the road to fiscal consolidation · 2014-03-21 · significant fiscal adjustment in the next few...
TRANSCRIPT
The Road to Fiscal Consolidation: An Agenda for National Dialogue
October 2013.
NATIONAL DIALOGUEthe road to fiscal consolidation
Eight years from now Costa Rica will celebrate two hundred years of independent democracy. What do we want our country to look like on this special date and towards the future? Clearly, it must be freer, more prosperous, more solid, just and equitable, with greater solidarity.
When we first began to build our Nation, we made a pact for justice, freedom and institutionality. We were innovators and daring. As time passed, with our collective work and vision, we enriched the pact with education, health and the protection of our environment ,in the construction of a solidary State.
We Costa Ricans are known for our vocation to dialogue as a means to solve conflicts and deal with situations that we confront as citizens. However, in recent years it has been difficult to reach a concrete agreement in response to political, economic and social challenges to guarantee a better and more sustainable quality of life. On example of such challenges is the sustainability of public finances.
We cannot allow the current fiscal problems to become a chronic affliction. Guaranteeing the solvency of the State is an issue of national interest, well beyond any particular government, and we cannot delay a discussion on this matter any longer.
A robust economic development averaging 5% annually, public investment that promotes social mobility and access by the population to public services, as well as a solid democracy based on respect for human rights and institutionality, together with an internationally recognized environmental policy, have all been paramount for our national development in the last 60 years. Sadly, we are beginning to see some creases in the pact that has sustained this development model over recent decades. We have fallen into a vicious cycle of lack of resources and deteriorating infrastructure and public services, aggravated by the citizens’ resistance to pay taxes arguing that the benefits from public spending are increasingly limited.
This Administration has made significant inroads into strengthening fiscal revenue and containing current spending. Among these are the design, discussion and legislative approval of several fiscal reform components, although the main tax component did not come into fruition for the reasons we are all familiar with. In spite of these efforts, the fiscal deficit remains at levels approaching 5% of the gross domestic product (GDP), clearly an unsustainable level in the mid- to long-term
Over the last nine months we have developed an extensive consultation process that has contributed to formulating this document “Towards Fiscal Consolidation: An Agenda for National Dialogue”. The document is a diagnosis with an inventory of options--not necessarily --to address the fiscal situation that we will use in the next few weeks to deepen
Open Letter to Costa Ricans
a dialogue with all sectors of society seeking areas of convergence that will become the bases for one or several bills of law.
This guiding Agenda for a comprehensive and transparent National Dialogue seeks to identify the actions needed to ensure economic integrity for the State.
The dialogue will cover four elements:1) strengthened governance and fiscal transparency; 2) greater efficiency and quality in .public spending; 3) a simpler, more progressive and fair tax and customs system; 4) a more effective financing strategy and execution of public investments; and 5) a fiscal policy that considers environmental sustainability.
The preservation of the State’s financial integrity is a constitutional mandate that must be balanced with the precept of covering the population’s basic social needs. In recent decades Costa Rica has given greater priority to increasing public spending to satisfy these needs than to the mandates that safeguard public finances. Thus, a high percentage of spending is financed with debt. But the rights protected by such spending are as important as citizens’ rights to the financial sustainability of the State.
Clearly it is not the norm for a government to discuss fiscal alternatives only four months prior to the elections, and it is not the traditional way of doing politics. Those of us with public responsibilities within the Government know that we will be turning over our positions in just a few months. Under such circumstances, it would be more convenient to just carry on with the usual administration of public finances until May 8th.But we are convinced this is not a responsible position toward Costa Ricans. And although we do not except political forces to adopt definitive positions during this time, democracy validates them as first-order actors to encourage dialogue. Particularly when they refer to the social pact we have built.
Under the current conditions of our public finances, we take on the commitment to explain the current situation to all Costa Ricans -- the risks we face as well as the need for action. A responsible society must be clearly aware of the challenges it faces and understand that problems do not solve themselves, but require the drive and support of each one of us.
We can no longer delay our endeavors to find a solution to this complex fiscal issue that affects the country’s wellbeing and prosperity. This dialogue that we begin today will be inclusive and transparent, and I encourage all sectors to participate actively in this national endeavor.
Edgar AyalesMinister of Finance
1. Introduction................................................................................................................................................7
Background...........................................................................................................................................7 Gaps in the Development Model...........................................................................................................8 Fiscal Sustainability.............................................................................................................................10 The Fiscal Consolidation Program.......................................................................................................11
2. Recent Developments in Central Government Finances.....................................................................13
3. Fiscal Governance...................................................................................................................................14
3.1. Recent Developments and the Current Status of Fiscal Governance.................................. 14 3.1.1. Fiscal Transparency...........................................................................................................14 3.1.2. Legal Security of the Taxpayer..........................................................................................15 3.1.3. Management Capacity of the Executive Branch...............................................................15 3.1.4. Teaching Tax Culture and Tax Compliance.......................................................................18 3.2. Options for Improving Fiscal Governance........................................................................18 3.2.1. Continued Progress in Fiscal Transparency Policy...........................................................18 3.2.2. Legal Security....................................................................................................................19 3.2.3. Management Capacity of the Executive Branch................................................................20 3.2.4. Strengthen Tax Compliance Progress...................................................................................20
4. Level and Quality of Central Government Spending...........................................................................22
4.1 Recent Evolution....................................................................................................................22 4.1.1 Wages................................................................................................................................22 4.1.2 Current Transfers...............................................................................................................24 4.1.3 The Budget Process and Evaluation of Public Programs..................................................25 4.1.4 Public Purchasing and Administrative Contracts..............................................................26 4.1.5 The Challenge of Efficient Increases in Educational Spending..........................................26 4.2 Options for Improving Spending Efficiency and Quality.........................................................29 4.2.1 Wages................................................................................................................................29 4.2.2 Current Transfers...............................................................................................................31 4.2.3 Budget Process..................................................................................................................32 4.2.4 Acquisition of Goods and Services.....................................................................................33 4.2.5 Education Expenditures......................................................................................................33 4.2.6 Quantification of Options Contributed to the Inventory to Contain Spending and Improve Quality............................................................................................................34
Table of contents
5. Efficiency and Progressiveness of tax system..................................................................................35
5.1. Recent Developments and Characteristics of the Tax System..............................................35 5.1.1. Fiscal Pressure in Costa Rica...........................................................................................35 5.1.2. The Current Tax System and Tax Spending (exemptions).................................................35 5.1.3. Recent Developments in the Area of Revenue.................................................................37 5.2. Options for Improving the Fiscal Revenue System................................................................37 5.2.1. Improved Revenue Administration....................................................................................38 5.2.2. Towards a Fairer, More Progressive and More Efficient Tax Syste...................................40 5.2.3. Quantification of Options Contributed to the Inventory to Improve the Tax System..........45
6. Public Indebtedness and Investment.................................................................................................46
6.1. Recent Developments and Description.................................................................................46 6.2. Options for Improving the Debt Structure..............................................................................48 6.3. Options to Drive Public Investment........................................................................................49
7. Fiscal Policy and Environmental Sustainability...............................................................................50
7.1. Green Taxes..........................................................................................................................50 7.2. Budget Assignments in Support of the Environment.............................................................50 7.3. Resources identified to Face Climate Change Related Contingencies.................................51 7.4. Environmental Satellite Account............................................................................................51 7.5. Institutional Policy of the Ministry of Finance in support of the environment.........................51
Table of contents
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In January, the Ministry of Finance commenced a national dialogue on the plan that the country must follow to reach a sustainable fiscal position. The purpose of this dialogue is for society to come together around a solution to the fiscal problem, and it is comprised of three stages. The first phase consisted in technical meetings and consultations covering public administration and spending and their determining factors, as well as tax administration and legislation; the second stage is a national dialogue between all sectors of society; and the third, a discussion in Congress regarding one or several bills of law leading to fiscal consolidation.
The first stage lasted nine months. The second stage begins with the publication of this document that will serve as the basis for the dialogue on public finances and the strategy the country must follow to guarantee the financial sustainability of the State, and to attain real financial instruments to improve the State’s contribution to the country’s economic and social development. The consultation process during the first stage comprised 60 meetings and is fundamental to the diagnosis and the set of possible actions. The present document is the basis for the dialogue that will ensue in the coming months and does not in any way limit the analysis of alternatives arising from the process.
We are compelled to comply with two constitutional mandates: to preserve the financial integrity of the State and to cover the basic needs of the population. In recent decades, governments have been focused more on the second mandate, by way of assigning resources to cover social needs without, in many cases, specifying the sources of revenue necessary to finance them adequately. This situation cannot continue: the rights protected by such spending are as important as citizens’ rights to the financial sustainability of their State -- and for public financing to contribute fully to the development of the country.
Midterm projections underscore the need for a significant fiscal adjustment in the next few years to attain sustainability in public finances and improve their contribution to society. Past experiences and conversations to date indicate the need to approach this fiscal issue from multiple fronts, including better governance and fiscal transparency, rational flexible spending and continued improvement in financing strategies. We must also strengthen the tax
administration and its structure, review exemption policies, and reinforce the fight against avoidance, evasion and smuggling seeking a more progressive, simpler and fairer system of taxation.
Background
Over the last 60 years development in Costa Rica was based on four pillars: the economic, social, political and environmental aspects. Costa Rica has achieved a high level of sustained growth since 1950 (5.5% annual average), one of the highest in Latin America. This sustainable growth has been a key factor in creating jobs, a fundamental variable for the country’s social policy.
In addition, Costa Rica has invested heavily in human capital since the XIX entury. National endeavors in education, health and broad-based social programs have provided the population with equal opportunities, social mobility and the tools needed for inclusive versatile growth, minimizing the typical conflicts arising from social inequality.
Measures such as mandatory free education for both sexes have had a significant impact since the early XX century, dramatically reducing illiteracy. The economic crises in the early eighties halted progress in education, particularly with regard to coverage. However, the programs implemented thereafter sought to broaden coverage in preschool and high school education and improve the quality of public education overall. Today, the country has a gross primary school enrollment rate of 100%. The Global Competiveness Report (2012) recognize the quality of our education. Although school attendance improved significantly between 1980 and 2012, the increase of resources in recent years was used primarily for salaries and did not address deficit in educational infrastructure or extend coverage.
During the 40’s Costa Rica established a public health system to provide social security-based medical services. Today the system is universal and mandatory and has allowed the population to reach a higher life expectancy than many countries in Latin America, comparable with the majority of European countries and the lowest infant mortality rates in Latin America.
1. Introduction
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Today, Costa Rica is also one of the Latin American countries with the highest public spending in education and health. This is a clear sign that it continues to be a fundamental pillar of the Costa Rican social pact that has permitted inclusive sustainable development. The abolition of the army in 1948 contributed to the creation of fiscal space to use a larger portion of the budget for social investment.
As a supplement to the policies for universalization of education and health services, in the 60’s the State of Costa Rica implemented social assistance programs to reduce poverty. These social strategies constitute an important supplement to investment in education and health that have jointly permitted better living conditions for a large sector of the low-income population and have driven human development in the country.
However, the effectiveness of social policies in education and health and combating poverty depend both on spending amounts and the quality of expenditures. Therefore, the quality and effectiveness spending are fundamental elements for achieving the sustainability of social policies.
Gaps in the Development Model
The social pact that has supported the Costa Rican development model has begun to show some important creases that must be addressed immediately. Some of the elements eroding this model are the high cost and deterioration of public services, limited capacity for executing public investment, and the stagnating tax burden. Moreover, inflation has dropped to annual levels of 5% after 25 years of double-digit inflation and its consolidation at lower levels continues to be threatened by fiscal imbalance.
The tax burden in Costa Rica is relatively low, especially when compared to other countries with similar development levels, and it has not grown in a manner consistent with the expectations of the population regarding the types of services it expects to receive. Because of this, large segments of the population have chosen to substitute public services that they consider unsatisfactory, such as health and security, with private services. Therefore their willingness to contribute through the payment of taxes towards the financing of these public services is eroding. Consequently, the country has fallen into a vicious cycle that has weakened the social contract
and the development model so beneficial to the country over the last six decades.
This phenomenon is not exclusive to Costa Rica. There has been a tendency in several Latin American countries for the middle class to bypass the public service network.
Moreover, laws that created expenditures did not include the corresponding source of financing. These spending mandates, rarely accompanied by programs that guarantee the effectiveness and quality of the expenditure, have had a significant impact on public financing and have led to rigid budgets. Currently, 95% of the National budget is committed to imperatives set in the Constitution, specific laws, wages, pensions and debt service. An example of the creation of expenditures without financing and without a clear program to guaranty effectiveness is the constitutional mandate to increase educational expenditures from 6% to 8% of the GDP.
In Costa Rica education indicators are strong as compared to the rest of Latin America; however, significant weaknesses persist, along with the spiraling cost of public education. Academic performance, as measured by PISA scores, is among the top three in Latin America, with decisive progress in coverage and infrastructure. Nevertheless, high school and university coverage remain relatively low accompanied by a persistent lack in educational infrastructure. Educational spending has risen strongly from 5.1% to 7.1% of GDP in only five years. Most of these additional resources have financed salary hikes resulting from the Government’s general salary policy during the same period. Nonetheless, they have also served to expand infrastructure and equity funds.Costa Rica still has excellent public health indicators,
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but the Costa Rican Social Security Administration (CCSS) is beginning to have financial problems that will worsen as the population ages. There is also a significant deficit in health infrastructure, even though revenue received by the institution from social security payments is one of the highest in Latin America. This has an impact on medical services for the population, causing longer waiting lines to receive medical attention in outpatient and hospital areas. The CCSS is working on a solution to these problems that must consider more efficient use of resources. The national dialogue on health insurance currently underway in Costa Rica is an excellent opportunity to search for solutions for this sector.
There are also problems with regard to poor quality and low execution of public infrastructure that have an impact on the competitiveness of the production sector and national growth. For many years Costa Rica has had the poorest indicators regarding execution of projects financed by international organisms. Although, currently, the country has a financed project portfolio in excess of US$ 6 billion, these projects take many years to execute, resulting in a gap in infrastructure. In order to obtain better performance rates in this area, roadway infrastructure production indicators are being incorporated into the 2014 National Budget, as well as in the budgets for National Roads Council (CONAVI Spanish acronym) and the National Road Safety Council (COSEVI Spanish acronym).
The distribution of the tax burden between labor and capital is strongly concentrated in the labor factor, largely because of taxes on labor that finance social security and social assistance and technical training programs. High taxes on labor also affect the unemployment rate and how fast the country responds to a recession. The country has still not recovered from the 2008-2009 crises in terms of the impact on unemployment, although the economy grew by close to 4.5% annually between 2010 and 2012. Close to 15% of public sector labor force salaries have grown faster than private sector salaries over the last five years. Automatic increases from extra pay benefits and pay increases in 2008-2010 and from the 50-percentile policy, created a large gap between salaries in both sectors for similar jobs.
Because economic growth in recent decades has been strongly concentrated in foreign direct investment (FDI) activities and high technology service exports, mechanisms must be identified to link these sectors with the rest of the economy for a better geographic distribution of its production
activity. Appropriate education and training for the population in the different regions, consistent with the aptitudes required by these dynamic sectors, is a key factor in linking it to the rest of the economy.
Finally the Costa Rican tax system is not comprehensive. It has a number of significant exemptions, often regressive and multiple loopholes that facilitate evasion, avoidance and tax fraud. The basis of the General Sales Tax (GST) is limited; excluding almost all services and does not tax a group of important assets. Income tax (IT) treats the same income differently, both for labor income and for unearned capital income. These characteristics often lead to the creation of incentives for those persons and companies that use their resources in less financially profitable activities. Activities that are more profitable from a private viewpoint, because they take advantage of differences in how income and expenses are treated for tax purposes. A large number of taxes have been formulated where the administrative cost is similar to the tax collected, resulting in high complexity and poor yield.
To guarantee the sustainability of the Costa Rican social contract over time will require improvement in infrastructure and education public services and reinforcement of the fight against poverty.
The country needs to simplify the tax system and improve its effectiveness, efficiency and fairness. It must intensify the fight against evasion, avoidance and smuggling; factors that not only affect tax collection, but also affect the willingness of those taxpayers who do meet their obligations.
The frequently regressive exemption policy must be reviewed based on a cost-benefit analysis of each regime. Simplification and reduction of different treatments for different activities will improve the use of diverse production resources in the country by removing the artificial profitability created by the current tax system.
Fiscal Sustainability
In the aftermath of the 2008-2009 financial crises, public finances deteriorated with the drop in the tax burden of approximately 2% of GDP. And the recurring increase in public spending, beginning in2006, was accelerated as a measure to mitigate the economic impact of the crises. This brought the financial surplus of 1% of GDP in 2007 to a 4% to 5% deficit in the last three years. If the current
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fiscal conditions continue, there will be a tendency towards rapid growth as the accumulation of public debt and increased international interest rates lead to an accelerated increase in interest payments. Financial conditions in the rest of the Public Sector will also deteriorate, mainly due to the increased Central Bank deficit. Debt and interest payments by this institution have grown significantly and may exert pressure towards higher inflation in the near future.
Unfortunately, neither the drop in the tax burden, nor increased spending was temporary. On the one hand the economy has shown growth, which in spite of being relatively strong under international circumstances, is far from that seen in the boom period prior to the crises, that permitted the tax burden to grow at 1.9% of GDP between 2004 and 2007. In fact after 2009, the tax burden returned to the level normally associated with the economy’s long term growth rate observed during the economic boom from 2004-2007.Increased public spending was mostly driven by wage increases (both in average salaries and new hires), conditioned transfer programs and transfers to the university sector. These types of expenditures are hard to reduce once they are created.
The Central Government has made important efforts towards improving its fiscal position. With regard to revenues, the Ministry of Finance continues implementing a strategy to improve tax collection. The General Tax Administration (the Dirección General de Tributación (DGT)) is promoting electronic payment methods to make it easier for taxpayers to pay taxes. Controls have also been strengthened through intelligence gathering, strict database analysis and audits using better defined risk criteria. The General Customs Administration (Dirección General de Aduanas (DGA)), is currently migrating from a merchandise control model to a risk model based on the importer instead of the specific product.
Significant effort has been made to contain the growth in current expenditure. In real terms wage growth slowed down from an annual average of 21% from 2009-2010 to less than 5% in the last three years. This was caused by an austere political policy that froze posts and increases to base salaries that have not exceeded inflation in the last two years; although upward pressure exerted by automatic triggers still persist. Current transfers also slowed down between both periods in real terms; from 23% to 8%, including strong financial
support to CCSS through correct budgeting of transfers to this institution during the last two years. Finally, bond issues on the international markets on the order of two billion dollars were made at historically low rates. This has curtailed interest payments stemming from continued increases in public debt.
Although these efforts permitted a 5% reduction in the financial deficit in 2010 to nearly 4.4% of the GDP in 2012, it was not sufficient to bring public finances to a sustainable position in the mid-term. This is particularly true given the perspective of increased international interest rates, increased spending on education in compliance with the constitutional mandate and, the need to increase public investment.
One projection, with relatively optimistic assumptions in terms of the capacity to recover 4% economic growth in the midterm, obtain moderate increases in interest rates and attain permanence in the current expenditure contention policy, indicates that the Central Government’s public debt will exceed 51% of GDP and the financial deficit will exceed 7% of GDP in 2018.
Under these assumptions, an adjustment of approximately 3.5% of GDP is required to bring the primary deficit to zero, in order to stabilize the ratio of public debt to GDP.Gradual implementation of this adjustment will stabilize the debt at approximately 40% of GDP within five years and bring the financial deficit to around 3% of GDP.
This projection could significantly change if there is less favorable development of critical variables. For example, if the tax burden is lower than projected, or primary expenditures of the Central Government exceed the projection, or if interest rates increase more than expected or the real growth rate is lower than projected, the fiscal adjustment necessary to stabilize debt would be higher. All of these contingencies have a moderate probability of occurring. One more point in the permanent real interest rate implies the need to increase the fiscal adjustment by 0.4% of GDP. Depreciation in real terms in the exchange rate will also affect public finances, both due to the impact on debt service in dollars, and the impact it may have on domestic interest rates and the financial cost of internal public debt.
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The Fiscal Consolidation Program
The fiscal deficit and rapid growth in public debt constitute important vulnerability factors for the Costa Rican economy. The economic crises in the early 80’s is a clear example of the severe impact caused by the deterioration of international loan conditions, if prompt action is not taken with regard to fiscal and domestic monetary imbalances. Accordingly, the implementation of a fiscal consolidation program as soon as possible is a priority for the country.
Public finances and quality of services provided by the State have deteriorated because of a series of factors, including:
• Repeated generation of expenditures without revenue;
• The Executive’s limited sphere of operation;
• Weak accountability mechanisms.
• The low tax burden in part reflects excessive identification and territorial based income tax exemption regimes and the high level of tax non-compliance.
• The rigidity of expenditures due to multiple constitutional and legal mandates.
• Wage inertia by the current civil service regime itself and automatic salary adjustments.
• The burden of current transfers within the National Budget;
• Scarce public investment execution capacity;
Resolution of all of these issues offers challenges that require a comprehensive approach covering all elements of public finances. The fiscal consolidation program is based on five pillars:
1. Strengthened governance and fiscal transparency.
2. Containment of public spending together with greater efficiency and quality.
3. Improvement in the tax and customs administrations and a simpler, more progressive, fairer and more efficient tax system.
4. Financing and public investment execution strategies that will permit financing the fiscal deficit at minimum cost, while driving the capacity for execution of economically and socially profitable public infrastructure.
5. Consideration of environmental sustainability in public policy
To strengthen fiscal governance and transparency, some of the elements that arose from the consultation process are:
a) strengthening the fiscal transparency policy ensuring, among others legislative approval of tax information exchange agreements to avoid double taxation already signed; b) more active citizen participation, communicating their priorities regarding the use of taxes and their opinion on services rendered by the tax and custom administrations; c) strengthening legal security; d) promotion of a tax culture at all educational levels and e) improving budget controls and the Executive’s management capacity, among others, by broadening the sphere of application of the Law on Financial Administration of the Republic and Public Budgets.
With respect to public spending, several topics arose from the public dialogue: a) mechanisms for improving the quality of public spending, including the assignment of result-based-budgeting; b) the dynamics of wage spending; c) the establishment of a single public purchasing system and review of the administrative contracts law; d) viability of pension regimes charged to the National Budget and e) laws and standards that establish specific uses and minimum spending, among others.
With regard to Central Government revenue, the consultations identified the need to improve the tax and customs administrations to permit increased collection and reinforce the frontal assault on avoidance, evasion and smuggling. At the same time, measures need to be taken to obtain a simpler, more progressive, more efficient and fairer tax system. To do this, improvement mainly in the two tax pillars must be considered: income tax and general sales tax. In addition, the possibility of giving tax administration more flexibility and independence must be explored. Computer systems must bemodernized and coordination between the tax
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and customs administration must be reinforced to improve auditing and control.
With regard to financing and support for public investment, discussions must involve deficit financing strategies, better public debt management, innovative options for financing investment projects, investor services and the need to strengthen investment project execution and evaluation by Central Government implementation units.
Finally, the environmental factor must be included in national fiscal policy discussions, by including not only the impact of tax policy and spending on environmental protection incentives, but also public spending to address climate change contingencies. The options incorporated into the inventory of measures on this issue include green taxes, such as charging a fixed amount per carbon unit emitted, incorporating environmental measures in a results based budget and incorporating a satellite environmental account into the national accounting system.
The Ministry of Finance proposal for National Dialogue describes a group of fiscal adjustment actions that take public finances on a road to sustainability over the next four to five years and toward improving its contribution to the economic and social development of the country. These options, not necessarily reached by consensus, emerged from the consultation process that began in January and now serve to deepen dialogue with all sectors of society to identify areas of greater convergence and eventually develop one or more bills of law.
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continue to exert pressure towards increasing the deficit (the expected increase in 2013 and 2014 is 5% and 5.8% of GDP, respectively). Considering the constitutional mandate to increase spending on education to 8% and the relatively optimistic assumptions regarding interest rates, projections for 2018 indicate increases in primary and financial deficits of 3.4% and 7.3% of GDP and an increase on public debt of 51% of GDP. The debt stabilization will require an adjustment of 3.5% of GDP in the midterm (4 or 5 years).
This adjustment requires a comprehensive action program that should include fiscal governance, efficient and rational public spending, tax laws and tax administration, as well as, financing strategies and strategies to drive public investment with environmental sustainability. The current situation and possible measures to be taken in each are described below.
2. Recent Developments in Central Government Finances
Prior to 2008 Costa Rican economic activity was very dynamic, with an average growth rate of 7.9% in 2007. This economic performance was a result of important increases in tax collection, for instance in 2008 the tax burden reached 16.3% of GDP. The increase in revenues along with the strong economic growth resulted in a positive financial balance for the Central Government in 2008 and a reduction of 25% of GDP in the public debt (despite the fact that the expenditure real growth rate started to show important increases in the last 3 years).
The 2008-2009 international financial crises had a strong impact on revenue and encouraged an expansionary current spending policy. As economic activity decelerated, revenue dropped by more than 2% of GDP, mainly due to a reduction in the sales and income tax collection. Furthermore, spending increased significantly mitigating the initial impact of the crises. However, the permanent nature of this spending increase led to an unsustainable fiscal position, since a large part of this new spending was in salaries and current transfers. In addition, revenues recovered only slightly in the years following the crises. After 2009 the tax burden returned to long term economic growth levels observed prior to the 2004-2007 economic boom.
After the 2008-2009 crises, the current administration took urgent measures to improve tax collection and contain public spending. These efforts reduced the Central Government’s financial deficit from 5% to 4.4% of GDP from 2010 to 2012. Nevertheless, this has not been sufficient to bring public finances to a sustainable position and to stabilize public spending in the midterm. Spending dynamics, especially with regard to interest payments,
12.0
13.0
14.0
15.0
16.0
17.0
18.0
19.0
20.0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Central Government Revenue and Spending(% GDP)
Revenue Expenditure
Source: Ministry of Finance
Central Government Balance Sheet Adjustment
(%GDP)
Description 2007 2012 Variation Financial Balance 0.6 (4.4) (5.0) Primary Balance 3.7 (2.3) (6.0)
Total Revenue1/ 15.5 13.7 (1.7) Total Expenditure 14.9 18.2 3.3
Primary Exp.1/ 11.8 16.1 4.3 Interest 3.1 2.1 (1.0)
Note: 1/ Net of FODESAF Source: Ministry of Finance
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3. Fiscal Governance
Fiscal governance refers to the balance between the rights and duties of taxpayers and the obligations of the State to provide public services. In addition to the duty to pay taxes in a complete, exact and prompt manner, citizens have the right to a legally secure and simple tax system, fair treatment and a system of accountability with regard to how the State uses public resources.
As for the obligations of the State, this includes the development of strategies, plans, measures and decisions that seek healthy seamless tax collection and appropriate use of resources. Tax collection rules must be clear and simple for taxpayers and accompanied by the necessary actions to prevent evasion, avoidance and smuggling; unfair practices that erode the system making it less fair and effective. With regard to the use of resources, the State must be accountable to its citizens, providing clear, accurate, specific and transparent information on how resources are assigned and the concrete results that such assignments produced on society.
3.1 Recent Developments and the Current Status of Fiscal Governance
The following section includes a brief description of the current status of fiscal governance in the country, centered on the following elements:
• fiscal transparency, including international agreements on the exchange of information, reports, fiscal statistics and budget management.
• legal security of the taxpayer
• the management capacity of the Executive
• teaching a tax culture
3.1.1 Fiscal Transparency
In the last five years the country has achieved important progress on fiscal transparency despite being considered a non-cooperating jurisdiction on international tax matters. Today the country is recognized in the Latin American region for adopting many of the best international practices on this matter. Among the actions that permitted this progress are:
1. Implementation of an ongoing improvement process in the tax and customs administrations.
2. More than 12 bilateral Tax Information Exchange Agreements have been signed.
3. Modernization of the tax legislation through the Law for Strengthening the Tax Administration and the Law for Enforcement of Fiscal Transparency Standards, resolving the lack of access to the financial information required under international information exchange agreements.
4. Ratification of the OECD Convention on Mutual Administrative Assistance in Tax Matters. This is an important multilateral agreement regarding tax cooperation and information exchange signed by 40 countries around the world that contributes to the fight against cross-border tax avoidance, evasion and supplements progress on national tax legislation.
Furthermore, in March 2013, Costa Rica was invited to participate in the International Monetary Fund (IMF) pilot program to apply a new methodology for the evaluation of fiscal transparency, referred to as the “Report on the Observance of Standards and Codes on Fiscal Transparency” The preliminary report issued in early May highlights the country’s consolidated practices on the level of coverage of the annual budgetary reports, the timely budgetary process, the role of the Comptroller General of the Republic (CGR Spanish acronym) as external auditor and the publication of extensive information on financial stability by the General Superintendent for Financial Entities (SUGEF Spanish acronym), among others.
It also discusses challenges in the reconciliation of fiscal reports from different sources, the separation of the budget approval process for the Central Government and the remaining public sector and the availability of information on projections, fiscal risk and its management.
One of the main weaknesses in terms of fiscal transparency, also discussed in the report, refers to the lack of budgetary control and timely dissemination of information for the consolidated public sector, because only the Central Government, representing approximately a third of total public
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sector expenditures, submits its budget to the Legislative Assembly. The budget for the rest of the public sector is submitted for approval to the CGR with a different fiscal calendar. This makes planning and efficient use of expenditures difficult and causes duplication between the Central Government and the rest of the public sector or between entities of the public sector. This situation affects the quality of necessary statistics to design and monitor fiscal policy.
The Ministry of Finance prepared an action plan to continue improving and strengthening fiscal transparency, this document is available to the public on the Ministry of Finance website and is described under section 3.2.1.
3.1.2 Legal Security of the Taxpayer
Within the rule of Law under which the Tax Administration operates, it must comply with a series of constitutional principles. Within these, legal security acquires a special dimension when it refers to prior conditions, requirements, and elements and circumstances where by acknowledgement of the latter gives validity to the Administration.
Legal security has three dimensions:
- knowledge and certainty of statutory law.
- Citizen’s confidence in public institutions and in the legal system in general.
- predictability of the effects derived from the application of the standards and of the actions themselves or third party behavior. 1
The principle of legal security is contained in the General Tax Code regulating the hierarchy of sources of Tax Law and considers the possibility of the Tax Administration issuing general resolutions. The latter seek correct application of tax laws within the limits set by relevant constitutional, legal and regulatory provisions. The purpose of these is to reach a balance between administrative powers and citizen’s rights.
Recent legal improvements require dissemination of any tax law regulations and any general guidelines or standards issued by the Tax Administration
before being finally issued and becoming effective. This opens a space for citizens in general to offer opinions on the effects and scope, improving legal security in all of its dimensions. This process was followed to issue Transfer Pricing Regulations and Tax Procedures Regulations.
Even though regulations play an important role, the Administration’s actions must be based on legal tax standards for maximum reduction of litigation loopholes and to guaranty the effective term of fair standards in conformity with best practices. An example of this is the recent amendment to Article 14 of the General Sales Tax Law whose regulations were not consistent with the current reality of economic activities in Costa Rica, not to mention a scope that gave rise to countless administrative and court discussions.
3.1.3. Management Capacity of the Executive
Article 26 of the General Public Administration Law establishes the following as one of the exclusive attributions of whoever holds the office of President of the Republic: “direct and coordinate the tasks of Government and of the central Public Administration as a whole and do the same with decentralized Public Administration”. However, in practical terms, the Executive’s management capacity is strongly limited. This is due to an inflexible spending structure determined in part by the creation by law of Government spending, without revenue to support it and by variations in legislation or in its interpretation that have limited the capacity of the Central Government to manage the other Branches and the decentralized Public Sector on administrative and financial matters.
3.1.3.1. The Creation of Expenditures without Revenue
The Costa Rican fiscal system contains a fiscal deficit structural trigger: Expenditures established by constitutional or legal mandate added to unavoidable obligations, such as interest and payroll payments, already exceed, by far, the Central Government’s current revenue. This spending represents 95% of the total budget and grows more rapidly than revenue. Budget spending established by constitutional mandate represents 34.4%, where as legal mandates account for 22.5%, unavoidable expenditures such as salaries and debt service constitute 37.9% and only 5.2% permit any level of flexibility.
1 Fajardo Salas, Gonzalo. “Constitutional Tax Principles”. Ed. Juricentro-1”.ed. SanJose.2005.P152
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The preservation of the State’s financial integrity is a constitutional mandate that must be balanced with the mandate to cover the population’s basic social needs. Articles 176 and 179 of the Political Constitution clearly determine the duty and the method for obtaining balanced healthy public finances. The first determines that the amount of budget expenditures cannot exceed probable revenue, while article 179 prohibits the General Assembly from increasing budget spending by the Executive Branch, unless new revenue is identified to cover it. At the same time, Article 122 of the Constitution prohibits the Legislative Assembly from “acknowledging obligations charged to the public treasury that have not been previously declared by the Judiciary or accepted by the Executive.”
Nevertheless, multiple State obligations have been established -by constitutional or legal mandate- without creating the corresponding revenue to cover them, exerting significant pressure on public finances. Examples of this practice are: the constitutional mandate to assign 8% of GDP to education and the legal mandate of transferring 7% of Income Tax to the National Child Welfare Agency (PANI Spanish acronym).
Compliance with these constitutional and legal mandates on expenditures has a very significant impact on public finances and on the Executive’s management capacity by severely limiting the proportion of the budget that can be varied to handle changing social priorities. Accordingly, all expenditures established by constitutional and legal mandate must be reviewed to evaluate whether they are justified.
In the past by recommendation of the Constitutional Court, the Central Government has requested to the Legislative Assembly to repeal laws that establish legal mandates without the corresponding source of financing. However, bills of law to that effect submitted in the period from 2001-2003 were voted against by the Permanent Financial Affairs Committee, and they were filed.
3.1.3.2. Management of Administrative and Financial Matters by the Other Branches
The Branches of the Republic have frequently argued that the independent powers and autonomy of institutions established by the Constitution allows
their separation from financial and administrative guidelines decreed by the Executive. This has led to their repeated deviation from financial guidelines (including wage policies) that seek a sustainable financial position for the Central Government.
Constitutional Court decisions support the vision of a unitary State and that the Executive Power is responsible for administrative and financial management of the State. These decisions indicate that the division of powers does not constitute an express constitutional or legal guaranty of autonomy with regard to administrative and financial matters.
The Constitutional Court’s vision of the State is important because it explains that the reasons that led to the theory of separation of powers in effect became a separation of functions 2. The Constitutional Court has stated that for more efficient compliance with political purposes, objectives and goals set forth in the legal system, those who conceived the Costa Rican State, conceived of it as a unitary State, because they considered that although duties and tasks must be distributed among the bodies that comprise it, precisely to better comply with the public services expected from the State; according to the Court, it must, as a whole, maintain unity and harmony in its actions.
This concept of unity and harmony in its actions is the basis of any organization and even more so in the case of the State.Although the specialization of responsibilities was conceived as a way of more efficiently addressing public purposes and in the case of the Branches of the State, as a means of achieving a balance of powers to prevent abuse of power, the fact that it is necessary to maintain a line of action and a level of coordination cannot be ignored, in order to allow each of the Branches to act in accordance with common objectives in the long and mid-term.
Administrative and policy management functions have been assigned to the Executive Branch. The first activity is performed by the State to satisfy diverse public interests demanded by citizens, and the second has to do with the political orientation of the administration in office aimed at developing the general purposes of the State as a whole. The Constitutional Court has developed the policy management function within the context of financial autonomy of the Branches of the State, stating that 3:
a) The Executive Branch establishes economic
2 Refer to Votes 5484-94, No. 6829-03 and No. 1148-90 3 Vote No. 9567-2008
17
in future Central Government liabilities.
Article 188 of the Political Constitution establishes the capacity to, in general, submit the autonomous entities to national planning criteria and particularly to the directives of bodies within the Central Administration, such as the Budget Authority, whose task is supplemental to and oversees that general policy.
This gives decentralized institutions the power to govern their own bodies and regulations, but because they depend on the State, which has higher regulations, they cannot refrain themselves from applying them. Although all autonomous institutions (with higher or lower levels of autonomy) have powers granted in some cases by Law and in others by the Political Constitution, they are circumscribed within the Branches of the Republic, the Executive Branch, and therefore cannot be above the higher body to which they belong.
3.1.4. Teaching Tax Culture and Tax Compliance
Education and Fiscal Culture are important pillars in the Administration of modern Public Finances. It becomes even more relevant with the current trend to let the taxpayer determine and pay its taxes, with subsequent controls by the Administration.
The promotion of voluntary compliance is fundamental to tax management. The perception of the need for taxes to ensure the wellbeing of societies, the fairness by which it is built, the effectiveness in collection, how they are invested and whether they provide quality public services, will be the elements that motivate better compliance.
For this reason the Ministry of Finance has carried out efforts to educate and increase awareness among citizens on the social purpose of taxes, under the premise that a convinced citizen is a citizen involved in the payment of taxes and in caring for public assets. Some of the actions taken include:
• Creation of the Fiscal Education Department and training for personnel in this area.
• Design of a webpage on fiscal education
• construction of a games room in the Children’s Museum to teach children the uses of taxes with simple and fun methods.
and social policy, its role in preparing the proposed budget for the Republic stems from that.
b) Independence in exercising the functions of each Branch does not imply an express constitutional guaranty of financial autonomy.
c) Financial management is a form of administrative action, accordingly from a constitutional point of view; it is possible to legally assign more powers to the Executive Branch.
Therefore, the basis for the Court not to consider that the independence of the Branches does not imply a constitutional guaranty of financial autonomy has to do with the primary or substantive function assigned in the Political Constitution to each one. Consequently since the Executive Branch is responsible for financial management of the State, a typical administrative action, its broad powers in this matter are reasonable.
3.1.3.3. Management of Autonomous Institutions with regard to Governance
Just like the other Branches of the Republic, the Executive frequently faces resistance from autonomous institutions that want to deviate from the Executive´s general financial guidelines that oversee the financial soundness of the State.
This issue has been magnified by the fact that the public sector budget, excluding the Central Government, is approved by CGR and not by the Legislative Assembly. The result is a more limited discussion on the budget for the remaining public sector than that on the National Budget that requires Congressional approval. At the same time, since 2001 several important public institutions, including CCSS, Costa Rica Electrical Institute (ICE Spanish acronym) and state universities have been excluded from the scope of the Budget Authority, in addition to the institutions not originally included in that law, consequently the important financial management and control mechanisms of the Executive over these institutions has been lost.
The Budget Authority has the fundamental role of formulating directives and guidelines on budgetary policy, for subsequent approval by the Executive Branch, regarding public sector institutions within its sphere of authority. The capacity to provide budgetary guidelines is particularly important because an inappropriate financial management of the rest of the public sector institutions could result
18
• train teachers in coordination with the Ministry of Public Education (MEP Spanish acronym).
• Decree declaring Education and Fiscal Culture as Public Interest. This implies a commitment on the part of MEP of including this subject in their school curriculum. The Board of Higher Education included the subject “Education and Fiscal Culture” as a sixth grade level subject within Civics and Social Studies, for the 2015 school year.
• Creation of a teacher’s guide, multimedia games and a Tax Assistance Core where Accounting and Business Administration students can help smaller taxpayers with basic tax issues.
3.2. Options for Improving Fiscal Governance
The consultation process considered a series of initiatives to motivate substantial improvement in fiscal governance, which are detailed in the following section:
3.2.1. Continued Progress in Fiscal Transparency Policy
Although the country has been working on complying with international standards on fiscal transparency and has received recognition for its achievements, we cannot let our guard down. The country must i) foster the process to remove double taxation, through double tax agreements and ii) formulate administrative improvements for an effective exchange of information; a very important topic for the second Peer Review phase of Fiscal Transparency and Exchange of Information (OCED) scheduled for June 2014.
In order to address certain weaknesses that persist in fiscal reports and production statistics, the Minister of Finance has formulated a work plan that strengthens these areas. The main components are:
a) Action to improve report quality:
- Complete the implementation of international accounting standards for the public sector to guaranty uniform accounting and budget classifications.The lack of uniformity in the accounting and budget classifications doesn’t allow the prompt consolidation of Central government budget execution statistics with the rest of the public sector. This impedes full
use of available information on the rest of the public sector.
-Reconcile fiscal reports and produce timely audit reports that guaranty the reliability of the information.
b) Actions to improve the budget process:
- Prepare budgets reports at different points of the budget cycle, for example present the approved budget at the start of the year, a quarterly execution at the end of each quarter and an annual execution.
- Strengthen the mid-term fiscal framework, to show the reviews on macroeconomic and fiscal projections related with previous years.
- Strengthen program performance measurements, consistent with the following efforts: use better program structures and performance indictors to allow migration towards a result-based program budget, improve performance evaluation and program impact to measure the results of policies (this evaluation usually requires long program application times to measure policy impact).
c) Actions to improve projections and risk management tools.
- Prepare debt sustainability analyses with multiple scenarios (to evaluate the impact of change on the assumptions).
- Incorporate, in the documents attached to the National Budget, a report on fiscal risk, including macroeconomic risk and contingent liability from social security and from the rest of the public sector, etc.
A fundamental factor to consider among the medium and long-term options to improve the budget process, is a change in the Political Constitution to incorporate the budget for the rest of the public sector into the National Budget process. This not only includes synchronization of Central Government schedules with the rest of the Public Sector within the budget process, but also the discussion and approval by the Legislative Assembly of the budget for the entire public sector and not only that of the Central Government. Unless the latter occurs, the CGR approval process for the rest of the public sector must be strengthened as described under Section 3.1.3. Management capacity of the Executive Branch.
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3.2.2. Legal Security
In order to ensure the sustainability of the efforts made to date towards strengthening public security, the Administration must have a centralized unity of purpose and constantly seek to improve the quality of administrative actions, improve taxpayer information and assistance services. To do this the following actions may be considered:
• Improve taxpayer information and assistance services by setting up a call center to provide timely uniform information to all citizens and develop tools to maximize the processes those citizens can make online.
• Strengthen the Administrative Tax Court that hears motions to appeal filed against appealable administrative actions, in order to foster swift effective justice.
• Encourage institutional communication and exchange of information between operating and territorial administrations and the Customs Administration to ensure uniform criteria on fiscal issues. This exchange of information is vital to eliminate situations that could produce different criteria between the tax and customs administrations.
• Implement better communication mechanisms between the Tax Administration and taxpayers for audit and monitoring processes so that taxpayers perceive that the tax procedure is carried out in conformity with pertinent legal and regulatory provisions fully respecting their rights and guarantees. These mechanisms should demonstrate the Administration’s respect for the principle of impartiality and the balance between the Tax Administrations audit powers and the taxpayers rights and guarantees.
• Keep tax regulations updated to respond to the changing economic reality. Out of date tax regulations open a gap with dynamic international standards and causes taxpayers to perceive a situation of legal uncertainty arising from the gap between reality and applicable regulations.
• Expedite the procedure for issuing regulations to tax laws to provide more accuracy for taxpayers and the Tax Administration itself with regard to its actions.
• Improve the public’s access to those resolutions and guidelines issued by the Tax Administration that
are useful and applicable to concrete cases that occur on a daily basis. This could be achieved with user-friendly guidelines.
3.2.3. The Executive’s Management Capacity
The following options may be considered for improving the management capacity of the Executive:
To control the impact of Government spending created by constitutional and legal mandate,
1. Enforce Articles 176 and 179 of the Political Constitution that establishes a fiscal limit to guaranty stability, so that “in no case may the amount of budget expenditures exceed probable revenue” and determines that the “General Assembly may not increase budget expenditures by the Executive Branch, if there is no new revenue to cover them”
2. Conduct a comprehensive review of legal mandates on spending and specific uses in order to return the necessary flexibility to the Executive Branch and reduce or reassign part of the expenses based on new needs.
To improve the management capacity and budgetary controls of the Executive Branch.
1. Broaden the scope of application of the Law on Financial Administration of the Republic and Public Budgets, No. 8131, to include several currently excluded autonomous institutions. This expansion of the scope of budget policy guidelines and directives must consider the particular characteristics of the different institutional groups within the State of Costa Rica to adjust the type of functions they have and the nature of the public bodies and entities they address. So that, in strengthening the State’s management and auditing capacity, the public goals that are the basis of each public entity, would not be altered or affected.
2. Make it mandatory for public State entities and bodies to deliver economic and financial information to the Ministry of Finance, the Budget Authority, the CGR, the Central Bank of Costa Rica (BCCR Spanish acronym) and other regulatory authorities in order to have first hand information available to know the current state of affairs and make pertinent decisions consistent with the unitary State principle.
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3. Change some CGR functions so that it can approve, monitor and evaluate the budgets of the rest of the Public Sector and to be able to verify that: current expenditures are strictly financed with current revenues, financing is consistent with the institution’s capacity for indebtedness and the link with the National Development Plan.
4. Strengthen, within the regulations, the powers of the Executive Branch to provide guidelines for the other branches on administrative and financial matters.
3.2.4. Strengthen Tax Compliance Progress
To strengthen tax compliance, consider the following actions that strengthen tax related education. For example:
• Enact a State Policy on Fiscal Education and establish mid and long term planning with formal coordination procedures among the Ministry of Finance, MEP and the Universities.
• Carry out an ongoing campaign to raise citizen awareness on the importance of paying taxes. This must be planned by the Ministry of Finance with the collaboration of the tax and customs administrations.
• Improve information, assistance and availability to taxpayers and users so that tax return filing and payment processes are natural and simple. Simplify in-person and Internet procedures, as much as possible, providing simple, concrete, complete and timely information for the payment of each tax. Also consider actions that seek more active taxpayer participation in prioritizing public spending, including:
- Provide a questionnaire for taxpayers (to be sent by the Administration together with the tax return) on how they want their taxes to be used. For example, they can choose between different projects, such as infrastructure, urban transportation, selective public policies, etc. The information gathered can be used to prepare public budgets more consistent with taxpayers’ opinions.
- Establish a mechanism for the taxpayer to evaluate the service rendered by any tax or customs administration in the country to continually improve services provided to users.
Strengthening inter-institutional collaboration is a key factor for controlling tax compliance, and the following actions should be considered:
• Improve the exchange of information between institutions, etc. by interconnecting information technology systems to facilitate the tax auditing and control processes. These should no longer be provided on paper or by digital file transfer methods, instead Information would be provided completely online with the appropriate security protection.
• Define a formal coordination structure between the Attorney General of the Republic (PGR Spanish acronym) and the Ministry of Finance, establishing sections specializing in tax and customs matters at the Administrative Law Court and setting up formal protocols for coordination between the Ministry of Finance, the Prosecutor’s Office, Public Defense, the Judicial Investigation Agency (OIJ Spanish acronym) with the Attorney General for closer expedited coordination.
• Establish permanent systematic Tax and Penal Law training and specialization processes, both for jurisdictional authorities and justice administration staff and for tax administration employees. To do this the Ministry of Finance Center for Financial Information and Training will establish an annual training and internship program in conjunction with the above agencies, in order to make short and mid-term plans for this training and education.
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4. Level and Quality of Central Government Spending
Central Government personnel). As a result, in the last five years, the average salary has increased by 25% of GDP per capita.
Central Government employment during this period grew at a rate similar to that of the population, therefore Central Government employment to population ratio in Costa Rica remained at around 2.6%, a lower percentage than in the majority of countries in the Latin American region.
As a consequence of the strong salary increases, the ratio of Central Government payroll to GDP has reached a higher level than the majority of the countries in the region and similar to that observed in OECD countries, even though the number of Central Government employees to population ratio is lower. In addition, if it is measured against fiscal revenue, Central Government payroll is well above that of any country in the region and members of the OECD. While the Central Government payroll absorbs more than 50% of tax revenue in Costa Rica, in Latin America and OECD member countries ranges between 20% and 35%.
4.1. Recent Developments
The dynamics of Central Government spending in the years immediately before and after the financial crises was a very important factor in the deterioration observed since 2007 in the country’s fiscal position. The majority of the 6% GDP increase in the Central Government’s primary deficit over the last 6 years has been due to a 4.2% GDP increase in primary spending, and a 1.7% GDP drop in the tax burden. This increase in primary spending mainly reflects a 2 percentage points of GDP increase in wages and a 2 percentage points in current transfers to: universities, the Social Development and Family Allowance Fund (FODESAF Spanish acronym), the CCSS and other public sector entities. The main characteristics of this current Central Government spending and the possible options to decelerate public spending are listed below.
4.1.1. Wages
The 2007 and 2012 wage increase was primarily due to an increase in the majority of public sector salaries produced by the 50th percentile policy in the period 2007-2010 (rather than an increase in the number of employees). The 50-percentile policy consisted of equalizing the wages of Central Government professionals with the 50th percentile salaries of the autonomous non-financial public sector. This led to an increase between 2008 and 2010 of approximately 50% in the average wage of Central Government. Meaning, the ratio of wages to GDP grew by 2 percentage points; of which 1.3 points corresponded to an increase in the education sector payroll (which employs close to 60% of
Central Government Wages 2007-2012
2007 2008 2009 2010 2011 2012 Change
Total (% of GDP) Central Government 5.2 5.5 6.6 7.1 7.3 7.3 2.0
Ministry of Education 3.0 3.1 3.9 4.2 4.3 4.3 1.3 Rest of Central Government 2.3 2.4 2.7 2.9 3.0 3.0 0.7
Employees (% of population) Central Government 2.4 2.5 2.6 2.6 2.6 2.6 0.2
Ministry of Education 1.4 1.5 1.5 1.5 1.5 1.5 0.1 Rest of Central Government 1.0 1.0 1.1 1.1 1.1 1.1 0.1
Average Gross Pay (ratio to GDP per capita) Central Government 2.2 2.2 2.6 2.7 2.8 2.8 0.6
Ministry of Education 2.1 2.1 2.6 2.7 2.8 2.8 0.7 Rest of Central Government 2.3 2.3 2.6 2.7 2.8 2.7 0.4
Source: Ministry of Finance
Central Government Fiscal Figures Adjustment (% GDP)
Item 2007 2012 Variation Total Revenue1/ 15.5 13.8 (1.7) Primary Expenditure 11.8 16.1 4.2
Wages 5.2 7.3 2.0 Procurement of goods and services 0.5 0.6 0.1 Current Transfers1/ 4.7 6.7 2.0 Capital Expenditure 1.3 1.5 0.2
Note: 1/ Net of FODESAF Source: Ministry of Finance
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Source: IMF with data from the Ministry of Finance, OECD and CEPALNotes1/ For Costa Rica this corresponds to Central Government employee wages, excluding workers from health services and tertiary education fields. To ensure comparisons between countries, for other countries total Government wages estimates exclude health and tertiary education wages
Salaries of Central Government and the rest of the public sector are significantly higher than those for the private sector in similar employment categories. The differences between Central Government salaries and private sector salaries range from 12% to 40%, with an average of 23%. This difference is even higher in the case of decentralized public institutions, where salaries exceed private sector salaries by an average of 49%.
In recent years important efforts have been made to decelerate wage expenditures. Since 2011, presidential decrees have been issued limiting the creation of Central Government posts to priority sectors such as security and education. In 2012, a policy to freeze vacated posts was implemented.
As a result of this policy, during 2010-2012, Central Government employment grew on average at a rate of 1,000 posts per year 4. This implies a slightly lower growth than the population 5 growth.
During this same period, increases to base salaries did not exceed inflation. This, together with the employment policy described, has decelerated payroll from a real average growth of 21.0% during 2008-2010 to a 4.7% during 2011-2013.
Despite this deceleration in the growth rate of wages in recent years, the burden of the Central Government payroll as a percentage of GDP has not declined. Automatic salary increases associated with the base salary (salary pluses) explain part of this behavior.
0 10 20 30 40 50 60 70 80 90
Total
Management positions
Professionals
Technicians and mid-level professionals
Administration
Services and administration
Unqualified labor
Public-Private Wage Premium by Occupational Group, 2012(Percent difference relative to private sector wage)
Other public entities Central Government
Source: Ministry of Finance with data from Labor and Social Security Ministry, National Home Survey 2012 and International Monetary Fund.
25.0
16.7
7.0 4.7 4.7
20.8
4.7
0.0
5.0
10.0
15.0
20.0
25.0
30.0
2009 2010 2011 2012 2013
Wages-Accumulated to August-
(Real annual growth rate)
Wages Avg. Growth (2007-2010) Avg Growth (2011-2013)
Source: Ministry of Finance
4 The majority of this increase in posts was intended for social security with little more than 2.000 posts
5 For the referenced period(2010-2012) there was an average increase of posts held in the Central Government of 0.95%. According to National Statistics and Census Institute (INEC Spanish acronym) estimates for the same period, average growth in the Costa Rican population was 1.30%.
AUTCRICZE
DNK
ESTFINFRA
DEU
GRC ISL
IRLITA
JPN
NLD NORPOL
PRT SVNSWE
GBRARG
CHLCOL MEX
02468
10121416
0 10,000 20,000 30,000 40,000 50,000 60,000
Tota
l Wag
es
(% G
DP)
GDP per capita (Adjusted for PPP)
Central Government Wages(excluding Social Security and Tertiary Educaction)
Source: IMF with data from Ministry of Finance, OECD and CEPAL
AUTBEL
CAN
CRI
CZE
DNKEST FIN
DEU
GRCHUN
IRLISR
ITAJPNKOR NLD
NORPOLSVK
SVNESP
SWECHE
USAARG
BRA CHL
COL
MEX
0
10
20
30
40
50
60
0 10,000 20,000 30,000 40,000 50,000 60,000
Tota
l Wag
es(%
Cen
tral G
over
nmen
t Rev
enue
)
GDP per capita (Adjusted for PPP)
Central Government Wages(excluding Tertiary Educaction)
23
4.1.2. Current Transfers
The main items comprising current transfers are: closed pension regimes which are charged to the National Budget, transfers to education (Special Higher Education Fund (FEES Spanish acronym) and School Boards), transfers to social programs (FODESAF) and transfers to the CCSS and to the health sector.
Expenditures for the closed pension regimes (paid by the Central Government) reached 2.5% of GDP in 2012. Projections show that this item will grow at a rate similar to the economy during the next decade. The burden of these regimes on the economy is explained largely by its benefits that substantially exceed those provided by the CCSS Disability, Retirement and Death (IVM Spanish acronym) Regime. While the average annual pension under special regimes reached between 1.7 and 2.7 times GDP per capita, the average IVM pension only reached 50% of GDP per capita.
An examination of the conditions offered by these special regimes explains these differences:
I. Replacement Rates: The average pension under special regimes (charged to the budget) is 90% of the average salary, while the average pension in the IVM Regime is 46% of the base salary.
II. Early Retirement: Participants in these regimes can retire upon reaching only 30-33.3 years of contributing to the regime as compared to a
minimum IVM retirement age of 60 years with 37.5 years of contributions.
III. Pension Indexation Rules: The majority of current pensioners in these special regimes acquired their rights prior to 1992 and retained benefit increases that link their pensions to their total salary from their last job before retirement. This lets them benefit from all salary increases given to active employees, including automatic increases and salary adjustments in line with the 50th percentile wage adjustments in the public sector. Pensions that acquired benefits post 1992 are indexed to base salary cost of living adjustments for active employees.
As a result the total cost of these regimes substantially exceeds the total pensions paid under IVM at this time, despite the fact that the latter covers a number of pensions that are three times higher.
Central Government Current Transfers Net of Revenue from FODESAF
2012
Description Millions of Colones % GDP % Total
Current Transfers 1,526,020 6.7 100.0 Pensions 568,670 2.5 37.3 Education 422,827 1.9 27.7
Universities1/ 308,005 1.4 20.2 School Boards 94,225 0.4 6.2 FONABE 20,597 0.1 1.3
FODESAF2/ 187,507 0.8 12.3 CCSS3/ 179,653 0.8 11.8 Others4/ 167,363 0.7 11.0
Notes: 1/ Includes FEES resources and other transfers to universities
2/ Covers 593,000 base salaries 3/ Does not include transfers to the CCSS Non Contribution Regime, already included under FODESAF 4/ Net of transfers to FODESAF Source: Ministry of Finance
0
20
40
60
80
100
0.0
0.5
1.0
1.5
2.0
2.5
Civil
Ser
vice (
close
d)
Educ
atio
n (clo
sed)
Judi
ciary
(ope
n)
CCSS
RCC
Civil
Ser
vice (
close
d)
Educ
atio
n (clo
sed)
Judi
ciary
(ope
n)
CCSS
RCC
Expenditure(% GDP)
Average pension(share of average wage)
Expenditure to GDP and Replacement Rate by Pension Regime, 2012
Source: IMF with data from Ministry of Finance and Superintendence of Pensions
‘
Generosity of Pension Regimes 2012
Average Annual Salaries Active
Workers
Average Annual Pension
(Thousand Colones)
(% Average salary)
(GDP per capita)
Special Regimes
Civil Service (closed) 9,193 8,277 90 1.7 Education (closed) 11,699 11,071 95 2.3 Judicial (open) 17,907 12,821 72 2.7
Other regimes CCSS 5,321 2,448 46 0.5
Collective Capitalization Regime (for Education) 11,699 6,255 53 1.3
Source: Ministry of Finance with data from STAP, SUPEN, Judicial Branch Board Pension Fund, National Pension Directorate, CCSS and IMF
24
Transfers to education reached 1.9% of GDP (1.35% for state universities, 0.4% to finance school cafeterias and materials through school boards and 0.1% for the National Scholarship Fund (FONABE Spanish acronym). The university component has grown from 1.0% to 1.35% of GDP from 2007 to 2012, an annual average growth rate of 13.9%, adding significant pressure to Central Government current spending.
Transfers to CCSS are used to finance medical insurance for those insured by the State (this includes the indigenous population) and State contributions to the social security of independent workers. This item has increased recently as a result of better estimates in the National Budget and increases in the independent worker population due to the 2008-2009 economic downturn. The Minister of Finance has a policy in support of CCSS, not only through correct budgeting of current transfers to this institution, but also by means of reconciliation and regularization of past debt, in addition to support for advisory services from international bodies.
Transfers to finance IMAS-FODESAF social programs constitute 12% of total transfers. Although these programs operate relatively well, according to recent evaluations by international bodies, there is room for improving their focus and expanding their coverage. The fragmentation and complexity of financing these programs makes it difficult to evaluate their financial management. In addition, there are programs that operate independently although their objectives and beneficiaries are similar, resulting in duplicate functions.
Significant progress has been made in this field by attaining a more transparent system with the formation of a single database of beneficiaries that will permit consolidation of the assistance received by an individual through different programs. Important progress has been made in statistics on each social program of the National Social Development and Family Allowance Department (DESAF Spanish acronym), by including these indicators on the department’s webpage.
Current transfers have decelerated significantly in recent years, with a reduction in its real growth rate from 23% to 8% from 2008 - 2010 to 2011-
2013. This declaration was achieved in spite of transfers to CCSS increasing as a proportion of GDP and limitations faced due to specific uses and unavoidable obligations
4.1.3. The Budget Process and Evaluation of Public Programs
The budget process must be a fundamental tool in the Government’s management capacity, including the capacity to control the level and quality of Central Government spending. However, spending inflexibility in Costa Rica and deficient measurement of public service production has limited the use of this tool for this purpose.
The lack of spending flexibility constitutes a significant obstacle for rationalization of transfers and other expenditures and to use the budget as an effective fiscal policy tool. This inflexibility derives from constitutional and legal mandates that create expenses without revenue to finance them. Of the total expenses budgeted for 2014, 95% involves
17.2
28.2
5.08.9 6.8
22.6
7.8
0.0
5.0
10.0
15.0
20.0
25.0
30.0
2009 2010 2011 2012 2013
Current transfers-Accumulated to August-
(real interannual variation)
Curr. Transf Avg growth (2007-2010) Avg growth (2011-2013)
Source: Ministry of Finance
National Budget
Composition of Budget Expenditures 2012-2014
Item 2011 2012 2013 2014
Composition Total budget expenditures 100.0 100.0 100.0 100.0
By constitutional mandate 31.2 31.3 32.2 34.4 By legal mandate 20.9 21.6 21.5 22.5 Other Obligations 41.7 41.7 41.0 37.9
Debt Service 33.7 33.6 32.9 29.1 Interest 8.7 8.9 9.9 11.6 Amortization 25.0 24.7 23.0 17.4
Wages (minus MEP and Judic. Branch) 8.0 8.1 8.1 8.8 Other Expenditures 1/ 6.2 5.8 5.3 5.2
Total budget expenditures % of GDP Total budget expenditures 26.4 26.5 26.0 24.7
By constitutional mandate 8.2 8.3 8.4 8.5 By legal mandate 5.5 5.7 5.6 5.6 Other Obligations 11.0 11.1 10.7 9.4
Debt Service 8.9 8.9 8.6 7.2 Interest 2.3 2.4 2.6 2.9 Amortization 6.6 6.5 6.0 4.3
Wages (minus MEP and Judic Branch) 2.1 2.2 2.1 2.2 Other Expenditures 1/ 1.7 1.5 1.4 1.3
Note: 1/ Includes expenditures for goods and services, capital formation and transfers to deconcentrated bodies and public companies Source: Ministry of Finance
25
compliance with constitutional mandates (34.4%) and legal mandates (22.5%), wages (8.8%) and debt service (29.1%). The remaining 5% are funds used for public investments, in addition to the State’s basic service payments where there is a large margin to work with.
The effectiveness of this budget process that seeks spending efficiency and quality depends mostly on the capacity to measure production and costs. The Ministry of Finance has taken large strides in this field. Quantitative indicators were included in the proposed National Budget 2014 to measure production in education, infrastructure, Ministry of Finance management and some programs to fight poverty. As well as indicators on coverage, desertion and enrollment by educational level, kilometers of road maintenance and building, activities of the Ministry of Public Works and Transportation (MOPT Spanish acronym), CONAVI and COSEVI and associated costs and performance indicators for the Ministry of Finance on customs clearance time, percent increase in monitoring merchandise entering the country and the number of internal and external audits.
4.1.4. Public Purchasing and Administrative Contracts
So far in 2013 the public sector has awarded bids for 1.7+trillion colones in materials, mineral products, advertising, building rentals and more than 100 other sub-items. The magnitude of public purchasing makes the State the main national consumer and investor, with 8% of GDP so far in 2013 and even reached 14.4% of GDP in 2011.
Purchases and awarded bids are concentrated outside the Central Government. The National Bank of Costa Rica (BNCR Spanish acronym), ICE and the Costa Rican Oil Refinery (RECOPE Spanish acronym) have the highest level of public purchases and bids awarded.
These institutions make few purchases using the State digital platforms, which makes it difficult, if not impossible, to obtain adequate detailed information on their acquisition processes. This is a significant limitation for making processes more efficient, effective and expeditious. It also makes it difficult for new vendors to participate, particularly micro, small and medium enterprises (MSMEs), because the access to the information may be an entry barrier.
4.1.5. The Challenge of Efficient Increases in Educational Spending
The constitutional mandate requiring the assignment of a minimum resources equivalent to 8% of GDP to education as of 2014 is an additional spending obligation of 1% of GDP, because the assignment in 2013 was close to 7%.
Opportunities for improving academic performance in elementary school and high school, in addition to greater development in educational infrastructure, no doubt constitute arguments for providing this sector with the resources necessary to address deficiencies in these areas. However, demographic trends, the current high cost of public education, the current fiscal imbalance and disparities in expenditures per student at different educational levels raise the question of the advisability of increasing the proportion of GDP used for public education without generating new revenue to finance it. This also underscores the need for mechanisms to propose efficient use of resources. As a minimum, resources for public education should be increased gradually to provide time for improving controls on spending and the capacity for executing investment expenditures.
Demographic trends predict a reduction in demand for educational services in the next decades. The fertility rate in Costa Rica has dropped significantly
6 Excluding Ministry of Public Education and Judicial Branch already included under constitutional mandates.
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
2007 2008 2009 2010 2011 2012 2013
Public Sector Purchases and Awarded Bids(% GDP)
Public Sector Central Government
Source: Ministry of Finance with data from the CGR
26
since the mid 80’s with a slow reduction in the number of school age children and a future reduction in high school and university age students. Current demographic trends predict a reduction in the 24-year old population from 41% in 2012 to 31% in 2030. In this context, real expenditures per student will increase significantly over time, even if educational spending as a percent of GDP remains constant. This increase would be greater if educational spending increases to 8% of GDP. Specifically, the expenditure per student as a percent of GDP per capita is projected to increase by more than 50% by 2030, assuming that the percent of coverage is maintained. Even if coverage were to increase to levels similar to OECD, expenditures per student as a percent of GDP per capita would brow by 15%.
The current cost of public education in Costa Rica seems high compared to other countries with comparable or higher per capita income and academic performance. Current educational spending as a percent of GDP in Costa Rica significantly exceeds educational spending in the majority of Latin American countries and is comparable to some OECD countries. In spite of this, academic performance measured by Project for International Student Assessment (PISA) tests is comparable to other countries with similar GDP per capita levels and, still does not seem to reflect the additional investment in education representing 7% of GDP. In this context, the country must reflect on whether increased academic performance truly requires more resources or more efficient use of resources.
One of the factors that impact this discrepancy between educational spending and academic performance is the strong increase in public sector salaries over the last five years. As a result of the salary policy followed by the majority of the Central Government, MEP´s salary expenditure as a percent of GDP increased from 3% in 2007 to 4.3% in 2012, which largely explains the increase from 5.1% to 7.1% of GDP in total educational spending. The rest of the Central Government, salary expenditures were mainly due to an increase in average salaries, rather than an increase in the number of employees. Currently the average level of teachers’ salaries in Costa Rica is high, even as compared with those of OECD countries, corrected for cost of living differences (Purchasing Power Parity - PPP).
ARGBRA
CHL
COLCRIMEX
PER
FIN
FRA
DEU
ITA
JPNPOLPRT
ESPSWE.
GBR
300
350
400
450
500
550
600
2 4 6 8 10
Aver
age
PISA
Sco
re
Education Spending (% GDP)
PISA Test Scores and Education Spending
Source: IMF and OECD
ARGBRACHL
COL
CRIMEX
PER
URY
FIN
FRADEUITA
JPNPOL
PRTESP
SWE .GBR
300
350
400
450
500
550
600
0 10,000 20,000 30,000 40,000 50,000 60,000
Aver
age
PISA
Sco
re
GDP per capita (PPP US$)
PISA Test Scores and GDP per capita
Source: IMF and OECD
-
10,000
20,000
30,000
40,000
50,000
60,000
Costa Rica OECD (starting salary) OECD (top of salary scale)
Teacher's Annual Salaries in Costa Rica and OECD Countries, 2010-2012
-PPP US$-
Primary Secondary Tertiary
Source: Ministry of Finance, OECD and IMF
27
In spite of high spending on education and important improvements in coverage, there is still a margin of improvement in secondary and tertiary education. Although high school enrollment rates are relatively high, the desertion rate at this level is important and affects the level of coverage. In the case of tertiary education, enrollment rates are much lower than for other education levels and for average enrollment rates for Latin America and OECD.
Another factor that may also affect the high cost of education is the need for better control in the use of resources transferred to the School and Administration Boards. MEP has significantly improved its capacity for investment in infrastructure, increasing annual investment from ¢6 billion to ¢30 billion. However, there is still a need for improved controls in the use of these resources by the school boards receiving transfers from the Central Government to execute smaller cafeteria service work and to improve school infrastructure.
In order to achieve improved efficiency in the use of resources by School Boards, continued work is required to address the following weakness:i. Low execution capacity in infrastructure projects, mainly explained by lack of education and appropriate experience of the members that comprise them.ii. Lack of strict control of contracts, particularly in
public purchasing processes, because they are not required to use the digital platforms. iii. Low capacity for supervision by Regional Directorates.
Although the payroll burden of university professors is not reflected in Central Government figures, but rather in the public tertiary education system, it does affect the effectiveness of transfers from the Central Government to FEES to obtain better educational coverage and quality. Despite the strong increase in transfers to universities since 2007, a large part of those resources have been used to increase professors’ average salaries, instead of using it primarily to expand coverage and reduce the infrastructure deficit at this education level.
There is also a strong imbalance between the resources for tertiary education and those for the rest of the educational system, which could potentially influence the quality results from the educational sector.
Costa Rica spends close to 130% more per tertiary education student than per secondary level student. In contrast, OECD countries’ expenditures per secondary school student is similar to that for a tertiary education student. While in Costa Rica the expenditure per secondary school student (measured as a percent GDP per capita) is 40% less than for OECD, the expenditure per tertiary education student is 50% higher. This, together with the fact that the percentage of matriculation in tertiary education in Costa Rica is close to one-third the matriculation for OECD, means that the system is substantially less fair and effective in the use of resources.
The magnitude of the current deficit implies that the additional educational expenditures would be completely financed by debt. This is so, because it would be difficult for a fiscal consolidation program to eliminate the entire current fiscal deficit of 4.5% - 5% of GDP and even less likely to eliminate the fiscal deficit arising from the added percent for education. Accordingly, it is important to keep in mind that the opportunity cost of the additional resources intended for education will be given by the financial cost of these resources, which, without a doubt, will grow as international interest rates increase in relation to today’s historically low level. The social return of expenditures in education must exceed this financial cost for such additional spending to make sense for the country.
020406080
100120140
Asia Korea Malaysia OECD Ireland Latin America
Costa Rica Chile
Enrollment rate, average 2004- 10 (% gross rate)
Secondary Tertiary
Current Transfers to Public Sector School and Administrative Boards
2008 2009 2010 2011 2012
Millions of Colones 48,792 65,478 78,457 86,519 94,226 Variation
34.2 19.8 10.3 8.9
% GDP 0,31 0.39 0.41 0.42 0.42
Source: Ministry of Finance
28
4.2. Options for Improving Spending Efficiency and Quality
The following section includes an inventory of options to improve spending efficiency and quality that arose from the consultation process started in January 2013. The purpose of this process, that included 60 meetings with technicians and opinion formers, was to compile an inventory of options that do not constitute a Government proposal, not necessarily achieved in consensus, but that will be the basis for a national discussion. The dialogue initiating at this point will expand these consultations to all sectors of society to discuss these and other options that may arise in the process.
4.2.1. Wages
The need to decelerate the rate of payroll growth is a recurring element that arose during discussions, motivated by the burden of wages in public spending and the strong growth since the middle of the last decade. One proposed strategy is to ease the payroll burden using control measures applied over 5 years. Several participants proposed that it would be necessary to work both with an austere hiring policy and a fiscally responsible salary policy to achieve this objective.
Because of the constitutional mandate that establishes minimum expenditures in education, the impact of savings in payroll v. total spending is not one to one. Close to 60% of the Central Government payroll is made up of the education sector and this means that only 40% of savings in payroll has the possibility of affecting total spending, if the education expenditures are kept at the bottom limit.
jobs per year) similar to 2011-2012.
Although savings in education sector payroll does not mean lower total spending, it is an important tool to give the sector more maneuverability because it improves spending quality by directing a larger proportion to investment in education infrastructure and to improve educational materials provided.
From the point of view of hiring policy, during the discussion several options were examined to contain spending on payroll by limiting the growth in the number of jobs per year. These options are described in the following box:
Options contributed to the inventory during the consultation process with regard to hiring policy
During the consultation process several options arose regarding hiring policy for the next 5 years:
1. Freeze the creation of new job post and a certain percentage of vacated jobs that are not filled. If this is adopted, it would be necessary to prevent disorder in the services rendered.
2. The no creation of new posts, without limiting the replacement of jobs vacated. This measure could save 0.12% of GDP in 5 years.
3. Increase the number of posts at a rate slower than population growth (close to a 1% growth rate or 1,000
0
10
20
30
40
50
60
Asia Korea Malaysia OCDE Ireland Latin America
Costa Rica Chile
Education Expenditures per student, avg2004-10
(% GDP per capita)
Secondary Tertiary
Source: Ministry of Finance with data from "Attracting Knowledge- Intensive FDI to Costa Rica", OECD
29
Options contributed to the inventory during the consultation process with regard to hiring policy
Some of the options in the field of salary policy that arose from the consultation meetings are:
• Establish a cost of living adjustment linked to total salary and not to base salary. This would permit a reduction in the growth rate of the base salary as compared to recent years when increases to base salary, on the average, were equal to or higher than inflation.This cost of living adjustment to base salary has the potential for affecting total spending, not only because of its impact on payroll, but also because of its impact on Central Government current transfers. Pensions (or at least part of them) and transfers to FODESAF depend on cost of living salary adjustments in the Executive and Judicial Branches, respectively.
• Reduction in the rate of accumulated annuities.
• Use an annual rate scale that is reduced with the number of annuities acquired. This would improve the incentive system, making the salary system more competitive at entry level and would be an incentive for a certain level of turnover among employees with more time on the job.
• Limit exclusivity payments: This payment is made to the majority of Central Government employees, even when exclusivity may not be necessary.
• Improve execution and minimize errors in MEP payroll currently administered using an obsolete computer system producing a high number of delays in payments to educators. Suggestions to solve this problem include: a) Use a reliable, modern computer system to make payroll payments for the entire Executive Branch and b) Take a census of MEP payroll to correct any errors arising from incorrect information entered in the old system. The Ministry of Finance is already working on developing and testing a new computer system to cover payroll for the entire Executive Branch starting in 2014.
A census of MEP payroll could take from 6 to 9 months. Similar studies in other countries have garnered savings of 1% to 5% in the audited payroll, which in Costa Rica is valued at 0.04% to 0.2% of GDP.In addition to these savings, it would prevent continued errors and delays in paying educators that cause them significant drawbacks.
With regard to salary policy, the need to contain salary increases was discussed, as well as some “bonuses” for the next five years. Although a more restrictive salary policy in the educational sector does not mean less public spending because of the constitutional mandate, this policy would free up resources to concentrate educational expenditures on reducing the lack of educational infrastructure
existing for many years and to improve the quality of study materials. A fiscally responsible salary policy would also make it possible to increase the number of professors, if necessary, without necessarily increasing the payroll burden on GDP.
30
Structural reform options to the public salary system contributed to the inventory from the consultation process
Salary discussions with fiscal experts underscored the need to consider structural reform to the public salary system. To important elements highlighted in this strategy are:
a) Establishment of a monitoring institution on public sector employment to institute objectives for the public sector salary policy, review the legal framework with regard to conditions of public employment, determine policies and practices for all public institutions, provide employment advisory services, determine financial management frameworks and develop a replacement for the public employment regime.
b) Develop a new wage system.
- Migrate towards an alternative salary structure where the base salary in the new public salary system covers all wages, incorporate all salary incentives within a single salary concept for all employees. The new structure will be governed by the “equal wages for equal work” principle. This will provide a more equitable and transparent salary system.
- Establish wages competitive with the labor market.
4.2.2. Current Transfers
The rationalization of Central Government current transfers can be addressed in four different areas:a) streamline pension regimes charged to the budget
b) review the range of specific uses and expenditures established by law
c) increase social assistance spending efficiency focusing on and seeking better coverage
d) eliminate duplications in Central Government using administrative units from deconcentrated entities.
4.2.2.1. Streamline pension regimes
As seen in Section 4.1.2, pensions charged to the budget are a significant burden to total spending and correspond to regimes that, in general, are more generous that the IVM Regime. From the consultations with experts on fiscal matters and opinion formers different options arose that seek to slow down growth in those spending items, using the less generous conditions of the IVM program as a reference. The options are described in the following box.
Options contributed to the inventory during the consultationprocesswith regard to the pension
regime.
• Increase contribution rates for active workers and those receiving a pension
• Seta maximum on overall pensions, similar to the one used for IVM.
• Eliminate options to retire prior to 60 years of age, no matter the number of years of contributions.
• Break the link between adjustments to pensions and the civil service cost of living salary increases. This is an important pre-requisite for a structural reform to the public sector salary system greatly needed by the country.
At the same time, at some meetings the need to make reforms to strengthen the IVM and Judicial Power regimes was suggested so that the Central Government does not have to finance any future deficit in both regimes.
31
4.2.2.2. Review the range of specific uses and expenditures legally mandated but without a source of financing
As we have seen in prior sections, the specific uses and mandatory fiscal expenditures not accompanied by revenue excessively reduce the maneuverability of the Central Government. This not only makes it difficult to channel funds towards new priorities, but also makes it difficult to make fiscal adjustments by streamlining spending. For this reason, revenue Assignments for specific uses must be reviewed along with constitutionally and legally mandated spending so that they are consistent with priorities and the need to guaranty the sustainability of Public Finances.
The constitutional mandate assigning 8% of GDP to public education and 6% of tax revenues to the Judicial Branch total 9.3% of GCP in 2014 and legal mandates and specific uses excluding capital transfers to CONAVI would total 2.3% of GDP.A reduction of 10% in current transfers associated with legal mandates (not constitutional) and specific uses would produce a savings of 0.23% of GDP.If we exclude transfers to CCSS from this calculation, the savings would be 0.15% of GDP.
4.2.2.3. Increase spending efficiency for social assistance
As mentioned, current social assistance programs are complex and fragmented and many duplicate functions. Some of the options to improve social assistance spending discussed were:
• Strengthen the process for the creation of a single poverty database. The National DESAF Agency has made significant progress in this field by creating a single database of beneficiaries that consolidates assistance received by an individual through the different programs and by publishing a webpage of performance indicators for the main social assistance programs. This effort should be expanded to cover the entire low-income population, whether or not they are currently beneficiaries of the social programs. This new database will reduce the depletion of benefits given to individuals not at social risk and expand program coverage to individuals who qualify for them because of their income level, but who are not currently beneficiaries.
• Review and prepare performance indicators for adequate accountability of each social program.
• Analyze the cost-benefit of social programs to identify the scope of each and unify programs with duplicate functions.
4.2.2.4. Eliminate duplications in Central Government using administrative units from deconcentrated entities.
There are a significant number of deconcentrated entities with their own administrative units, this has lead to duplication between them and the supervising Ministries. One option to eliminate duplication is to centralize the rendering of administrative services in the supervising Ministry, which will then provide these services in exchange for payment by those institutions.
4.2.3. Budget Process
Continue the process already begun to migrate to a results-based program budget to identify the products from each program and eventually the cost of each of the products and public services, thereby facilitating evaluation and subsequent actions to improve each program. The definition of public production is not only the basis for assigning financial resources in the budget, but also permits the determination of quantity and quality.
As a supplement to this process to develop budget indicators, a mid to long-term plan must be developed to evaluate the impact of the different Government budget programs to make decision on whether to change, eliminate or reinforce them.
4.2.4 Acquisition of Goods and Services
At these consultations and meetings during this stage it was concluded that it is important to implement a public contracting policy using the single digital platform. In this way the use of public resources will be expedited and be more efficient and effective accompanied with reinforcing Central Government oversight.
Information and communication technologies offer a high potential for delivering more benefits to the Central Government. They can shorten and accelerate public purchasing processes, with more efficient procurement and savings in money and
32
time. Moreover, digital platforms reach a broader audience and provide more publicity by automating and strengthening information flows regarding opportunities to supply the State. This leads to an increase in participants with less access to information, such as MSMEs, increasing competition and therefore attaining better quality, larger quantities and lower prices for public procurement.
The single digital platform, according to discussions, is an important step that needs to be supplemented by other efforts. Digitalization is a means towards better internal control and must be supplemented by an entire administration system that safeguards public resources from misconduct and/or waste, either deliberate or by omission.
The better practices by OECD countries recommend risk-based approach to purchasing management. Accordingly instead of attributing defects and failures to the system, an operations related “risk” approach is used by analyzing possible alert factors and defining strategies and actions to reasonably mitigate and comply with institutional objectives.
This system is based on managing risk through the following five actions:
1. Involve all of the organizations to identify and define the risks faced, dividing them into categories (for example: administrative, legal, budgetary, security, etc.) and classifying them in terms of magnitude of impact and probability of occurrence.
2. Describe all existing controls used to mitigate risk classifying them into corrective, preventive or deterrent.
3. Evaluate the effects of existing risk controls and organize them as effective, ineffective or nonexistent.
4. Devise a risk map to clearly and concisely present risks requiring immediate attention (high magnitude and high probability), periodic attention (low magnitude and high probability), monitoring (high magnitude and low probability) and control (low magnitude and low probability).
5. Produce guidelines at the level of upper management to decide what to do with regard to risk (for example, avoid, mitigate, transfer or accept them) as a basis for monitoring them.
These actions will strengthen the scope of the digital platforms beyond efficiency and savings in public funds, because they provide the State with better tools to address other equally important objectives such as environmental issues (refer to Fiscal Policy and Environmental Sustainability) or strengthen and expand the participation of MSMEs in public purchasing. The latter can be attained through procedures to facilitate compliance with requirements and processes, supply chains and supplier consolidation. In fact, variants to tender designs should be assessed to permit granting bids to MSMEs if their bid does not exceed the lowest offer submitted by a certain percentage. When correctly used, this could be a mechanism for generating more competition in tender processes where MSMEs do not currently participate, which could reduce prices currently paid by the State.
4.2.5 Education Expenditures
Meetings with fiscal experts underscored the need to study a more correct way to distribute the additional point as a percentage of GDP under education, as well as how fast education expenditures can increase without involving inefficiency due to lack of execution capacity and control. It was also recommended that the mid-term focus should be to improve the composition of expenditures on education and move towards a more equitable system. In order to encourage efficiency in educational spending, the following topics were discussed, among others:
• The conditions that must exist to increase educational spending to 8% of GDP.
• The need to assign a larger percentage of resources to education infrastructure and improve the capacity for executing infrastructure spending, both for MEP and for Boards of Education.
• The need to evaluate the distribution between the resources used for each education level.
• The level and rate of growth of salaries in tertiary education.
In addition, emphasis was made at the meetings regarding the importance of discussions on what should be considered part of education expenditures. Given the reform to Article 78 of the Political Constitution that establishes “For State education, including higher education, public expenditure shall not be less than eight percent (8%) annually of the gross domestic product,
33
pursuant to the law”, it would be relevant to define which expenditure items are considered part of State education. The State provides a series of services that supplement the functions of MEP and that are part of the education process for the population. This can include investment in science, technology and telecommunications, culture and technical training for labor activities. Accordingly, it is important for society to decide what services provided by the State are part of the state education concept referred to in the Constitution.
It is also important to define up to what point the concept of state education depends on the source of financing for services provided by the State. For example, should training services provided by state entities such as the National Learning Institute (INA Spanish acronym), financed with funds from the National Budget, be considered part of state education. However, the Constitutional Court
Fiscal Consolidation Program Return on Expenditure Containment Measure
(% GDP) Measure By Year In 5 years
Salaries No new posts created 0.02 0.12 1% lower cost of living increase on base salary 0.05 0.24 Reduce annuities by one percentage point 0.01 0.05 Decreasing annuities scale 0.00 0.01 Limit payment of exclusivity 0.02 0.02 Better payroll control using INTEGRA 2 + +
Pensions 0.44 0.44 Increase contribution rate to 15% 0.20 0.20 Fix pension ceiling at 1.4 million colones per month 0.21 0.21 Increase retirement age (by one year) 0.03 0.03
Review specific uses (10% Reduction)1/ 0.23 0.23 CCSS 0.08 0.08 FODESAF 0.06 0.06 Other specific uses 0.09 0.09
Revert variation in constitutional mandate for Education 1.00 1.00
Note:1/ Excludes transfers to CONAVI, Judicial Branch and Education Source: Ministry of Finance
has ruled that INA services are not part of state education. It would be relevant for society to reflect on this issue.
4.2.6. Quantification of Options Contributed to the Inventory to Contain Spending and Improve Quality.
Some of the main options contributed by the consultation process to improve the spending efficiency and quality are quantified below. Of importance is the fact that this group of options does not constitute a Government proposal and consensus was not necessarily reached, but they serve as a basis for national discussion. Ministry of Finance technical staff quantified these measures to provide additional elements for dialogue in the next stage.
34
5.1 Recent Developments and Characteristics of the Tax System
5.1.1. Fiscal Pressure in Costa Rica
Costa Rica has a relatively low tax burden compared to other countries in the Latin American and Caribbean Region, especially considering its level of development. If social security revenue and revenue from exploitation of natural resources are considered, the tax burden in Costa Rica is slightly lower than the average for Latin America .However, if we exclude revenue from social security contributions Costa Rica has the third lowest tax burden in the region.
5.1.2. The Current Tax System and Tax Expenditure (exemptions)
The current tax system is based on two pillars, the general sales tax and income tax, representing 67% of total tax collected.
5.1.2.1. Income Tax
Income Tax (IR Spanish acronym) should be an appropriate tool for taxing the real economic capacity of the different taxpayers, in a fair and progressive manner. However, in its current form, it does not fully meet these principles, mostly because it is territorial and identification-based. This identification-based characteristic generates a wide range of tariffs that results in arbitrage leaves important untouched wealth, such as capital gains and income generated from abroad. These design problems contribute to the increased levels of evasion.
The principal of territoriality permits tax arbitrage by residents of the country in other fiscal administrations. This is the case of national residents that file income taxes with jurisdictions having lower income tax rates, diluting Costa Rica’s tax base. Even though this income is often generated in the country, currently taxpayers are not required to prove otherwise. This places the burden of proof on the Tax Administration, making it difficult to stop abuse.
Because of growing regionalization of national and international companies, the poor practice is expected to worsen over time unless corrective measures are taken.
5.1.2.2. General Sales Tax
The General Sales Tax (IGV Spanish acronym) in Costa Rica is a partial value added tax because it taxes general merchandise sales and, only some services by exception. At the same time, there is an emphasize on physical and not financial accreditation leading to discussions between the General Tax Authority and taxpayers with an elevated tax administration cost. Finally, although the services sector is one of the most dynamic in the Costa Rican economy, this sector is not part of the IGV tax base.
Many of the current problems in controlling evasion are cause by loopholes in the country’s legal system. In cases of tax evasion where there are advanced auditing systems and even criminal charges, practices that tend to use untaxed activities have been discovered (for example capital gains) as a way to cover up taxable income. The growth of certain sectors not subject to tax or with low taxes within taxed economic activities, also opens up the possibility for increased evasion or, in some cases, intensive use of avoidance strategies.
5. Eficiencia y progresividad del sistema tributario
0.05.0
10.015.020.025.030.035.040.0
Arge
ntin
a
Barb
ados
Braz
il
Beliz
e
Jam
aica
Urug
uay
Chile
T &
T
Ecua
dor
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ragu
a
Boliv
ia
Hond
uras
Peru
Colo
mbi
a
Para
guay
El S
alva
dor
Cost
a Ri
ca
Dom
. Rep
.
Pana
ma
Gua
tem
ala
Mex
ico
Adjusted Tax Burden, 2010-Latin America-
(% GDP)
Tax Income Soc. Contrib Nat Resource Expl
Source: Ministry of Finance with data from IDB
7 To be able to compare fiscal pressures between countries, the three main sources of financing are taken into account: tax revenue, those from the exploitation of natural resources and all contributions intended for financing social security.
8 Recently there has been progress in recognizing the financial deduction, with the reform of Article 14 of IGV that allows for accounting-financial deductions in the merchandise production process
35
5.1.2.3. Exemptions
The characteristics of the current tax system includes a number of significant exemptions that total 5.6% of GDP, of these 1.8% of GDP corresponds to a large quantity of income tax exemption regimes and 3.5% of GDP to IGV exemptions. Half of IGV exemptions (approximately 1.7% of GDP) are associated with the basic consumption basket and supplies to produce it. The exemptions of total consumption goods within the basic consumption basket is a poorly focused subsidy and a relatively costly way to achieve the objective of protecting low-income consumers. The majority of other IGV exemptions (1.6% of GDP) are services. Only a small list of services are taxed (for example, restaurant and hotel services).
From an efficiency viewpoint, exemptions on services impede better traceability of sales taxes in an economy increasingly oriented towards them. In addition to being a loophole for evasion, exemptions on services are also regressive, because they are mainly used by high-income consumers (for example, private health or education services).
Income tax exemption regimes include, for example:
- different treatment of capital gains, which is taxed using an identification-based system with a range of rates from zero to 50 percent, according to the legal figure used. The tax collection loss from exemptions for this type of income is 0.4%of GDP.
- special Free Zone regimes imply a tax expenditure of 0.6% of GDP
- exemptions to cooperatives and employee associations, foundations and others represent 0.16% of of GDP.
- bonuses and school bonus represent 0.3% of GCP.
5.1.2.4. Evasion, Avoidance and Smuggling
Evasion, avoidance and smuggling or tax non-compliance are elements that tend to destabilize a society. They produce a gap between the taxes the country should collect according to established law and the real tax collected. Less collection means fewer resources to provide public services. This leads to increased debt and a slow deterioration in the quality and quantity of services provided by the State.
Estimated tax non-compliance for 2010 in Costa Rica is estimated at 5.8% of GDP.However, this should not be interpreted as lost, because tax non-compliance exists in different degrees in every country. Moreover, an important part of tax non-compliance corresponds to avoidance generated by opportunities permitted by current laws.
Tax non compliance can be mitigated by improving the design of the tax system, simplifying it, expanding the tax base, minimizing preferential treatment and introducing standards that better establish taxpayer consumption patterns.
Two groups of economic agents traditionally pay fewer taxes than they should. The first is the formal or semi-formal sector that has developed mechanisms to avoid or evade their taxes. The second is that part of the population the chooses informality to avoid paying the taxes corresponding to them under the law.
To discourage the use of non-compliance mechanisms by the formal sector, the Ministry of Finance has made efforts to reinforce monitoring and control of taxpayers and the activities they generate. In addition the Ministry of Finance has encouraged formalization through electronic invoicing and fiscal lottery, the Fiscal Control Police (PCF Spanish acronym) and the DGA have been strengthened to combat tax evasion and smuggling. This has increased detection of customs irregularities and doubled the value of merchandise seizures in recent years.
DGT is implementing a strategy to make it easier for the taxpayer to pay their taxes, supplemented with better control to capture and punish tax evaders. Approval of the “Law for Compliance with the Fiscal Transparency Standard” in September 2012 (Fiscal Transparency Law), has given the DGT a tool for simpler access to bank accounts when a taxpayer is being audited. At the same time, information is being crosschecked between taxpayers using better tax intelligence tools to detect suspicious behavior, key elements for an effective, systematic and well-founded reduction in tax noncompliance.
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5.1.3. Recent Developments in the Area of Revenue
A fundamental pillar in the DGT strategy is to make it easy for taxpayers to pay their taxes. To do this a series of changes have been made to the processes and procedures. New electronic platforms have been designed, both for filing and for collecting IGV and IR.Both tax returns are filed on line and the IGV is paid on line as well. IR taxpayers still have the option to file a paper or electronic return, although DGT is making the necessary efforts to make online filing mandatory in the near future. Current return coverage is 78% for income tax and 100% for sales taxes. Despite this recent progress, system access requires improvement and user services must be strengthened.
The Law to Strengthen Tax and Customs Management approved in September 2012 provides more tools for the Ministry of Finance to reinforce its tax collection capacity, while organizing and making taxpayer rights explicit. The new law establishes the obligation of the taxpayer to be current in its tax payments to be eligible for exemptions under the Law. It defines tax infringement as failure to file self-assessments, filing incorrect self-assessments, requesting compensation or tax refunds that do not apply and obtaining undue benefit from the regulations for each tax; it extends the prescription period from 3 to 5 years to 4 to 6 years and creates “Fraud against Public Finances” defined as an action or omission by a taxpayer that constitutes fraud against public finances, with a penalty of 5 to 10 years in prison, provided the amount not paid exceeds five hundred base salaries10.
In its effort to approach OECD standards, Costa Rica has worked for several years to strengthen fiscal transparency, among others, by signing agreements to avoid double taxation and promote the exchange of tax-based information. In addition, the Law on Fiscal Transparency approved in September 2012 gave the tax administration the authority to share the banking information of its taxpayers with administrations in other jurisdictions with whom they have signed agreements and have the right to open the bank accounts of a taxpayer that is being audited, without any indication of illicit tax behavior, as previously required.
5.2. Options for Improving the Fiscal Revenue System
The following is an inventory of options to improve the fiscal revenue system derived from the consultation process begun in January 2013. As mentioned in the prior chapter on public spending, the purpose of this process was to compile an inventory of options that are not a Government proposal and not necessarily obtained in consensus, but that will serve as a basis for national discussion. The dialogue initiating at this point will expand these consultations to all sectors of society to discuss these and other options that may arise in the process.
5.2.1. Improved Revenue Administration
5.2.1.1. Internal Taxes
In the last few years the Tax Administration has been working to increase tax collection. However, additional actions must be adopted to strengthen tax administration.
The Ministry of Finance is in the process of substituting a model based on inflexible hierarchical structures with one that promotes a long term vision, capable not only of driving reforms, but of implementing them with a sufficient level of autonomy to expedite them and have the capacity to assign the resources to activities with higher return. The new model seeks to increase the levels of voluntary compliance by taxpayers, with an adequate balance between collection and management costs.
The adoption of a strategy aimed at increasing voluntary compliance levels encompasses two simultaneous and supplementary lines of action.
1. make it easier for taxpayers to comply with their tax obligations at the least cost possible.
2.strengthen auditing work to penalize evaders. It is indispensable, therefore, to reinforce the fight against tax fraud, transmitting the message to society that the tax administration is capable of quickly detecting and correcting tax noncompliance.
To do this, the Tax Administration must explore new approaches to its current operations with regard to autonomy, functional structure, management model and use of information technology.
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a) More independent Tax Administration
To satisfy the requirements for a modern tax administration demanded by society, it must have a certain level of independence. This means that it must introduce changes into the personnel selection system by substituting the current aptitude test used to enter any public entity, by others placing special emphasis on the basic knowledge required for those who serve in the tax administration. At the same time it must reinforce the administrative career path linking it to meeting academic or work experience requirements and that quality of the work done. The latter highlights the importance of building indicators that will begin a performance evaluation process based on meeting qualitative and quantitative goals.
In order to establish adequate retention levels of qualified personnel, reasonable wages must be guaranteed, that are also linked with meeting quantitative and qualitative, and individual and collective goals.
It is also important to improve coordination between DGT and DGA, sharing information to strengthen the fight against tax evasion, avoidance and smuggling.
The DGT must take the steps to become an organization with sufficient autonomy and flexibility to administer its resources. With this in mind, an entity within the Ministry could be created with a level of authority in managing human potential and control strategies, but under the general guidelines of the Ministry of Finance that manages the country’s fiscal policy.
b) Management Model
The DGT is in the process of transforming its tax management to one in which each area does its work independently, to an integrated process-based control model. This will make it possible to visualize and highlight the interrelations between the areas involved to promote adequate compliance with tax obligations.
The management model will focus on the vision that society and the tax administration are allies. The taxpayer must understand the use and purpose of the taxes to encourage voluntary compliance with its tax obligations, allowing the DGT to concentrate on taxpayers that pay higher taxes or that meet high non compliance risk profiles.
The model will be based on the following principles.
• Trust. The DGT must have the ability to measure taxpayer behavior and that of tax services users. This requires the development of tools to guaranty data quality and reliability.
• Shared Responsibility.Theresponsibility of formal and material compliance with tax obligations must fall on the taxpayer and its legal representatives.
• Self-Assessment. The taxpayer is the one responsible for making a voluntary self-assessment of its obligations and the Administration will accept it as correct, except for cases where it must verify the information.
• Use of Information Technology. Thetax management processes will be based on intense, integrated and intelligent use of information technology for all tax management processes. At the same time, the DGT will provide the taxpayer with the tools needed to be able to do the most processes individually (self-help).
• Transparency. The information in the hands of the Administration on each taxpayer may be none by the latter, thereby encouraging voluntary compliance. The public must be aware of the Indicator criteria and legal standards that regulate the actions of DGT.
c) Organizational Structure
The modernization of the DGT must be reflected in its organizational structure that must be based on process management to permit efficient administration with better taxpayer services. The main elements of this proposed reorganization are:
1. Reorganize the functional structure of DGT in light of an integrated process management model.
2. Simplify the administrative structure.
3. Ensure the comprehensiveness of the functions without separation by tax or by type of action. The information generated by each unit must also be available to the entire organization.
4. Design an organization model for a new Revenue Department to include the possibility of creating an entity under the Ministry of Finance for better compliance with the mission of the revenue area.
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5.2.1.2. General Customs Administration
Traditionally the National Customs Service (SNA Spanish acronym) of Costa Rica has been oriented more towards facilitating rather than controlling foreign trade operations, resulting in:
• A weak control.
• Proliferation of free trade agreements that lead to increased foreign trade customs transactions with physical structures in poor conditions.
• Lack of transaction traceability and intelligence record controls in the Customs Information Service.
• Lack of non-intrusive tools (scanners) to verify merchandise container units.
As of 2012 the DGA began implementing a Strategic Plan to control all stages of commercial flow and all operators.
Some achievements include:
• Operator Profiles to know each one of the importers of Costa Rica.
• SNA Risk Matrix for better selection of audit subjects.
• Manifest risk analysis. Previously controls were centered only on the declaration of imports. Today it has been extended to manifests, transit declarations and warehouses.
• Adjustments to Information Technology System functionalities for Customs control (TIC@ Spanish acronym), more in line with legislation, emphasizing the implementation of automatic controls.
• Searches of merchandise offloaded at fiscal warehouses to verify the quantity and quality of the merchandise imported.
• Issue directives to eliminate poor practices related to what Customs must do with left over undeclared merchandise.
• Infrastructure improvements: Underscores the work done at Peñas Blancas because of its impact on better organization of trade flows.
The DGA will continue to consolidate a culture of control under the premise that customs are control tools, emphasizing the importance of have expedited customs that is not a bottleneck for international trade. This would be possible if there is a good port and border infrastructure and a computer system that permits, not only recording all transactions, but tracing them as well. Diverse technologies must be incorporated to reinforce control, such as bar codes and radio frequency identification, among others, to minimize the transit time of merchandise through customs.
5.2.1.3 Strengthen the Fight Against Smuggling
Smuggling is the introduction of merchandise without paying customs duties dictated by law and without complying with national health standards. Therefore, smuggling mainly affects the public health of society and generates financial damage for the state.
Accordingly, reinforcing the fight against smuggling from the roots by adjusting the DGT and DGA strategies will more effectively and decisively strengthen controls on merchandise entering and leaving the country.
To fight smuggling there must be a solid PCF with support from all levels. Consequently, a more professional police force is being promoted. For example, to be a PCF officer, applicants must go through a rigorous process.PCF has also increased its force, equipment and has implemented a comprehensive strategy including close coordination with the DGA, the Drug Control Police (PCD Spanish acronym), the Costa Rican Institute on Drugs (ICD Spanish acronym) and the Public Police Force, among others.
PCF leads the fight against smuggling with a strategy emphasizing information and police intelligence gathering, identifying potential perpetrators, often linked to organized crime. The results of this new strategy have been remarkable. For example, in 2012 the liters of liquor seized increased by more than 200%, while in 2013 this has further increased by 30%.
The fight against smuggling must constitute a joint effort between civil society, the production sector and the Government so that we all understand the negative consequences of smuggling on society.
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5.2.1.4. Technological Vision
The new management model must generate correct prompt information for the Ministry of Finance to know taxpayers better and monitor processes from start to finish. This requires a technological platform to:
• Facilitate voluntary compliance, providing the necessary mechanisms for taxpayers to easily comply with their obligations.
• Guaranty information integrity from the source until it is received and processed.
• Offer an overall vision of the situation of each taxpayer, without the information being broken up by tax or stage of the management procedure.
• Incorporate tools that guaranty that the data is error free.
• Satisfy the requirements of the current tax system and possible amendments.
5.2.2. Towards a Fairer, More Progressive and More Efficient Tax System
Section 5.1 presented the principal characteristics of the Costa Rican Tax System, including a description of the main taxes and the different exemption regimes. This section presents the options arising from the consultation process over recent months to simplify the tax system and make it more progressive, efficient and fair, some of which could require changes to tax laws.
The options described below seek to strengthen fair and progressive principles. A tax is fair, when there is equal tax for equal income. A tax is progressive if those with the highest income have a proportionally higher tax burden. A tax is efficient from the point of view of the effect of the economic assignment of resources, if it induces few distortions or in fact improves the assignment of resources. Normally, but no always, the most efficient tax systems are those with broad tax bases and relatively low tax rates (compared to high rates and reduced bases).
Under these circumstances society is facing the need for balance between considerations of fairness and progressiveness and considerations of economic efficiency.
The consultation process identified the importance of a comprehensive review of exemption policies as an element of the Fiscal Consolidation Process to see if it still meets fairness objectives or if these can be achieved at a lower fiscal cost.
5.2.2.1. General Sales Tax
A value added tax (IVA Spanish acronym), without exemptions, provides the tax administration with important control tools to encourage all participants in the production chain to require an invoice. With this invoice the producer can demonstrate and accredit the IGV paid to its vendors.
The weak link in controlling the production process in the IVA chain is the final consumer; accordingly it is important to give the tax administration the tools to encourage them to ask for invoices. In an IVA system, consumers have little incentive for requiring an invoice, because they cannot deduct it from their tax payment. To motivate the final consumer to request an invoice, the possibility of using some incentive schemes was proposed, such as tax cash-backs, virtual points for participating in the tax lottery or supplementary savings on their pension (pension-consumption scheme).It is important to finance these incentive schemes appropriately.
For the IGV to become an IVA, the following steps are required.
(i) eliminate and minimize exemptions to IGV, including services
(ii) extend the deduction principle to goods and services
This will permit maximum traceability of transactions in the production chain. However, it is important to keep in mind fairness in analyzing the cost-benefit of exemptions.
Costa Rica is one of the few countries that totally exempts from IGV the supplies necessary to produce exempt goods, such as those included in the basic consumption basket (0 rate).In addition, there is a mechanism that authorizes direct exemption of supplies, without having to process a tax refund with DGT which makes control difficult and promotes tax fraud. The consultation process identified the option of keeping the zero rate only for export goods and services, going gradually into an expeditious tax refund system to substitute direct
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exemptions.
There are also some services, referred to as having “merit”, that when consumed produce benefits for society, such as education and health. These services are mainly provided free of charge by the Government, although in recent years these services are increasingly provided by the private sector. According to The National Statistics and Census Institute (INEC Spanish acronym), private health and education services are consumed, mostly by mid to high income families..
The impact on the cost of private education and health services when taxed under an IVA is lessened by the possibility of deducting the IVA paid for the supplies. Under the current IGV regime it is not possible to deduct taxes paid on supplies used to provide services and it is added to final consumer service costs.
5.2.2.2. Income Tax
Currently, there are several income tax exemption regimes that represent a tax expenditure of 1.8% of GDP.Modernization of the IR requires an analysis of each one of these regimes and the adoption of an explicit exemption policy.
Better international practices indicate that dual income tax system could contribute to improved fairness and progressiveness in the IR.The system consists of taxing income from work and capital gains differently. In practice the purpose is to use a progressive tax on work related income, and taxing capital gains at a single rate, among others, to discourage arbitrage permitted by multiple rates.Fiscal experts agree that the principal of income tax universality, no matter the nature or geographic origin, could contribute to encourage fairness and progressiveness in the tax system. This can be done by adopting the principles of:
I. Overall income, by which taxpayers pay taxes on their income based on a progressive scale no matter the activity that generates it.
Options Contributed to the Inventory during the Consultation Process with Regard to Sales Taxes
Some options considered during the consultation process to improve the design of IGV and improve collection capacity are:
• Migrate from an IGV with deductions to physical incorporation to an IVA with financial deductions.
• Expand the IGV (or IVA) tax base to all products and services that are currently exempt.
• Consider a treatment other than the basic consumption basket for the low-income population. In this regard, some specific options were discussed:
- Establish a preferential rate, different from zero, for the basic consumption basket and supplies.
- Keep the basic consumption basket exempt and tax supplies for other goods with a preferential rate in order to maintain the traceability of transactions in the production process.
- Personalized IVA compensation for the low-income population below the poverty level. This implies the need of a database of low-income consumers, who will receive a direct subsidy equivalent to their IVA payments and a mechanism to expedite delivery of this subsidy. DESAF has made progress in creating a single database of beneficiaries registered in social programs, but a poverty census would have to be conducted to identify all low-income persons.
• Consider different treatments for goods of merit, according to efficiency and fairness principles. Specifically;
- Tax private education services, introducing different rates per educational level considering efficiency and fairness. For example, studies based on the latest income and expense survey show that more than 90% of private basic education and mid level students come from families belonging to the 20% of the population with the highest income, a percentage that drops to 50% for private university students.
- Tax private health services. The rate applied must reflect the consumption pattern for private health services by the population according to income level. According to the income and expenses survey, the consumption of private health services is concentrated among consumers with the highest incomes.
• Consider increasing the tax rate.There are different options to go from the current sales tax to a value added tax and each of them has a different impact on collection. The adoption of an IVA expanding the base to all services, leaving the basic consumption basket exempt, could generate a return, but if the basic consumption basket is partially tax, the return would be better. If in addition to expanding the base, the general tax rate is increased, every percentage point would generate 0.3% of GDP in additional collection.
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II. Worldwide income, which taxes all income no matter the geographic origin.
5.2.2.3 Other Taxes
In addition to reviewing income and sales taxes, other options were proposed during these consultations to strengthen collection, including changes in vehicle property tax, in the tax on the transfer of assets, in the joint tax and on some taxes in support of the environment. These and other proposals are described in the box below.
Options Contributed to the Inventory during the Consultation Process with Regard to Other Taxes
The following are some of the options discussed during the consultation process that could contribute to strengthening collection and/or efficiency through other taxes.
The following are some of the options discussed during the consultation process that could contribute to strengthening collection and/or efficiency through other taxes.
• Increase the annual car registration fee for all luxury cars. This measure was very effective during the application of the Fiscal Contingency Law.
• Introduce a tax on financial transactions for a specific period. This tax, also known as the checkbook tax, would tax the majority of bank transactions except for payroll deposits. At that same time, could consider a preferential tariff to encourage certain transactions, such as electronic transactions. This tax would have the capacity to collect significant amounts in the short term, but could be less effective and highly inefficient in the mid-term because of its trickle down effects. Its short-term collection capabilities should be compared against its negative impact on banking and growing the economy. Its impact on the distribution of income would depend on multiple factors and requires detailed study..
• Establish a single rate for transferring real and personal property, currently at 1.5% for real property and 2.5% for personal property.
• Simplify the Joint Tax to strengthen housing programs (on luxury homes) to facilitate compliance and auditing.
• Establish a tax on the assets of individuals and companies domiciled in the country. The tax base is the joint value of assets owned by the individual or company, subtracting a minimum exception for individual taxpayers and liabilities for companies. The main purpose of this tax is to obtain information on taxpayer consumption patterns, therefore the international practice is implemented at very low rates.In an effort to consider the environmental variable in the design and implementation of fiscal policy, the following options were discussed (green taxes):
Options Contributed to the Inventory during the Consultation Process with Regard to Income Taxes
The following are some of the options discussed during the consultation process that could contribute to improving fairness and progressiveness of the income tax.
1) Charge a uniform tax rate on capital gains (interest, dividends). Currently, the identification-based character of the tax permits the payment of different rates depending on the legal figure chosen, leaving loopholes for arbitrage between rates.
2) Change the tax scale for individuals with a profitable activity in order to discourage arbitrage between this figure and the micro and small company,
3) Incorporate income from financial assets to income of financial entities, applying the tax to the company income (overall income) because this income is directly related to the main business of the financial entities.
4) Consider surpluses distributed by employee associations and cooperatives as capital gains.
5) Tax capital gains generated abroad when they are repatriated to Costa Rica. This could be considered a first step towards a system based entirely on territoriality to one that taxes all income received by the country’s residents no matter the source (worldwide income).Tax payers who repatriate capitals must demonstrate that this income was produced for work done or return on investments made that comply with the tax obligations in the country of origin. A grace period could be considered during which taxpayers could declare their equity in order to avoid taxes on income received during periods prior to the introduction of the tax.
6) Discuss the treatment of free zones, including the IR rates and the requirements for being a member of this regime, making cost-benefit analysis on these. An appropriate balance must be achieved between the benefits from direct foreign investments under this regime and the cost in terms of income that the tax administration does not receive.
7) Reduce social security charges on labor, increasing the income tax on company profit in the same proportion. This combination would have a high probability of reducing the cost of the work factor and would be an employment incentive for the formal sector of the economy. This benefit must be balanced against the negative impact of this combination of taxes on demand for investment and growth. Increased collection arising from increased taxes on profit would be transferred to CCSS, making it a neutral proposal for its finances. The recent reform in Colombia could be used as an example for possible implementation.
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- Exemption from vehicle restrictions by paying for the right of transit every day of the week.- Tax on carbon dioxide (CO2) emissions, based on indicators such as the effect of greenhouse gases (GHS) with engine on or the kilometers since the last revision.para las empresas. El fin primordial de este impuesto es obtener información sobre los patrones de consumo de los contribuyentes, por lo que la práctica internacional es implementarlo con tasas muy bajas.
En el esfuerzo para considerar la variable ambiental en el diseño e implementación de la política fiscal, se discutieron en las reuniones las siguientes opciones (impuestos verdes):
- Exención de la restricción vehicular por medio del pago de un derecho para circular todos los días de la semana.
- Impuesto por emisión del dióxido de carbono (CO2), basado en indicadores como la emisión de gases efecto invernadero (GEI) con el motor en marcha o los kilómetros recorridos desde su última revisión.
5.2.3. Quantification of Options Contributed to the Inventory to Improve the Tax System
The following section quantifies the main options described in this chapter arising from the consultation process that began in January 2013, it includes the estimated return of administrative improvements, legal changes and the reduction of certain exemptions. These options do not constitute a Government proposal and a consensus was not necessarily reached, but they serve as a basis for a national discussion. The quantification of these measures was done by Ministry of Finance technical staff to provide additional elements for dialogue in the next stage.
Fiscal Consolidation Program Return on Revenue Measures
(% GDP) Income Tax
New income tax scale for individuals with profitable activities1/ 0.02 New higher income tax scale2/ 0.06 Capital Gains Tax on Real Property 3/ 0.08 General Regime for Banks before capital gains4/ 0.08 Distribution of Dividends5/ 0.00 Surpluses from Cooperatives 5/ 0.04 Interest on securities5/ 0.03 Reinforced territorial income tax5/ +
General Sales Tax One percentage point increase in the tax rate (on current rate) 0.30
Tax all services, except Health and Education, at 13% 0.62 Tax Health (return on each VAT percentage point) 0.01 Tax Education (return on each VAT percentage point) 0.01 Tax Basic Consumption Basket (return on each VAT percentage Point) 0.11
Of which inputs 0.03
Other Taxes Tax on Financial Transactions6/ 0.31
Increase Transfer Taxes 0.10 Used Vehicles7/ 0.01 Real Estate8/ 0.08
Lottery Winnings9/ 0.07 Increase luxury vehicle property tax10/ 0.03 Tax on Assets11/ 0.01
Notes 1/ ¢3 million minimum exempt. From ¢3 million to ¢7 million at a rate of 15%. More than ¢7 at a rate of
25%.
2/ Salaries between ¢1,071,000 and ¢4 million at a rate of 15%. Salaries between ¢4 million and ¢7 million at a rate of 20%. Salaries above ¢7 million will pay a rate of 25% on the margin.
3/ Rate of 15% on capital gains
4/ General Regime of 30% for banking institutions
5/ Assumes uniform rate of 15% on passive income
6/ Two rates: on preferential at 0.1% and the other at 0.15%
7/ Asset transfer tax of 3% (vehicle transfer tax at 2.5% to 3%)
8/ Asset transfer tax at 3% (real estate transfer tax at 1.5% to 3%)
9/ Rate of 15%
10/ For luxury vehicles50% higher rate than property tax
11/ Rate of 0.1% on the value of the asset
Source: Ministry of Finance
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These bond issues on the international market allowed the Government to save on interest payments, by placing this debt at rates far below domestic rates and an improved debt profile by extending average debt expiration.
However, good management of public debt is not a solution to fiscal lack of sustainability issues and the limitations involved in the use of fiscal policy as a tool for macroeconomic Regulations. The need to place this public debt to finance unsustainable fiscal deficits has consequences that good management can reduce but not eliminate. Growing debt such as faced by the country with Central Government deficits of 5% or more can produce increases in interest rates that will have an impact on investment and exert pressure on exchange rate appreciation impacting the competitiveness of exports.
Public Investment
As of the 90’s the country’s roads have been deteriorating lagging behind other Latin American countries. According to a sector investment analysis of the National Public Investment Plan 2009-2010 prepared by the Ministry of National Planning and Economic Policy (MIDEPLAN Spanish acronym), this sector has problems with institutional execution capacity, lace of pre-investment studies and legal problems, including expropriations. There are also problems with the quality of the work, operation monitoring, maintenance and design.
According to the National Public Investment Plan (PNIP Spanish acronym), to promote tourist development investment the country requires a national docks to offer basic safety conditions, improve and expand airports, reinforce investment in horizontal and vertical signage (with emphasis on roads accessing tourist destinations), and improve the basic infrastructure throughout the country.
Investment in science and technology has been low, although it has a high social value. Among the main problems indicated by MIDEPLAN are: lack of specialized research and development centers with adequate facilities and equipment, insufficient resources to ensure technical support for initiatives and projects and poor links between the university
6.1 Recent Developments and Description
At the beginning of the millennium, the debt as a percent of GDP was significantly reduced as a result of better fiscal balance and high economic growth.Costa Rica reached growth levels of more than 7% in 2006 and 2007. This boom was reflected in the strong increase in tax revenues, reaching a positive financial balance between 2007 and 2008 and a reduction in Central Government debt by 25% of GDP compared to 41% for 2004.
However, the 2008 world financial crises and the actions taken by the Government to mitigate its impact caused deterioration in public finances. The ratio of debt to GDP since 2008 has grown, reaching 35% in 2012.
In spite of efforts made to increase tax collection and contain the expenditure growth, the fiscal deficit is still high. According to the Ministry of Finance the expected financial deficit for 2013 is 5.0% of GDP, and its financing will increase public debt to 36.5% of GDP.
After almost a decade of absence on international markets, the Ministry of Finance issued two bonds for placement abroad for US$ 1 billion each. The success of these placements was based on the country’s strengths, including competitiveness, a solid institutional framework, world leadership on environmental issues and its democratic traditions and social respect. The first was issued at an interest rate of 4.250 % for a 10-year term. The second bond issue was for 12 years (at 4.375%) and 30 years (at 5.625%).
6. Public indebtedness and investment
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1984
1985
1986
1987
1988
1989
Source: Ministry of Finance
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Central Government Debt (%GDP)
Total Debt GC Internal Debt Foreign debt
35.3%
29.2%
6.1%
2004
2005
2006
2007
2008
2009
2010
2011
2012
Foreign debt
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research and development systems and the private and corporate sector. Also contributing are the low levels of digital and technological literacy and scarce financing for this type of investment.
The main problems in the environmental, energy and telecommunication sectors are associated with the capacity for formulating and executing projects, lace of regulatory frameworks, timing of investments and type of interinstitutional coordination. The energy sector requires maintenance of existing work, development of new generation plants as a function of growing demand, continued investment in transmission and distribution, seeking renewable energy production alternatives.
The health sector has a series of weaknesses related to programming and budget processes that
impede the satisfaction of the basic needs of society, creating gaps in attention services due to saturation, inadequate infrastructure and equipment.
With regard to the security and crime prevention sector, the main concerns identified by PNIP are the need to design investment-programming methodologies with regard to infrastructure, information technology and communication and renewal and maintenance of police units. In addition it needs to improve police equipment and uniforms, institutionalize ongoing training processes at the National Police Academy and promote specialization abroad. The Program to Finance Investment Projects 2010-2014 was formulated to face these issues which involved four types of actions: security, social wellbeing and protection of the most vulnerable, environment and
Program for Financing Investment Projects 2010-2014
(Millions of US$)
Actions Program/Project Amount
Sec
urity
Fighting poverty and crime
Strengthen Security Program for the Prevention of Violence and Promotion of Social Inclusion 1/
132.4 Attack Risk Factors
Improve institutional Response
Soc
ial
Wel
lbei
ng
and
Pro
tect
V
ulne
rabi
lity Social Policies
to benefit vulnerable sectors
Includes sectors such as education and health
Higher Education Improvement Project 2/ 200.0
Env
ironm
ent Environmental
wealth to drive economic growth
Construction of an inclusive development model for the environmental sector
Program for Tourism in Protected Wildlife Areas 3/ 19.0
Potable Water and Sanitation Program for Sub National Level 3/ 73.0
Com
petit
iven
ess
Strengthen human capital and innovation
Development of production and sales support
Innovation and Human Capital Competitiveness Program 3/ 35.0
Strengthen and Expedite capital markets
Electrical Development Program (2012-2016) 250.0
Improve investment climate
Develop innovative financial Mechanisms appropriate for needs
Geothermal Projects (Pailas II and Borinquen I and II) 715.0
Improve national infrastructure
Project for Rehabilitation and Expansion of Route No. 32 (Route No 4 to Limon section) 4/
466.0
Moin Port Modernization Project 3/ 55.0
Notes: 1/ Approved by Legislative Assembly in 2012 2/ Approved by Legislative Assembly in 2013 3/ In process of approval 4/ In process of preparing for submittal to Legislative Assembly Source: Ministry of Finance
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competitiveness.
The Ministry of Finance is in the process of strengthening monitoring of public investment projects under execution. The Department of Public Loans (DCP Spanish acronym) is improving channels of communication with those executing these projects; giving the decision making support to ensure successful implementation of the projects.
An important limitation for executing public investment is the lack of execution capacity in public institutions. There is a gap with regard to project preparation and evaluation and the obstacle of efficiency and effectiveness in execution. Contracts and acquisitions, particularly those linked to expropriations have been a serious problem for the success of projects. As a consequence of these factors, variations in disbursement schedules are common along with programming the progress of activities. Accordingly, there are multiple requests for extending the disbursement periods and contract expiration dates.
6.2 Options for Improving the Debt Structure
Debt management is a fundamental element in the Ministry of Finance’s financial strategy. Its objective is to satisfy the Government’s financing requirements and compliance with payment obligations.
In the mid-term, the strategy should seek a balance between the cost of financing and management risks. This is achieved by establishing clear debt management objectives, transparency, adequate institutional frameworks, as well as through the definition of a debt strategy, prudent risk management and development of an efficient market for government securities.
The main challenges faced in strengthening financial management of the Central Government, include:
Define a bond placement policy that permits attainment of a debt structure that complies with cost and risk management midterm objectives. The design of this strategy requires the preparation of awareness and service simulation exercises and a debt profile and risk scenarios regarding the behavior of the macroeconomic variables involved.
• Maintain and consolidate a program regarding relations with investors, risk scoring agencies
and international organisms to establish direct channels of communication and dialogue with the Government. This will create trust, credibility and transparency, all elements necessary to expand the database of potential investors and other financing options.
• Maintain a presence on international markets in order to have access to external financing when financial conditions warrant. Recent bond issues on international markets confirm the importance of maintaining and transparent disclosure of information to facilitate investment decision-making.
• Improve coordination between domestic issuers. The signing of the “Framework Agreement for the Coordination of Public Debt between the BCCR and the Ministry of Finance” is the first step towards establishing a general framework of conditions for effective coordination of the public debt between BCCR and the Ministry of Finance, to guaranty its organization.
This agreement will permit the preparation of a comprehensive sovereign debt management strategy for more efficient auctions, direct access by institutional investors to the primary public debt market and the development of an action plan to unite sovereign issues.
• Migration towards a single sovereign debt issuer scheme. Competition, without appropriate coordination, between the Government of the Republic and BCCR on the same debt market tends to increase financing costs. For this reason, studies are being made on mechanisms and options to migrate towards a single sovereign issuer scheme on local markets.
• Central Bank Capitalization: This will permit consolidation of the low inflation rate as done in recent years.
• Broaden the external financing planning horizon beyond the current legislative authorization to issue US$4 billion on the external market Intensify the use of financing mechanisms with infrastructures that are different from traditional loans with international organisms, such as concessions and trusts.
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6.3 Options to Drive Public Investment
Inefficiency in the execution of public investment has become one of the most important obstacles to promoting the competitiveness of the Costa Rican economy in recent decades. In view of this, the Ministry of Finance is in the process of creating a department of public investment that will be responsible for supporting Government agendas for the design and implementation of strategies to execute projects. This unit will coordinate closely with MIDEPLAN and its functions will be concentrated in two areas: the execution of projects and the promotion of public-private associations.
To perform work in the area of project execution it will have professional staff qualified on subjects relating to project management, to create a more specialized approach and more value added. This will strengthen a culture of projects in public institutions. This unit will support executing units during the different stages of project formulation, execution and evaluation, as well as the definition
of an improved organizational structure.The Unit of Public-Private Associations will be in charge of planning, directing, coordinating and controlling activities related to agreements and contracts arising from public-private association schemes that will permit well-founded decision making. To that end the unit will establish technical criteria and methodological guidelines for the analysis of investment projects developed under these schemes.
It must strengthen the information technology system to monitor loans that finance public investment programs/projects and promote changes in elements of the Administrative Contracts Law that could be an obstacle to project execution, such as the number of appeals to tender awards and the time permitted for resolving them.
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Several decades ago Costa Rica made the decision to incorporate environmental sustainability as a fundamental development pillar. When designing a fiscal policy environmental variable along with economic and social variables must be taken into consideration. This means supporting the country’s efforts for the protection of ecosystems, the reduction of greenhouse gases, the adaptation to climate change and growth based on increasingly clean technologies with low environmental cost. There are several lines of action, described below, that the Ministry of Finance can use to contribute towards achieving these objectives.
7.1 Green Taxes
Green taxes have a positive impact on innovation, through which increasingly higher environmental goals can be reached at lower cost. Since companies and consumers are not aware of the cost to others generated by pollution, society on its own will “produce” too much (negative external factor).Likewise, innovation can be discouraged when innovators cannot capture the benefit of their innovation (positive external factor).The very nature of innovation and pollution suggest that the Government must assume this very important role in order for society to reach its optimum environmental goals.
Green taxes can have a high environmental impact, and may even generate greater collection. From an environmental perspective, the success or failure of a green tax is not measured by collection, but by its impact on behavior so that actions that will damage the environment will not be taken. To deter contamination and offer incentives for cleaner technological innovation, the level of the tax is a significant factor because the higher the rate on the contaminating activity, the more significant the incentives to stop contaminating and innovate.
For example, to reduce contamination, carbon produced by the transportation sector could be taxed directly. This sector emits the highest level of pollution and projections indicate that it will maintain this increasing trend. To the extent that individuals receive incentives to stop using vehicles that pollute the environment, the country can significantly reduce its greenhouse gas emissions (GHG).Incentives must be generated through a
complete range of actions to offer incentives for teleworking, improvement and expansion of public transportation, road reorganization, urban planning and pollution taxes.
With regard to green taxes themselves, one option to consider is to charge a fixed amount per unit of carbon emitted. The main variables for estimating carbon emissions would be used, such as the emission of GHG with the motor on and the kilometers since the last revision. This would work as a supplement to the reduction of taxes on hybrid vehicles (reduced from 30% to 10%), no taxes on electric cars (0%) and the regulations that the Ministry of the Environment and Energy (MINAE Spanish acronym) is currently working on to charge a tax of 30% of the value of any vehicle that does not meet the energy efficiency required under the Law for Energy Efficiency.
The goal should be that that the rest of the tax system should be at least neutral with regard to climate change. The agricultural sector becomes important at this point because it is largely exempted and is the second highest GHG producing sector in the country. The option to tax agricultural inputs that produce significant amounts of GHG, such as fertilizers, is a step towards carbon neutrality.
7.2. Budget Assignments in Support of the Environment.
In the 2014 budget, the Ministry of Finance identified some ¢33 billion colones in environment related projects that will increase reforestation and reduce vulnerability to climate change. These projects can be divided into two groups of equal weight. Those managed by MINAE to prevent climate change through transfers to the National Forestry Financing Fund (FONAFIFO Spanish acronym) for prevention and mitigation actions, as well as transfers to the National Conservation Area System (SINAC Spanish acronym) to buy up lands in protected wildlife areas. On the other hand there are items assigned to MOPT to handle emergencies and natural disasters linked to climate change.
The identification of budget resources intended for these purposes must be systematic to migrate towards results-based programming including the environmental component. Each Ministry must list
7. Fiscal Policies and Environmental Sustainability
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its actions to reduce GHG emissions and mitigate the effects of climate change. This has to be done both at an institutional level and through programs with civil society, the production sector and the rest of the public sector
7.3 Resources identified to Respond to Climate Change Related Contingencies
In addition to the resources incorporated into the National Budget, the State has resources to handle emergencies related to climate change pursuant to Law No 8.488, Article 43 that creates a National Emergency Fund and contingent loans from the Interamerican Development Bank (US$100 million) and from the World Bank (US$ 60 million).
The country is in the process of joining a regional risk insurance scheme against natural disasters, an initiative coordinated by the World Bank that will permit Central American countries to join together in a scheme already operating in Caribbean countries.
7.4 Environmental Satellite Account
The Ministry of Finance is collaborating with BCCR to develop an environmental satellite account, focusing on a first stage, in the contribution of national accounts to water and forests. This process, which is part of the base year change project, has allowed the country to be part of a global initiative led by the World Bank for countries to make an accounting of their natural resources. Once the economic contribution of biodiversity becomes visible, its conservation will be understood in the future as an investment and not an expense.
One of the main global challenges for fiscal policy within the environmental agenda, is climate change. We must be aware of the value of climate as a public global asset and appropriately record social and environmental impacts. Moreover there is a lack of symmetry, in the sense that the countries that have contributed the least to the problem are suffering the most impacts, as in the case of Costa Rica.
7.5. Institutional Policy of the Ministry of Finance in support of the environment.
The Ministry of Finance is committed to the environment and his proposal is to reach the carbon neutral objective prior to 2020. To achieve this, the Ministry is working in close collaboration with the CGR to implement a series of initiatives such as the creation of an office of Environmental Action to incorporate the environmental variable in all institutional investments. It also seeks the reduction of carbon emissions by using digital instead of paper files, facilitating the payment of taxes by electronic methods, renewing the vehicle fleet and expanding teleworking.
Many of the actions to reduce emissions have an additional value beyond their environmental impact. For example, teleworking generates savings in leasing office space and the use of goods and services and also reduces highway congestion and makes the country less dependent on petroleum. That is why it is important to incorporate the environmental variable in the budget as a good practice to systematically measure all savings and costs for these measures to the country, to be able to establish a baseline from which to better manage long-term environmental policy. NATIONAL DIALOGUE
the road to fiscal consolidation
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NATIONAL DIALOGUEthe road to fiscal consolidation