Costa Rica: Public Finance Plans are Not Sustainable

By ICEFI and CLALS*

President of Costa Rica Carlos Alvarado Quesada

Carlos Alvarado Quesada, President of Costa Rica, April 2018/ Wikimedia Commons/ Public Domain/ https://es.wikipedia.org/wiki/Archivo:Carlos_Alvarado_Quesada_CAQ_PAC_03.jpg

The Costa Rican government’s draft budget for 2020, presented to the Legislative Assembly on August 30, reveals that shortfalls in tax revenues, high deficits, and accelerated public debt endangers the country’s ability to continue its social services and maintain its traditional level of democratic governability. The fiscal reforms that Costa Rica has undertaken – Law 9635 on Strengthening Public Finances – have proven, at best, insufficient to correct the imbalances envisioned in the new budget.

  • The budget proposes a tax burden of 13.2 percent for 2020 – equal to that observed in 2018 before the tax reforms were implemented but below ICEFI’s estimate for the end of 2019 (13.5 percent). This rollback is alarming because it essentially erases the gains expected from the reforms. It is due to increased levels of tax evasion and avoidance, and illicit capital flows.
  • The government projects public spending to reach 8,475.5 billion Colones (US$14.0 billion), accounting for 22 percent of GDP – slightly below the 22.1 percent approved for this year but higher than ICEFI’s estimate for the end of 2019 (20.9 percent). The 2020 proposal implies cuts to public spending that will affect key ministries, including Education and Public Works and Transportation, the budgets of which will decline 1.4 and 0.4 percent from this year, respectively.

Costa Rica’s fiscal deficit poses another long-term challenge. The draft budget contemplates a deficit that would reach 7.8 percent of GDP, higher than ICEFI’s estimate of 6.1 percent for 2019. For Costa Rica’s fragile public finances, this would suggest an inability to achieve fiscal sustainability in the medium term despite the recent tax reform.

  • The proposed budget would grow national debt to 64.7 percent of GDP in 2020, which is double the debt level observed during the earlier years of the decade (29.9 percent).

The failure of the tax reform law underscores Costa Rica’s urgent need for a fiscal accord that responds to the challenges of economic growth, social development, and democratic governance. To avoid such a scenario, tax officials will have to devise and implement plans and strategies next year that will stop and reverse the steady loss of the Executive’s ability to collect taxes. The cuts to education, public works, and transportation could erode Costa Rican well-being. Public budgets reflect the priorities of a society, and both the Executive and Legislative authorities in San José have the obligation to expand debate to include input from affected sectors. Costa Rica will face even greater challenges if it fails to formulate a budget that includes a responsibly progressive tax regime; reduction in tax evasion and under-reporting; greater control over illicit capital flows, adoption of a principle of worldwide income; increase fiscal transparency and accountability, debt restructuring, and maintenance of spending levels that guarantee adequate universal services. 

November 18, 2019

* The Instituto Centroamericano de Estudios Fiscales conducts in-depth research and analysis on the region’s economies. This is the first in a series of summaries of its analyses on Central American countries.

Chile Elections: Bachelet’s Partial Victory

By Maribel Vasquez and Eric Hershberg

President Michelle Bachelet / Photo credit: Chile Ayuda a Chile / Flickr / CC-BY-NC-ND

President Michelle Bachelet / Photo credit: Chile Ayuda a Chile / Flickr / CC-BY-NC-ND

Elections last Sunday didn’t give former President Michelle Bachelet the strong mandate that she wanted but she appears well positioned to win the second round and the honor of serving a tough second four-year term. An underwhelming number of Chileans headed to the polls to cast their votes for the president of the republic, parliamentarians, and for the regional councilors. Polls had indicated that Bachelet would win convincingly in the first round but, with 46.7 percent of the ballots cast, she fell just short of the 50 percent needed to avoid a run-off election on December 15. Conservative Evelyn Matthei, from the governing right wing Alliance Party, received 25 percent of the vote in the first round and has little chance of winning the run-off: another 17 percent of Chileans voting in the first round opted for candidates running to the left of Bachelet, and observers predict they will either stay home in December or select the former president as a second best option.

A 2012 change in voting law appears to have hurt Bachelet’s percentages. Under the new norm, Chileans for the first time were automatically registered to vote in presidential and congressional elections upon reaching 18 years of age, instantly expanding the electorate from eight to 13 million potential voters. But also for the first time, voting was not compulsory, and that proved consequential. In a country where public opinion polls have long shown high levels of alienation from the political system, particularly among younger segments of the population, abstention reached unprecedented heights. Fewer than seven million Chileans turned out to vote on Sunday, representing only around half of those eligible to do so. Turnout was undoubtedly suppressed by the stubborn persistence of Chile’s binomial electoral system, a holdover from the Pinochet dictatorship’s 1980 Constitution that gives the losing party a bloated presence in Congress (in order to receive both seats in any given district, the winning party or coalition must win double the percentage of the vote received by the runner-up, so frequently even a wide margin between the two top vote getters generates an equal allocation of seats). Bachelet’s center-left coalition, the New Majority, has proposed amending the constitution to make the electoral system more reflective of public preferences. But the newly-elected Congress, selected according to the rules of the authoritarian regime, is unlikely to generate the super-majorities needed to achieve constitutional changes that would alter the system so as to democratize congressional representation.

Getting elected to a second four-year term as Chile’s president might prove to be the easy part for Bachelet.  Harder still will be pushing forward the ambitious policy reforms she has promised. An especially prominent issue in the campaign was the demand of a growing student movement to reform Chile’s privatized education system, and Bachelet responded with a pledge to guarantee free, quality higher education to all Chileans, to be funded by a proposed increase in corporate tax rates and elimination of tax deferrals used widely by Chilean companies. Yet while Bachelet’s bloc secured the simple majority needed to secure modest tax reform, it fell short of the super majorities needed to secure education reform or change the electoral system or constitution, and the rightist opposition is loath to cede ground on either of these issues, which are also legacies of the Pinochet constitution. To enact the key pillars of her agenda, Bachelet’s second presidency will need to calibrate difficult negotiations with Congress with popular pressures to fulfill democratic aspirations for political representation and a more social democratic approach to public services than has been possible to achieve during the first 23 years of post-authoritarian rule.

Cuban National Assembly Takes Modest Steps on Reforms

Photo by Nathan Laurell via Flickr http://www.flickr.com/photos/nglklm/7146331353

Speaking to the two-day semi-annual session, President Raúl Castro reiterated the leadership’s commitment to undertaking the reforms outlined in the Sixth Party Congress last year.  He didn’t explicitly address concerns reported in international media that implementation of the reforms has been halting, but he announced several concrete steps to be undertaken this year.  Among them is the creation of non-agricultural cooperatives – allowing a new form of private enterprise in 222 business areas and announcing government loans for them – and greater decision-making autonomy for state enterprises.  The Assembly passed a new tax law, details of which have not yet been published.

Castro was a little defensive about the lack of an “updating of migration policy” – widely understood to include lifting the requirement for exit visas – while “ratifying the will of the Party and State leadership to carry out the reformulation.”

From the beginning of the current round of reforms, Raúl Castro and the Communist Party have cautioned that the changes will be introduced gradually and adjusted during implementation.  The credible reports of frustration with the pace of change notwithstanding, the National Assembly appears to have validated that getting the reforms “right” is more important than doing them fast.  The government probably calculates that the new cooperatives and tax law are important elements of an infrastructure for change, but slow or partial implementation will undermine them.  The perennial question remains whether the government’s concern with control discourages important energy among the individuals it is counting on building the new limited private sector.

Fiscal Policies Worsen Security Crisis in Central America

From left to right: Aaron Schneider, Maynor Cabrera and Hugo Noe Pino at the June 5 event on Central American fiscal policy.

Economists are warning that Central America – unlike some South American countries and Mexico – has still not rebounded from the 2007 global economic crisis, and that current fiscal policies dim prospects for improvement.  After making progress reducing poverty prior to 2007, the subregion has been stymied by static tax policies, insufficient investment in physical infrastructure, corruption, and natural disasters induced by climate change.  This is the assessment of Hugo Noe Pino, Ricardo Barrientos and Maynor Cabrera, economists from the Central American Institute on Fiscal Studies (ICEFI), and Aaron Schneider, Professor of Tulane University, who presented their work at a CLALS-sponsored seminar at the Woodrow Wilson Center on June 5.

The specialists’ research indicated that political resistance to fiscal reform is strong and comes from both new and traditional political and economic interests.  Elites have not found common ground with the middle and lower class in most of Central America – a key element of Costa Rica’s success prior to the financial crisis.  Absent an enduring fiscal pact, countries in the region are likely to remain plagued by persistently slow growth and unusually skewed income distribution.

Violence and security dominate Washington’s agenda on Central America, but this focus largely misses the underlying dynamic between economic decline and crime throughout the subregion.  Elites favor policies that discourage effective state‑building – including investment in security forces paid well enough that they are less vulnerable to corruption – and that exacerbate social inequalities.  Political fragmentation and low citizen confidence in government institutions have dire consequences for national security, and countries get caught in the Catch‑22 of being unable to attract investment from abroad and encourage development from within as long as fiscal policies fail to promote an educated, healthy and skilled workforce.

CLALS currently has a program investigating how traditional, renewed and emerging elites shape the political and economic landscape of Central America.  For more information click here.  And click here for a video of the ICEFI presentation and discussion at the Woodrow Wilson Center.