El Salvador: Draft Budget Confirms Structural Problems in Public Finance

By ICEFI and CLALS*

US banknote lot

U.S. Banknote Lot/ Creative Commons/ https://www.pxfuel.com/en/free-photo-jqchd

The budget that President Nayib Bukele submitted to El Salvador’s Legislative Assembly in September increases much-needed social spending appropriate for the country’s current socio-economic context, but it lacks clear objectives and benchmarks — and fails to address ongoing structural problems in public finance.

  • The proposed budget is based on revenues of US$5.466 billion, 92.7 percent of which will come from taxes. In gross terms — without considering tax rebates — that amounts to a tax burden of 18.2 percent of GDP, just below the 18.3 percent that ICEFI estimates for 2019. In net terms, the budget claims taxes will reach 18.1 percent of GDP (compared to 17.7 percent in 2019), but that figure is not realistic: it estimates tax refunds of only $16.5 million — compared to $117.4 million for the January-August period of this year. This error threatens to undermine serious Legislative debate.

Spending in the proposed 2020 budget reaches $5.774 billion — equal to 20.8 percent of GDP, compared to 22.3 percent estimated for 2019. Some areas that are already struggling, such as environmental programs, face significant cuts, while others will experience modest decreases and increases.

  • According to the draft, Central Government operating costs will decrease by 1.8 percent of GDP, driven by cuts in contracting of services and purchase of goods as well as in current transfers. Capital expenditures, on the other hand, will increase 0.3 percent over 2019 — that is, about 3.3 percent of GDP.
  • The Central Government’s spending on social development is slated to grow to its highest level in decades — about 10.5 percent of GDP ($2.921 billion), compared to 9.7 percent this year. The main beneficiaries of the increase will be municipal governments, pension systems, trusts for social security, and health care. With some 800,000 children and adolescents lacking schools to attend, the proposed increase in the education budget — from 3.73 percent (in 2019) to 3.75 percent — is minimal.

The budget anticipates a slight increase in the federal deficit. The non-financial public sector, including trusts to cover social security obligations, will experience a deficit of 3.1 percent of GDP (compared to the 2.7 percent that ICEFI estimates for 2019) — pushing total public debt to 70 percent of GDP. That’s less than the 70.7 percent estimated for 2019, but ICEFI cautions that the decline could easily evaporate as the government faces growing demands over the course of the year. Either way, debt servicing will remain the most significant item in the 2020 budget, reaching $1.102 billion (4 percent of GDP).

The perennial challenge that El Salvador’s leaders like their counterparts throughout the region  face is how to stimulate economic growth and reduce inequalities to make the state more democratic and effective. But this budget, if implemented as drafted, will achieve neither goal in politically significant ways. The fiscal data underscore that the fundamental structural problems low revenues, inadequate public spending, and high fiscal deficits and public debt remain unaddressed.

  • The increase in capital spending, while positive, is insufficient to have its desired impact of driving economic growth. ICEFI’s analysis indicates that the jump in social spending is certainly warranted by the growing unhappiness in various social sectors, but also falls far short of what’s needed to reverse ongoing negative trends. The cuts in environmental protection from a minuscule 0.07 percent of GDP (2019) to 0.05 percent seem outright foolish for a country that has already shown vulnerabilities, which could aggravate existing economic and social conditions. Rather than taking on the serious challenges El Salvador and its economy face, the 2020 draft budget kicks the can down the road, without credible expectation that the task will be easier in the future.

December 9, 2019

* The Instituto Centroamericano de Estudios Fiscales conducts in-depth research and analysis on the region’s economies. Data and charts supporting this article can be found by clicking here. This is the third in a series of summaries of its analyses on Central American countries.

Honduras: Facing the Budget Challenges?

By ICEFI and CLALS*

Honduran Lempiras

Honduran Lempiras/ Alex Steffler/ Flickr/ Creative Commons

Honduras’ proposed budget for 2020 reduces support to the country’s most needy – while protecting the military and security agencies – and, particularly if the debate on priorities is not made more inclusive, risks exacerbating already high political tensions and chronic economic mismanagement. On the revenue side, the draft budget shows a drop in tax revenues from 18 percent of GDP in 2019 to 16.5 percent – which, ICEFI has found, is not justified by technical analysis of the circumstances. Government spending – excluding payment on the national debt but including transfers to funds and trusts – equaled 19.7 percent of GDP, compared to 21.5 percent in 2019. (ICEFI estimates that the average government spending in Central America in 2019 will be 18.5 percent.) This drop will affect most public entities, particularly in social spending.

  • Education faces deep cuts. The budget of the Secretariat of Education, for example, will drop from 4.85 percent of GDP in 2019 to 4.49 in 2020. Transfers to public universities are slated to be reduced 23.1 percent from 2019 levels, and scholarships are also on the chopping block – cut 27.5 percent for national and 37.5 percent for international scholarships.
  • Health spending in Honduras – the country with the highest poverty rates in Central America – will decline from 2.39 percent to 2.37 percent at a time that inflation is more than 4 percent. The budget for Infrastructure and Public Services will be hit hardest – cut from 0.82 percent of GDP to 0.40 percent. Capital expenditures or investment will decline 33.5 percent year on year, including 38.5 percent from machinery and equipment and 34.6 percent for construction.
  • One of the only government sectors seeing increases is in the military and security, according to ICEFI. The 2020 budget proposes a 39.6 percent increase from 2019 on military and security equipment.

At first glance, the budget would appear to produce a surplus in 2020 of about 0.4 percent of GDP, which is double that ICEFI estimates for 2019. But factoring in the transfer of resources to the funds and trusts – a more reliable way of tracking fiscal behavior – the deficit will actually be 1.5 percent of GDP. That’s lower than ICEFI’s estimate of the deficit this year (1.9 percent), but it is achieved at the expense of the wellbeing of a majority of the Honduran population.

If approved and implemented as proposed, the budget will set back several strategic goals that the Honduran government itself has set. The budget confirms the government’s desire to reduce the public deficit principally through cuts to social spending and some capital expenditures – even though the approach contravenes commitments made under the UN Convention of the Rights of the Child and General Comment No. 19 (2016) on public budgeting for the promotion of children’s rights, which establishes that states should not deliberately adopt regressive measures that undermine child’s rights.

  • Although some provisions of the budget in principle could expand production of goods and services, they do not clearly point to either social inclusion, especially in terms of gender, age, and ethnicity. Budget allocations dedicated to attention to women are very low, equaling barely 0.19 percent of all spending. Neither does the budget focus on achieving any particular Sustainable Development Goals (SDGs).

The transparency and inclusiveness of the budget debate in the Honduran Congress will be crucial to determining the longer-term impact of this budget on human rights and the provision of public goods and services to the most vulnerable Hondurans, including children, adolescents, and women. Executive and Congressional decisions on the budget will shift the country’s path toward prosperity and governance – or continue down a path of instability and tension. More breaks for those capable of paying taxes, while cutting essential services to those who cannot, will be a step in the wrong direction. At a minimum, Honduran leaders should demonstrate the benefits of such moves will outweigh the costs. The legitimacy and effectiveness of the Honduran budget will depend on a broad, inclusive, and honest debate.

November 26, 2019

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

Tax Reform or Governance Revolution?

By Andrew Wainer*

Photo Credit: Reuniones Anuales GBM / Flickr / Creative Commons

Photo Credit: Reuniones Anuales GBM / Flickr / Creative Commons

Taxation to fund development is becoming central to U.S. foreign assistance policy, but it would be a mistake for USAID and other foreign assistance agencies to view tax reform solely through the technical lens of financing for development.  In September, USAID Assistant Administrator Alex Thier penned an article subtitled, “Why Taxes Are Better than Aid.”  This follows the announcement in July of the Addis Tax Initiative at the UN Financing for Development Conference, where the United States and other donors pledged to double the amount of technical assistance for taxation in developing nations.  By most accounts, the potential fiscal benefit of increasing taxation –“domestic resource mobilization” (DRM) in development parlance – is huge.  The World Bank and International Monetary Fund estimate that in 2012 DRM in emerging and developing nations generated a combined $7.7 trillion.  This dwarfs average annual foreign assistance outlays, which in recent years have averaged about $135 billion.  One of many examples cited by USAID is El Salvador, where a $660 million increase in annual tax revenues has been channeled to health, education, and social services, as well as other development programs.

The issues of fair and transparent taxation are often a secondary component in discussions of DRM but – as events in Guatemala and elsewhere demonstrate – can also generate revolutionary transformations in governance.   Even as U.S. agencies emphasize the technical side of DRM assistance, organizations that monitor taxation are sparking historic citizen revolutions through revelations of governmental tax corruption.

  • The UN-sponsored International Commission against Impunity in Guatemala (CICIG) was created in 2006 to strengthen the rule of law through “investigation of crimes committed by members of illegal security forces and clandestine security structures.” But it was CICIG’s revelations of a customs tax corruption network that brought 100,000 Guatemalans into the street in a single day.  The protests led to the forced resignation and jailing of President Pérez Molina as well as a surge in citizen engagement unseen in the country’s modern history.

The intimate link between taxation and governance should be a central factor in how the U.S. government and others think about DRM.  As the OECD states, “The payment of tax and the structure of the tax system can deeply influence the relationship between government and its citizens.”  DRM should place a high premium on the governance impact of tax reform, where appropriate.  Tax reform not only increases government revenues, but as the case of Guatemala demonstrates, it can also strike at the heart of ossified structures of governance and can spark revolutionary changes in the relationship between citizens and states.   

November 12, 2015

* Andrew Wainer is the Director of Policy Research in the Public Policy and Advocacy Department of Save the Children USA.

Honduras: Charter Cities Lurch Forward

By Fulton Armstrong

Choluteca, Honduras Photo Credit: Jonathan D. / Flickr / Creative Commons

Choluteca, Honduras Photo Credit: Jonathan D. / Flickr / Creative Commons

The Honduran government expects to get the green light this month from a Korean consulting firm for a master plan to hand governance of several small communities over to private investors to develop them, but concerns about the plan run deep and appear unlikely to fade.  Called ZEDEs – the Spanish acronym for “Employment and Economic Development Zones,” the specially designated areas are also called by their proponents charter cities, model cities, and startup cities.  The first tranche of towns facing conversion are in the southern Honduran departments of Valle and Choluteca, with a new port built on the Gulf of Fonseca.  The government says that the affected communities will remain an “inalienable part of the Honduran state,” but amendments to the Constitution, laws, and regulations permit their governing body – which is unelected – to establish “policies and regulations” and their own police and other public services.  Called the “Committee for the Adoption of Best Practices,” the board is dominated by representatives of Honduran millionaires and an even greater number of non-Hondurans of predominantly libertarian ideology.  Among them are American anti-tax crusader Grover Norquist; former President Reagan’s son Michael; and Michael Strong, chief executive of Radical Social Entrepreneurs.  The ZEDEs’ guiding principle is to liberate communities from government taxation, oversight, and corruption in order to attract investment and stimulate prosperity.

The ZEDEs initiative has been plagued by opposition since its inception, however.  Numerous reports underscore that the affected communities were never consulted, and demands for a referendum have repeatedly been rebuffed.  Honduran implementation of the model has been rejected by the U.S. economist who proposed it, Paul Romer (formerly of Stanford University; currently at New York University).  He withdrew because of the lack of Honduran transparency, including secret deals with interested U.S. parties.  The Honduran Supreme Court initially voted 4-to-1 against a Constitutional amendment allowing creation of ZEDEs in 2012, but the Congress impeached the four dissenters and replaced them with supporters who voted unanimously in favor.  There are numerous reports of intimidation of local civil society leaders, who deem them credible in view of clashes between wealthy businessmen and campesinos in other areas resulting in hundreds of deaths in recent years.

Honduras has a desperate need for economic growth – two-thirds of the population lives below the poverty line – and its model of national governance, riddled with corruption and non-transparency, is indeed in crisis.  But there’s no evidence that fighting one form of corruption with another non-transparent system will help anyone but the big investors.  Indeed, Honduras has ranked among the most violent countries in the world for several years, with the term “failed state” looming darkly over it – making it perhaps the worst place to experiment with provocative new models of governance without popular consultation or support.  Critics seem to have a good case: real reform and economic stimulus would focus on cleaning up the government and holding accountable the elites that have brought the country to ruin and now are trying to impose this model on their fellow citizens, rather than usurping the affected communities’ sovereignty.

March 19, 2015

Elite Power and State Strength: A Timely Focus of Academic Studies

By Eric Hershberg

lapidim / Flickr / Creative Commons

lapidim / Flickr / Creative Commons

Insufficient state revenues are one fundamental reason that many Latin American governments fail to provide their citizens with adequate education, health care, public transportation, environmental protection and the physical and technological infrastructure needed to move their countries toward high-income country status.  As a whole, the region’s governments were able to spend only 14.8 and 15.25 percent of GDP in 2013 and 2014, according to the UN Economic Commission for Latin America and the Caribbean (ECLAC).  Rationalization of expenditures is a goal that can only be pursued in practice if there are adequate funds to begin with, and few Latin American states have that luxury.  (To be sure, even where states are well financed, as in Brazil and Argentina, governments typically fail to spend resources efficiently.)  Historically primitive and regressive tax systems have not evolved in a manner consistent with the development needs of the region.  During the second decade of the 21st century this remains a major obstacle for those who strive to build more effective and democratic states across Latin America.

Several ambitious new books in comparative political economy offer insightful and complementary analyses of the political conditions that perpetuate state weakness as well as the dynamics that offer hope of overcoming it.

  • Aaron Schneider’s 2012 Cambridge University Press volume on State-Building and Tax Regimes in Central America was an initial contribution to this emerging literature, linking that sub-region’s changing relationship to the world economy to aggressive efforts by different factions of the elite to fashion tax systems that reflect their narrow interests rather than a broader agenda of societal development.
  • A book that will be launched later this month in Guatemala City builds on this work by underscoring the importance of political contestation regarding the fiscal arena more broadly – encompassing state expenditure as well as revenue. That study, prepared under the auspices of CLALS and the Instituto Centroamericano de Estudios Fiscales (ICEFI), illustrates the ways in which Central American elites have exercised disproportionate influence to render states ineffective and regressive: they contribute little to state coffers and extract much from them, with consequences that diminish the life chances of a majority of that region’s population.
  • Tasha Fairfield’s conceptually ambitious and empirically rich comparative study of South American cases, to be published later this year by Cambridge University Press, is a landmark contribution to literature on elites and Latin American political economy. It consists of a thorough comparative analysis of Argentina, Bolivia and Chile, revealing that strong business associations tied closely to the state augment elite capacity to block progressive tax reforms.  Conversely, she finds that social movement influence over the state can undermine elite capacity to resist the sorts of taxation needed to redistribute wealth.
  • Evelyne Huber and John Stephens demonstrated previously, in their 2012 University of Chicago Press book on democracy and the left, that there is a clear link between the capabilities of the political left in democratic regimes and the prospects for more equitable social policies in Latin America. Such policies, as this recent wave of publications make clear, will only come about if societies develop systems of taxation compatible with the emergence of effective states.

Scholarship on Latin American economic development has until recently devoted little attention to political power imbalances as drivers of state weakness and the consequent failure of societies across the region to forge pathways toward developed-country levels of income and opportunity.  These studies highlight the centrality of elite collective organization and behavior, as well as the political strength of countervailing forces in society, for determining levels of taxation across the region.  Taken as a whole, this welcome wave of social science research restores Latin American political economy to its rightful place as a domain of scholarship that speaks to the concrete challenges facing the region today and in the future.  Policymakers throughout the hemisphere who speak of democracy and economic growth need the clear analysis to progress that scholarly works such as these provide.

February 5, 2015

Elections in Brazil: The Force of the Latin American Left

By Eric Hershberg and Luciano Melo

Aécio Neves – Senador & World Economic Forum / Foter / CC BY-NC-SA

Aécio Neves – Senador & World Economic Forum / Foter / CC BY-NC-SA

The first round of Brazil’s presidential election has set the stage for a runoff playing primarily to class differences.  By the eve of the election, polls hinted at the real possibility that the center-right candidate Aécio Neves of the Brazilian Social Democratic Party (PSDB) would edge out the other principal opposition contender, former Minister of the Environment Marina Silva.  Silva enjoyed a spike in the polls after she replaced the late Eduardo Campos, who perished in a plane accident in August, as the Brazilian Social Party (PSB) candidate.  Sunday’s results confirmed Silva’s decline, as she captured only 21.3 percent of the votes compared to 33.5 percent for the PSDB and 41.6% for incumbent President Dilma Roussef of the Worker’s Party (PT).  The PT used its potent propaganda machine to portray Silva as a potentially dangerous candidate – an indecisive leader who could not be trusted to sustain popular social programs such as the Bolsa Familia conditional cash transfer program, which has helped lift millions of Brazilians out of poverty.  Also, Aécio and Rousseff built their images upon two iconic ex-Presidents – the former on Fernando Henrique Cardoso (FHC) – seen by the middle and upper classes as the leader who managed to defeat hyperinflation and putting Brazil on track for economic growth – and the latter on Lula, Rousseff’s mentor, who is idolized among the most disadvantaged parts of Brazilian society as the President who helped the poor become less poor.

To win the runoff on October 26, Aécio needs at least 70 percent of Silva’s votes – she has only hinted at supporting him – while Rousseff would succeed with only half of that.  It is clear that Dilma and the PT will double down on their negative advertisements, now aiming at Aécio rather than Marina.  The PT’s barrage over the airwaves will highlight the risks of abandoning the course set out by Lula and followed by Rousseff.  Voters will be told that the opposition may underfund cash transfers, privatize the state oil company Petrobrás or treat it as a profit-making enterprise rather than as a development bank, thus increasing unemployment as occurred during the Cardoso years.  And the PT will no doubt remind voters of its consistent efforts to boost minimum wages and chip away at the vast inequalities that had long characterized Brazil.  Surely they will portray Neves as an elitist out of touch with the majority that has benefited from the PT’s redistributionist agenda.  Aécio and the PSDB, by contrast, will highlight the worrisome slowdown in growth under Rousseff, the failure to significantly improve public services – it was frustration over health, education and, particularly, urban transportation that drove the social protests that began in mid-2013 – and the over-regulated and over-taxed economy.  Most of all, Neves’ campaign will harp on the persistent scandals that have bedeviled the PT over the past decade and that have helped to fuel popular disdain for politicians.

The election results in Brazil are likely to become increasingly polarized in terms of class.  Dilma appears poised to prevail in the poorest states of North and Northeast, where Bolsa Familia and other cash transfer programs, subsidies, wage increases and Lula’s image are compelling.  In turn, Aécio should come out ahead in the richer states such as São Paulo, which offer the largest pool of voters and where highly educated and middle- and upper-income Brazilians are concentrated.  We make divergent predictions: Hershberg anticipates a PT victory, since for all the speculation about the travails of the Latin American left, it has built very substantial foundations of support in societies that credit the left with finally making some advances to tackle Latin America’s yawning inequalities.  Warnings that Aécio represents a return to elite rule will resonate among the PT’s electoral base, and the PT’s success will be nourished by its powerful organizational capabilities.  Melo, by contrast, anticipates a PSDB triumph.  In this scenario, the corruption, disappointing growth rates over the past two years as the commodity boom has slowed, and widespread frustration about the quality of public services will generate an anti-incumbent dynamic that will bring to an end a dozen years of PT rule.

October 10, 2014