| Costa Rica | Apr 28, 2019
While tax reform is but one step needed to rally Costa Rica's economy, the government is unlikely to view it in isolation from other economic imperatives such as employment and the projection of a competitive commercial environment.
Costa Rica has taken welcome economic strides over the past decade, establishing its credentials as a competitive tech hub; this in addition to tourism. And yet local economic slowdown and informality continues to curb its progress up the commercial competitiveness ladder. Public sector expenditure, for one, needs taming, a task that prospective tax reform seems to be aimed at achieving. Then there’s the opposing view.
Costa Rica’s fiscal deficit is burdened by high government financing at a time of relative economic slowdown. And for the Ministry of Finance, fiscal reform gained greater urgency mid-year as the fiscal deficit of the Central Government, at 3.3% of GDP, printed a six-year high. Of the total deficit, roughly two thirds are interest due. Tax collection remains a stubborn underlying factor.
In August, congress approved the “lets-go” Bill of Strengthening of Public Finances. This transformed the general sales tax into a VAT of 13%, thereby extending the covered tax base to services hitherto not covered. It set a 4% rate on the purchase of packaging, wrapping and raw materials, among others. The bill also proposed taxes on books in all formats, air tickets, and equipment and machinery plus services for agricultural and agroindustrial production. The bill placed a ceiling of CRC5.4 million on the civil servant salaries as well as of heads of state and public administrators and the equivalent of 18 minimum monthly salaries for the lowest private sector income segment.
The Voice of Business
Costa Rica’s commercial sector has been keen on fiscal reform, while adding a call for the government to also address employment and high production costs. In August of 2018, it underlined the need for positive messages from the government pertaining to economic activity, in addition to better public sector oversight. The Union of Chambers harked back to Costa Rica’s GDP growth of over 5% back in 2012, in stark contrast to the Central Bank’s predicted 3.2% for the year.
The Association of Free Trade Zone Companies of Costa Rica (Azofras) was concerned in September that the bill, while addressing the need to tame public finances, would not maintain the VAT exemption on the local purchases of goods and services of free zone companies, both for export products and for their own local operations. It stated that it was in competition with “135 countries and 3,500 free zones, which is why the free zone regime must be strengthened to build loyalty to companies already here and attract other companies that continue to generate more quality jobs and productive chains.” Local food producers had opined that the proposed lifting of VAT on the basic product basket would incentivize imported produce at their expense.
Tax But One Component
October’s approval of the Bill of Strengthening of Public Finances attracted positive comment from the Costa Rican Union of Chambers and Associations of Private Business Sector (UCCAEP), with a caveat. Tax reform, despite taxing higher income brackets, is, it argues, but a component of the broad change needed in the economy. UCCAEP stressed that Costa Rica needed to formalize the informal economy, estimated at an unsupportable 44%, adopt a single pension system, and galvanize growth.
Stagnant Business Confidence
In August, UCCAEP data revealed scant business confidence in efforts to boost national competitiveness, and in the future of their respective industries. Given the above observations this was hardly surprising, and a stagnant business confidence print of 6.2 had hardly budged from 6.4 a year earlier. The challenge for Costa Rica is to create the conditions for sustainable growth. The latest tax reform is a step in the right direction. And it’s not all grim. The country for one is seemingly poised for OECD membership, which while no panacea, as we have stated elsewhere, is confirmation of confidence in economic fundamentals going forward.