Review: The New Costa Rican Government Tax Plan

Although there have been some tax reforms in the past, there have been attempts to improve the tax revenue process to reduce evasions and reduce spending, but the results have not been satisfactory.

The Public Sector Deficit (PSD), in relation to GDP (Gross Domestic Product), in 2010-2013, was 5.63% and, according to the Central Bank, this year 2013 it will be increased to 5.80% and a projected 6.6% for 2014.

If this situation keeps going on without a new comprehensive tax policy, the State will be in financial ruin with a PSD of 7% to 8%, in relation to GDP at end of 2018. To correct this situation, a new government will need to adopt the following policies, aimed at lowering the PSD to 2.5% or 3.5% in relation to GDP for the period 2014-2018:

1. Public spending policy. Improve sector efficiency and provide better services with less use of resources by:
• Rationalizing public sector spending and reduce the size of the State, in order to obtain an economy that is equivalent to 2.5% of GDP.

Efficiency of Central Government (CG). Decrease CG bureaucratic spending by eliminating unnecessary placements and avoid duplication, reduce disability and stop further streamlining to achieve greater efficiency and lower their weight within the PSD, from the 87.4% of today to a 70%.

• Review the current transfer system to eliminate unnecessary tasks, as well as reduce their amount by forcing recipients to be more efficient in the performance of their activities.
• Reduce the state wage bill by claiming the unconstitutionality of public sector collective agreements in the excesses and the abusive privileges enjoyed by government employees, in relation to the equal rights of private sector employees.
• Reduction of compulsive job policies through forced retirements of staff that reach retirement age and voluntary retirement programs. The eliminated job positions will not rehabilitated.
• Disable the process of recruitment of new staff for two years.
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2. Revenue policy. Increase revenues and improve their distributional effect through a tax system that favors lower income classes and, in an equitable and fair way, get more taxes from the higher classes in the form of rents.
3. Reduce tax exemptions. It is neither fair nor equitable to implement a tax reform by charging taxpayers with more than usual while the system privileges through exemptions important sectors of the economy. The exemptions must drop from 5.8% to 3%, in relation to GDP, through:
   • Exemptions on income tax must be reduced, from 1.78 % to 0.75% of GDP by forcing all activities that generate income to pay this tax, including: free zones, cooperatives , associations, foundations , trusts, profit properties , income from non-residents, bonuses and school salaries.
   • Reduce from 3.69% to 1.5% of GDP the general tax exemptions on sales, eliminating preferential treatment in local consumption.
4. Tax Reform. Improve income tax at a rate of 2.5 % of GDP and increase the tax burden from 13.7% to 16.3% of GDP through a reform that includes the following settings:
   • The income tax will be differentiated by lowering the tax on lower income wages and increasing the tax on higher incomes. There will be a scale of 5% for lower wages to ¢2.5 million, 10% for salaries in the range of ¢2.5 to ¢5 million, 15% for the range of ¢5 to ¢7.5 million and 20% for incomes higher than ¢7.5 million.
   • The income tax over net profits will be differentiated according to the category each business. Micro companies would be exempted in the first two years and then 5%, small (10%), medium (15%), large (20%) and big corporations, both national and foreign, operating in the country (35%). There will be a formula that takes into account the following variables: annual sales, property status, employment levels and earnings before taxes to determine their category.
   • Increase the tax from 30% to 35% on net profits of all financial intermediaries supervised by Sugef.
   • Set a Value Added Tax (VAT) in 15% and replacing the current sales tax.
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5. Reduce tax evasion. Increase monetary penalties on tax evasion and legislate to consider the lifetime ban of evader companies and businesses.
6. Improve the process of tax collection.
7. Merge ministries and related institutions. This would start a process of State restructuring in order to reduce its size, for greater public sector efficiency and reduce spending.

   This process will mean to merge ministries and institutions with similar functions, either complementary or competitive, and close other institutions that this study recommends.

8. Privatization of some public companies. The restructuring of the State shall endeavor to decouple its entrepreneur, banker and merchant activities, to effectively focus on public safety, education, health, justice, public infrastructure and all areas reserved to it by the Constitution. Non-tax revenue that is no longer received will be offset by the sale or grant of such businesses, with direct taxes on them.

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This article was written in Spanish by William Hayden – The General Manager of the National Bank of Costa Rica (1997-2009) and is summarized here in English for our readers…

Andrew Makarik

to@welovecostarica.com

Andrew Makarik is the main editor of WeLoveCostaRica, a fan of this sunny country. He is also a loving husband and a has a lovely daughter. By being a devoted family man and the biggest Costa Rica fan, he wants to make more people feel at home there. WeLoveCostaRica unites people and helps them find new home or a new travel destination. This website is a friendly community where everyone can find not only information, but also new friends and travel pals. Andrew is also passionate about IT and programming, so he himself maintains a friendly atmosphere in this cozy environment of WeLoveCostaRica.com.