related to the management of Public Debt, which by July 2020 represents 65.8 percent of GDP. If the debt management problem is not solved, the overall fiscal situation will not be solved either.
• Finally, the path chosen by the Government of Costa Rica goes in the opposite direction to what UNCTAD recommends in its recent Report on Trade and Development 2020 (see https://unctad.org/es/PublicationsLibrary/tdr2020overview_es.pdf) in which three essential measures are suggested: a bold push in public spending to drive economic recovery, increase wages and hold corporate income. The above aim to address inequality (recall that Costa Rica ranks 9th among the most unequal countries on the planet) and to rebuild the economy from the devastation caused by the coronavirus pandemic.

In this sense, Latindadd urges the Government of Costa Rica to put aside the policies and measures that support this request to the IMF, and adopt an appropriate approach that takes into consideration the pandemic as well as the economic and social crisis that the country is going through. It also calls on social organizations in the country to be vigilant about this possible agreement.

Finally, we urge the IMF to definitively close the dark chapter on conditional austerity, which only contributes to an unequal recovery from the crisis, directly and negatively affecting our countries.

Latin America, October 5, 2020