President Laura Chinchilla’s tax system overhaul, which was presented to lawmakers on Monday, aims to generate more than $1 billion in government revenue, thereby helping to reduce the biggest fiscal deficit in Latin America.
Costa Rica’s year-end 2010 deficit soared to 5.3 percent of the gross domestic product (GDP), or about $2.3 billion.
Chinchilla’s plan is seen as a crucial political step toward addressing some of the country’s most pressing financial problems. But getting the reform package through the Legislative Assembly could take months.
The reform package’s plans include generating revenue by chasing down tax evaders, offering fewer exemptions and converting the country’s tax structure from a mixed sales tax structure to a value-added tax (VAT). The VAT would move to 14 percent – up from the current 13 percent sales tax.
Chinchilla also hopes to make certain utilities – gas, electricity and rent – exempt up to pre-established margins (not yet defined), double the tax on asset transfers, and increase a vehicle tax by 10 percent, among other measures.
By calling it a “solidarity” tax reform package, Chinchilla hopes to stave off significant political opposition to the reform package, particularly from lawmakers who are against moving entirely to a VAT structure. Supporters of the reform, however, say the richest 20 percent of Costa Ricans would assume 60 percent of the tax burden, and workers earning less than $1,300 a month would not have to pay income tax, according to a Finance Ministry statement.
“Solidarity is the center of the proposal,” said Finance Minister Fernando Herrero. “We are eliminating tax exemptions that benefit the wealthy.”
But those who oppose the tax still say it is unfair.
“The name ‘solidarity tax’ is just to sell it,” said Gustavo Arias, who will represent the left-leaning Citizen Action Party (PAC) in the initial committee debates. “We think the tax [as proposed] will fall on the shoulders of the people with the least economic means.”
“It’s not that we aren’t in favor of a tax reform,” he added. “Our party has campaigned for more taxes, but what we need is a tax structure that is more fair.”
Arias is particularly concerned about a 14 percent VAT, as even a consumer tax hike of only 1 percent could hurt households struggling to make ends meet.
“Right now, people don’t even have enough money to pay for their basic needs,” Arias said. “With even a small increase in product prices, it would make it impossible.”
As the bill moves forward in legislative debate, PAC leaders have asked that all eight political parties be represented in the discussion and that a special commission be formed for the debate. As it stands today, the bill is scheduled to go before the assembly’s Finance Commission, in which only a handful of the parties are represented.
“It’s bad form on the part of the government to promote the approval of a complicated bill that requires the support of all factions, in a forum that doesn’t guarantee a pluralistic and transparent discussion,” said PAC legislator Jeannette Ruiz in a statement. “[It leaves] debate to the floor of the assembly without reaching a previous preliminary consensus.”
But according to Chinchilla’s right-hand man, Presidency Minister Marco Vargas, the bill took months to present precisely because it was being examined by dozens of political entities and analysts. “This has been our most vetted bill,” he said.
Despite the preplanning, the proposed reform seemed dead in the water before it even made it to the assembly this week. Finance Commission President Guillermo Zúñiga announced – then delayed – his resignation, citing differences with President Chinchilla. A report from the Washington, D.C.-based political research firm Eurasia Group said it was “unlikely that any meaningful reform would be approved.”
“Just look at the [current] political dynamic and the [reaction] in the assembly,” report author Heather Berkman told The Tico Times. “[By] the reaction of the opposition and the response from people in Chinchilla’s party … it’s clear that this will be an uphill battle” (TT, Jan. 14).
Chinchilla tried to salvage the reform by announcing a hiring freeze and sweeping cuts within the central government. She set a goal of scaling back government spending by 20 percent and ramping up efforts to go after tax delinquents.
Legislative changes are only a piece of the reform, she said. But, in the end, they may be the most important. Chinchilla has said that no amount of saving will fix the deficit, which is forecast to increase by half a percentage point this year.
“We are financing recurring expenses with debt,” Finance Minister Herrero said.
The tax reform bill could eliminate tax exemptions for certain sectors, including public banking and private health care.
Private schools with tuitions under ₡110,000 ($220) would also be tax-exempt. Other private schools, except universities with accredited career tracks, would be required to pay a 10 percent VAT. Public transportation and taxi services would be exempt.
The shift to a VAT would generate 68 percent of expected new revenue under the plan.
Groups on both sides of the political spectrum oppose the plan. Libertarian Movement Party lawmakers staunchly oppose any new taxes, calling them “unsustainable for the majority of Costa Ricans.” Libertarians say the government must be streamlined instead.
“It’s time that the government started tightening its belt and stopped asking for sacrifices from the people,” Danilo Cubero, a Libertarian leader, said in a statement. “As an opposition party, we demand that, instead of levying new taxes, the administration stop spending billions on superfluous things.”
The reform would also levy a 15 percent tax on dividends from the National Stock Exchange (currently 5 percent), a 15 percent tax on capital gains, a tax increase from 1.5 to 3 percent on property sales, and a 10-percent increase on automobile taxes (current taxes range from 0 to 65 percent).
Referring to the bill, Herrero said, “A country as small as ours is more vulnerable to financial swings and is in urgent need of growing its public and private investment. We aren’t trying to establish stability in just any manner that comes with a high social cost. For that reason, we are proposing a path toward solidarity to resolve our financial problems.”
Before the bill is sent to the assembly’s Finance Commission, and ultimately to the assembly floor, it must first be debated in public hearings, a bureaucratic requirement that could drag out the process for months.
Meanwhile, National Liberation Party lawmaker Zúñiga, who will be responsible for shepherding the plan through the process, said he will hold off resigning from the assembly until May. He said he plans to dedicate “a good amount of time to the bill to ensure its advancement.”