As Central America's Economies Struggle, Guatemala Digs in for a Tax Fight

As Central America's Economies Struggle, Guatemala Digs in for a Tax Fight
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The global economic decline has hit Central America hard. Unemployment has increased, remittances from emigrants have declined and governments face rising deficits and debt that jeopardize their ability to meet increased social demands. The story is similar in much of the world, but the situation is particularly precarious in these countries, because they are among the poorest nations in the Americas and have weak economic and social safety nets.

Governments in the region have responded to the economic decline by promoting fiscal adjustments to improve their balance sheets. El Salvador recently passed a gasoline tax and revised its value-added tax, and President Mauricio Funes hopes to pass tax increases on liquor, tobacco and luxury goods. In Honduras, de facto President Roberto Micheletti proposed sweeping reforms, before withdrawing the media-dubbed paquetazo due to pressure from Congress and president-elect Porfirio Lobo to put off major legislation until the new government assumes power. Meanwhile, Guatemala has witnessed the fiercest budget fight of all. Supporters of President Alvaro Colom's proposed reform have taken to the streets and threatened opposition legislators, but these efforts have failed to keep Colom's opponents from obstructing congressional proceedings. Thus far, Colom appears to be losing the legislative battle.

Taxation is a contentious issue in every country in the world, but the topic is especially fraught in Guatemala. Guatemala has long had the lowest tax ratio--tax revenue as a percentage of gross domestic product--in Latin America, a region notorious for weak tax collection. The low tax ratio is part of a legacy of a racist, extractive Guatemalan state, predicated on making profits for economic elites through the cheap (for many decades, forced) labor of a predominantly indigenous majority. Since the state cared little about the needs of most Guatemalan citizens throughout most of the country's history, social spending was minimal and taxes remained negligible.

To confront this legacy, the 1996 Peace Accords stipulated an increase in the tax ratio, from 8 to 12 percent, as an integral part of the settlement to end the 36-year civil war. But, by 1999, Guatemala's tax ratio was still only 9.1 percent, compared to the Latin American and Central American averages of 19.1 percent and 19.4 percent, respectively. (According to the IMF, typical tax ratios are 40 percent for high-income countries, 25 percent for middle-income countries, and 18 percent for low-income countries.) Right-of-center governments and well-organized economic elites nominally accepted Guatemala's 12 percent goal, but obstructed implementation. By the middle of this decade, and after continued international pressure, Guatemala finally met the 12 percent mark. But the tax base has remained narrow, and exemptions and loopholes abound for the wealthy to avoid paying into the system.

This year, president Alvaro Colom--the first left-of-center president elected in Guatemala since the 1954 coup ousted Jacobo Arbenz--has renewed the tax fight. His proposal to Congress includes increasing taxes on businesses, commercial rents and the cellular telephone industry.

Colom's proposal has met predictably fierce opposition. Digging their heels in against Colom, opposition legislators stayed away from several sessions of Congress, preventing the legislature from reaching its quorum. When they did attend, they used procedural quirks--similar to a filibuster in their effect--to prevent further debate and voting on Colom's proposed reforms.

In response, the country's teachers' union blocked several major roads last week to pressure the Congress to approve an expanded state budget, including increased funds for the Ministry of Education. Matters then got out of hand when dozens of pro-Colom mayors--who support the reforms because of promised funding increases for municipal coffers--descended on Congress to pressure legislators. They burst into a meeting of legislators and then surrounded, grabbed and pushed opposition members around the room. The mayors' goal was to pressure the opposition into action. But their ill-conceived plan backfired, however, as the President of Congress--himself a supporter of Colom's reforms--subsequently had to declare a recess until January.

Colom's opponents--the strongest of which come from the right-wing Patriotic Party--have justified their position by arguing that more taxes will reduce investment and new employment opportunities. They further criticize Colom's government for a lack of transparency in social spending and argue that spending reforms must precede tax increases.

In particular, these legislators have accused Colom of distributing benefits through Mi Familia Progresa, a conditional cash transfer program, along partisan lines. Colom's opponents have argued that the First Lady, Sandra Torres de Colom, who heads Colom's signature Cohesion Social council, is using Mi Familia Progresa as a patronage tool to drum up support for her potential presidential candidacy. Recently, Colom's opponents declared victory when the Constitutional Court demanded that the government make public the list of program beneficiaries. The government complied with the order last week.

Opposition parties have also raised concern over financial transfers to Cohesion Social from other ministries' budgets. These are legal, but in large scales may undermine key ministries' effectiveness, so legislators have pleaded for greater transparency.

Colom should certainly introduce as much sunlight as possible to demystify government spending. Critics are also probably right that Colom should have been more diplomatic in introducing the reform, instead of declaring his unwillingness to negotiate with his opponents. Finally, real concerns exist about the cellular telephone tax. Colom has promised to create an oversight commission to ensure that the tax would not be passed on to consumers, as this would mean just another regressive tax in an already regressive tax system. Basic economic theory, however, suggests that it would be very difficult--perhaps impossible--to ensure that the firms absorb the full weight of the taxes.

Surely then, Colom is not faultless in the reforms' failure thus far. But a longer-term view makes it hard to see the opposition as acting in good faith. Simply put, Guatemala has seen this kind of right-wing foot-dragging on tax reform before. Recent events reflect continuity with events leading up to and following the Peace Accords, when CACIF (the Coordinating Committee for Agricultural, Commercial, Industrial, and Financial Associations) obstructed tax reform and efforts to address land and social inequality. Now, CACIF is among the groups of elites pushing back against Colom's efforts to collect more taxes from the business community and make the entire system more equitable.

The claims that increased taxation will hurt the country ring hollow when one realizes that, even if Congress passed all the reforms, Guatemala's tax ratio would still pale in comparison with virtually all Latin American countries. The truth is that Guatemala has dire social needs that the state must address, as the market alone will not solve them. One pressing example is this year's drought and the ongoing wave of acute malnourishment and hunger-related deaths. In arguing for greater assistance to affected communities, the UN Special Rapporteur on the Right to Food made clear that increased taxation must be part of the equation. This is one of many examples that underscore a simple reality: without greater tax revenue, the government will not be able to meet the needs of Guatemala's most vulnerable citizens.

Now, if Congress cannot reach an agreement, Colom will face the choice between accepting mounting public debt and implementing austerity measures. Significant increases in debt could hurt Guatemala's macroeconomic outlook and raise concerns for creditors. Having to repay such debt in the future could also mean a less ambitious long-term development agenda. Meanwhile, short-term cuts in education and health care would deal a blow to Colom, whose agenda centers on the expansion of social service coverage. Such a cost reduction strategy could also hurt the government's plan to increase the size of the police force, a pressing concern in a country with rampant drug and gang-related crime.

In short, the current tax reform debate in Guatemala may well shape the last two years of Colom's presidency. If Colom's opponents win this fight, it could embolden them to attack Colom's other priority areas, ultimately undermining his agenda for the remainder of his term.

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