Woodrow Wilson Center – American University Washington, D.C. June 2012

Outline Chapter 1: A decade of turbulence Chapter 2: Fiscal revenues and expenditures: structure and implications for inequality Chapter 3: Fiscal revenues and expenditures evolution Chapter 4: Fiscal challenges from a political perspective Final remarks

A DECADE OF TURBULENCE Chapter 1

A decade of turbulence Three phases of a decade of turbulence: deceleration, expansion and crisis The most severe crisis in the last 30 years Services have become the engine of economic growth, boost by family remittances, tourism, FDI and exports However, economic growth was low in labor intensive sectors Poverty was reduced slowly ( ) Due to the severity of the crisis, the achievements reached in poverty reduction were reversed

Three phases of the decade of turbulence Source: Icefi, based on official data.

…with the most severe crisis in the last 30 years Source: Icefi, based on official data.

Services have become the engine of economic growth Source: Icefi, based on official data.

…boosted by family remittances, tourism, FDI or exports (with different levels of intensity) Source: Icefi, based on official data.

…boosted by family remittances, tourism, FDI or exports (with different levels of intensity) Fuente: Icefi, basada en datos oficiales.

Due to the severity of the crisis, the achievements reached in poverty reduction were reversed Source: Icefi, based on official data.

1. Complementary role of fiscal and macroeconomic policies – Role of fiscal policy in promoting economic growth – Counter cyclical policy that moderates impacts of economic shocks – Improve coordination between fiscal and monetary policy – Big space for cooperation in Central America No only economic integration Regional public goods The big challenges (1)

FISCAL REVENUES AND EXPENDITURES: STRUCTURE AND ITS IMPLICATIONS FOR INEQUALITY IN THE REGION Capítulo 2

Structure of fiscal revenues and expenditures: implications for inequality Public expenditure is a key tool to reduce inequality – In Central American countries (CAC) exist a relation between lower poverty and higher levels of public social expenditures – Social expenditures in education and health benefit more the poor in CAC Tax system could prevent more inequality and it’s the main source of funds for public expenditure The impact of tax system in the income distribution is low because the low collection of direct taxes – Low revenues from Personal Income Tax – High levels of fiscal benefits for a few (like tax exemptions) – High levels of income tax evasion – Almost inexistent real estate taxes

Fiscal revenues depend mainly on taxation, specially in the lowest fiscal revenues countries in the region (El Salvador, Guatemala) A reduced group of countries have diversified its fiscal revenues sources, beyond taxes and grants (Panama, Costa Rica) Level and composition of public expenditure have notable differences between Central American Countries Allocation of resources to social expenditure was a priority, even on crisis years Social expenditure structure – Education and health: the main targets – Social protection: the big difference Structure of fiscal revenues and expenditures: implications for inequality

Public expenditure is a key tool for inequality reduction Source: Icefi, based on official data and ECLAC.

Public expenditure in health and education benefits the poor in Central America Education (% of public expenditure in education) Health (% of public expenditure in health) Source: Icefi, based in Barreix, Bes and Roca (2009)

Tax system has a low redistributive impact Source: Icefi, based in Barreix, Bes and Roca (2009)

… mainly because of the low collection of direct taxes Direct taxes participation (% total) International comparison of tax structure (% GDP) Source: Icefi, based in official data and Gómez-Sabaini, Jimenez and Podestá (2010).

The redistributive effect of taxes and transfers is much higher in Europe than in Latin America Source: ECLAC, based on Goñi, López and Serven (2008) Central America = -3.7% USA=-16.6%

The low collection of direct taxes is explained by… Low revenues from personal income tax High tax exemptions High income tax evasion Others (weak tax administration, political factors)

Fiscal revenues depend mainly on taxation, especially in countries with the lowest fiscal revenue Fiscal revenues NFPS (% GDP) Fiscal revenue structure (% total ) Source: Icefi, based on official data.

Level and composition of public expenditure has notable differences Public expenditure NFPS (% GDP) Public expenditure categories (% total) Fuente: Icefi, basada en datos oficiales.

Allocation of resources to social expenditure was a priority, even on crisis years Macroeconomic priority (% GDP) Budget priority (% total public expenditure) Fuente: Icefi, basada en datos oficiales.

Social expenditure structure : education and health, main targets; social protection, big difference Fuente: Icefi, basada en datos oficiales.

2. The challenge of raising more tax revenues remains – Recent progress on direct taxation is important, but still there is a long way to advance in tax administration, tax evasion, and elusion reduction – Real estate taxes, a tool to strength local government finances – Explore fiscal revenues diversification: better management of public enterprises, public assets and other non tax revenues The big challenges (2)

3. Promote greater equity in public expenditure – Improving level and allocation of social expenditure, now with institutional strengthening – Face new challenges like climate change and insecurity – Continuous evaluation of social programs and infrastructure projects, with better beneficiaries identification The big challenges (3)

FISCAL REVENUES AND EXPENDITURES EVOLUTION Capítulo 3

Main findings Improved fiscal revenues: sustainable? Public expenditure growth – Wages and transfers grew during the crisis – Public investment was sacrificed Strong relationship between revenues?, fiscal deficit and economic performance – Fiscal revenue highly dependant on imports Debt outlook is better than a decade ago: external debt was reduced and created fiscal space to face the crisis Three fiscal sustainability scenarios

Improved fiscal revenues: sustainable? Total Fiscal revenue ( ) (% GDP) Central American average Tax Burden (% GDP) Source: Icefi, based on official data.

Public expenditure growth: wages and transfers up, investment down (% GDP) NFPS IIIIII CR SV GT HN NI PA Expenditure change in anti-crisis plans Central government (% GDP) Source: Icefi, based on official data.

Strong relationship between fiscal revenues, fiscal deficit, and economic performance Deficit (% of GDP) Deficit increase in 2009, according to revenues or expenses Source: Icefi, based on official data.

Strong response of fiscal revenue to business cycle, highly dependant of imports Fiscal revenue growthTaxes linked to imports Source: Icefi, based on official data.

Debt outlook is better than a decade ago: external debt was reduced and created fiscal space to face the crisis NFPS Country TotalInternalExternalTotalInternalExternal CR ES GT HN NI PA Fuente: Icefi, basada en datos oficiales.

Three sustainability scenarios 1.Orthodox Fiscal adjustment – Non viable 2.Financial sustainability – Public sector financing at current level – Gradual and progressive reforms in revenue and expenditure – Fiscal deficits around business cycles (with rules) 3.Sustainability with equality and growth – More fiscal revenues – Transparency – Equality and economic growth

FISCAL CHALLENGES FROM A POLITICAL PERSPECTIVE Chapter 4

Main findings Public sector reforms are very hard to achieve due to political factors Key role of Legislative Branch Tax structure strongly influenced by economic elites and their State role paradigm Fiscal reform great challenge: how to make alliances

Public sector reforms are very hard to achieve due to political factors Tax reforms are the best example Ambitious reforms are very hard to be approved Actors’ roles, power shares and interests determine reforms outcomes – State branches – Economic elites – Popular sectors Proposed and approved reforms ( ) Source: Icefi, based on official data.

Actors, institutions and processes Legislative Branch central role – Growing political parties fragmentation – Reform approval more difficult in countries with more fragmented political parties Economic elites and their power exercise – Their influence on State configuration models – Influence on the tax structure – Tax incentives vs. Public expenditure

The great challenge: finding allies First pillar: recover citizen trust on public sector – Real and verifiable actions can reduce citizen distrust, via transparency and anticorruption measures promotion – Campaigning to communicate the results achieved Second pillar: allies search – Emergent elites interests – Popular sectors – Look for pro-reform coalitions

Summing up Final remarks: the big challenges 1.Economic challenges 2.The challenge of raising revenues remains 3.Promote greater equity in social expenditure (+) 4.Political challenges – Fiscal reforms approval by fragmented legislatives – Influence of economic elites and limited vision on competitiveness (only demand tax exemptions) – Transnational elites involvement demands incentives and motivations to distance themselves from traditional opposition and to contribuite State strengthening through fiscal reform – Prevent clientelistic practices on policies addressed to popular sectors – Earn medium class trust on State