"Our Tax Policy is Regressive, Terrorist and Unimaginative"
Julio Francisco Báez and his brother Teódulo are both lawyers
and experts in tax policy. The Báez brothers, as they are known, are the authors of the best selling book ever published in Nicaragua, Todo sobre impuestos
(Everything about Taxes), now in its fourth edition. The following has been transcribed from a talk that Julio Francisco gave at envío on the characteristics of the country’s tax policy
Julio Francisco Baéz Cortés
By looking at fiscal policy, one can understand, analyze and interpret a country's socioeconomic life. A brief look at the past 30 years of Nicaraguan history shows us significant differences in fiscal policy. In the 1970s, the Somoza government's tax policy fit within the government's set of economic policies; it had no defining characteristics of its own. There was more “stability,” in the sense that there were no significant fluctuations in fiscal policy. The administrative rules of the game were clear, and everyone knew they had to be followed. In the 1980s, tax policy was at the service of revolutionary policy, which had a different economic rationale. Fiscal policy in those years was characterized by the fact that taxes were not seen as a source of funds for government administration. A transition to another economic policy, one tied to the structural adjustment plans designed by international financial institutions, began in 1990. That first year, until 1991, was a trial run for the transition, and for tax policy. Since 1991, tax policies have been reorganized, and fiscal issues have taken on an importance they never before had in Nicaragua. Since then, the tax component has had more weight throughout the economy.
In the 1990s, the tax model was simplified from a technical standpoint by streamlining and simplifying a series of measures that had excessively complicated fiscal policy. This was a step forward, but nothing else was done to make the structural adjustment plan's new tax structure more rational. For example, tax policy in the 1990s has been unfair to salaried workers, who are the most punctual, reliable taxpayers in Nicaragua, since their employers withhold their income tax from their wages.
Nicaraguan salaried workers are abused. It is unfair that they are taxed on a salary base that is constantly being eroded by the devaluation of the national currency. In the 1980s, the state paid for the erosion in the value of the currency. In the 1990s, taxpayers absorb it. This is a substantial change in fiscal policy.
Salaried workers who earn less than 50,000 córdobas a year do not have to pay income tax. This ceiling was established in June 1997, and has not moved in two years. But 50,000 córdobas in 1997 [around US$5,000] are not the same as 50,000 in 1999 [now about $4,000]. An equitable tax policy would periodically readjust the ceiling under which one is exempted from paying income tax. To be just, this ceiling should now be around 62,000 córdobas a year.
The Nicaraguan tax structure, however, is not just. The simplest classification of taxes groups them into two categories, direct and indirect taxes. Direct taxes are those paid directly by the owner of capital or income. Indirect taxes are those paid on intermediated transactions, which do not tax people's earnings but rather their activities, and which affect everyone. In Nicaragua, the General Tax on Value (IGV)—known as Value Added Tax (VAT) in most other parts of the world—is 15% on all goods or services purchased.
Since indirect taxes affect all citizens equally, they can be very inequitable. A Miskito Indian who buys rubber boots on the Río Coco in the Atlantic Coast pays the same 15% as a professional who buys stylish shoes in a fashionable Managua store. The amount each pays is different in absolute terms, but the same in relative terms. More important, it affects them unequally: the burden is heavier on the one who has less. The blow dealt by this implacable tax is so “democratic” that it is unjust, so “equal” that it is inequitable.
Consumers must pay the IGV on half of the 52 products that make up the basket of basic goods, and some of these products are very basic. Exempting all the products in the basket of basic goods from the IGV would mean putting a redistribution policy into effect. The professional with money doesn't buy underwear made in Nicaragua by Tricotextil; she buys imported brands. Her purchase is fairly subjected to the IGV. But the unemployed single mother, who takes in other people's washing and ironing, buys nationally made underwear. It is unfair that her purchase is subject to the IGV. Exempting the 20 or so nationally produced products subject to the IGV that are in the basket of basic goods would boost national industry and benefit the poor, but the government has shown no interest in such a policy.
The structure of direct and indirect taxes in Nicaragua is extremely unbalanced, and has been kept that way, virtually unaltered, since 1990. Consequently, the inequitable relation between direct and indirect taxes has been aggravated even further. Less than a year ago, the UN's Economic Commission on Latin America and the Caribbean (ECLAC) published a very rigorous and extremely interesting study titled, “The fiscal pact.” It found that Nicaragua has the most unbalanced relationship between direct and indirect taxes of any country in Latin America. This fiscal inequality is known as a regressive tax system. In Nicaragua, the structure is so regressive that it proportionally taxes the little undergarments a poor mother buys for her baby more than it taxes capital or income.
Nicaraguan fiscal policy is very regressive indeed. The relation between indirect and direct taxes is 85:15; that is, 85% of taxes collected are indirect and 15% are direct. It must also be remembered that a multitude of wage workers who earn very little but still have to pay income tax are responsible for a share of this 15% of direct taxes.
This disparity in taxation in Nicaragua has not changed over the 1990s. In the 1980s, the relationship was 70:30, 75:25, although those figures are not comparable to the current ones since the general economic framework of that time was very different from today. In the 1990s, changes in the imbalance have been minimal: 85:15, 86:14, 87:13. The unequal relationship hasn't changed, and not one single economic policy measure is aimed at establishing greater equilibrium, at favoring certain sectors to begin to close this gap somewhat.
This inequitable structure produces winners and losers. While the exemption ceiling for those who earn less has remained the same, a law was passed recently to reduce income tax for those who earn the most. Thanks to the reduction, companies and associations are the winners, as are salaried workers who earn more than $200,000 a year. Thus, top executives who previously paid 30% in income tax now pay 25%. But salaried workers who earn $4,500 a year pay more taxes now, since the exemption ceiling was never moved.
Why isn't anything being done to rectify such a clear inequity? Is it because the government is asleep, or irresponsible or just nasty? No; it is because its economic rationale is to strike “democratically,” except in the case of income tax, where it is generous with one sector but does nothing for another.
Not only is the tax system inequitable, there is also a suffocating tax burden. The tax burden is the sum of taxes paid by the whole society as a portion of the sum of goods and services that society generates—its Gross Domestic Product, or GDP. In other words, the tax burden is the percentage of the GDP taxes represent. According to the ECLAC report, Nicaragua has the highest tax burden of any country in Latin America: over 20% of the GDP. Furthermore, as the report itself explains, its calculations do not include contributions to social security or municipal taxes on property or sales. According to our calculations, which do include those, the burden is even higher, around 25% to 30%.
According to the Inter-American Development Bank, the average tax burden in Latin America should be around 14%. The fact that the percentage is so high in Nicaragua means that fiscal revenues are the state's financial lifeblood, as well as a form of economic torture that oppresses the population.
In not one single month of its administration—except in April 1999, during the transport strike—has the Liberal government failed to boast of surpassing its tax collection goals. This demonstrates that there are no collection problems in the country. The numbers show that in Nicaragua, the burden is heavy, and the contributors faithfully pay their taxes.
Although the Liberal government collects well, it spends too much, more than it brings in. This is the first year in Nicaragua's fiscal history in which the fiscal deficit has amounted to a third of the budget: the budget is 9 billion córdobas [about $750 million], the revenue only 6 billion córdobas [about $500 million]. Given such a stunning deficit, what does it mean to surpass collection goals? It means having to collect new and higher taxes to close the gap.
Another characteristic of Nicaraguan fiscal policy is that it is highly centralized. The word “municipality” does not even appear in the letter of intent the government sent to the International Monetary Fund in 1997, or in the balance statement sent in 1998, or in the letter of intent published in August 1999. Nor is there any proposal or even a note about local democracy, local power, local projects. Centralized tax collection is the heart and soul of government fiscal policy.
With such a policy, municipalities are merely decorative. The government has not signed a single law or agreement in which it has pledged to strengthen local democracy or decentralize in favor of the municipalities. In contrast, the process of privatizing property still in state hands is explained in minute detail in the Enhanced Structural Adjustment Facility (ESAF) agreement with the IMF. And that is because the privatization process will put more resources into state coffers while decentralization implies transferring resources to the municipalities.
Nicaraguan municipalities are like Cinderella. In all legal aspects, they're at the back of the line. They're also the big losers in the tax reforms of the 1990s. The central government has granted tax exemptions to big businesses at the cost of the municipalities' economic health, since the overwhelming majority of exemptions affect municipal rather than central government revenues. This began to happen under the Chamorro government and the Liberal government has accentuated the trend. We could say that the municipal governments are paying the price of the exemptions granted at the central level, and this weakens the municipalities. They are also weakened by the fact that although the Constitution states that a percentage of the budget is to be assigned to the municipalities, the exact amount was never defined and disbursements are made in a discretional way. Yet another weakness stems from the chaotic state of the legislation. For example, Managua's tax plan, which establishes taxes charged in the capital, imposes a circulation tax on vehicles that travel within city limits. But in the country's other municipalities, this tax no longer exists. It was included in a different law, and that law was repealed under the Chamorro government. No one realized that by repealing this law, they were repealing the vehicle tax. So the municipalities lost this source of funds.
Citizens have no defense against this fiscal logic. The document listing the government's commitments in the IMF structural adjustment program includes the approval of several laws related to the economic adjustment. But it makes no mention of the law that would permit citizens to bring a court case against the state, which is essential for protecting citizens against governmental abuse. The Supreme Court drafted such a bill two years ago, which is not perfect but is technically solid. It would provide citizens with at least one tool to resist power. Right now, we have virtually none. The only procedures available to us are ambiguous, obsolete and full of loopholes, or are very slow, complicated and cumbersome, only for dire cases. The Supreme Court's bill would provide an intermediary step between these two extremes.
In the ESAF agreement, which guides the country's economic policy, the losers are clearly defined: the citizens, defenseless against abuses of power; and the municipalities, without resources or any real power. All structural adjustment programs aim to close the fiscal gap; this is the IMF's golden rule. To close that gap, the government is taking the easiest route: raising taxes. It has said as much to the IMF: if the tax collection plan falls apart because of a disaster or any other reason, we'll increase the IGV. Raising it by one percentage point would allow the government to collect millions of córdobas more a day. Balancing deficits by increasing tax collection is the easiest route in any economic policy.
Fiscal policy should not be limited to tax collection; it has to be more creative. Fiscal policy can resolve many social problems, and can even be used as an effective tool to reactivate the whole economy. As one piece within a complete strategy, it can become a lever of economic reactivation. In Nicaragua, the only place where this perspective has been applied so far is in the recently approved Tourism Law, a very good law, the best in Central America, revolutionary in many ways.
The emergency caused by Hurricane Mitch could have been a great opportunity to make a creative shift in fiscal policy. The government could have opened a special office to expedite the distribution of all aid directly to the victims, ensuring that the aid was legally supervised but exempting it from taxation. It also could have established a policy of fiscal rewards or incentives, but the government saw such initiatives as populist and was unwilling to loosen up on fiscal discipline.
In Colombia, after the most recent earthquake in the coffee-growing region, the government put a very creative fiscal policy into effect to encourage landowners to provide some of their land to resettle the victims. The state bought the land directly at a reasonable price, the market price, and gave a tax break to those who sold it, a reward for helping to resolve a serious social problem. The government also established tax incentives to encourage businesses to work in the disaster zone and neighboring regions. In Nicaragua, there hasn't been even a hint of this kind of policy, despite a disaster the scale of Mitch. It is no wonder that landowners have opted to offer their land at speculative prices in a devil take the hindmost attitude. And the government still has been unable to find 900 hectares of land for the victims in Posoltega, those most affected by the hurricane. This is a sin, as well as a demonstration of the government's incapacity.
A typical case that shows the current government's fiscal style and the level of impunity that reigns in fiscal policy is Managua's vehicle tax. The tax is cheap—the cheapest in Central America—and, unlike most other taxes, has not been raised in five years. But since the Managua municipal government lacks the capacity to collect it, it has taken the easy route: repression. The municipal government signed an agreement with the police to collect the tax. The tax collector visits taxpayers accompanied by the police. Seeing the municipal tax collector arrive along with a police officer is an insult, to say nothing of unconstitutional, since it means putting the public force at the service of fiscal repression. But it is done with impunity.
The fuel tax is another typical case, which requires a bit of history. The IMF and the World Bank noted three years ago already that the Nicaraguan government was using a discretional policy to set fuel prices and taxes in order to increase tax revenues. The regulation in effect at the time was a decree that gave the government a great deal of legal maneuvering room to set any price and any tax. Although it is true that Nicaragua does not produce oil and thus depends on the international price of crude oil, it is also true that the economy requires a relatively stable policy for such a leader price. Seeing what was going on, the IMF obliged the government to include in the ESAF agreement a commitment to approve a Law for the Sale of Hydrocarbons, which would clearly establish the fuel taxes that would be levied. Despite this requirement from the multilateral lending agencies, the government has only passed a law regarding oil exploration, not its sale. This task remains pending.
There is yet another characteristic to add to this troubling panorama: fiscal terrorism. What is fiscal terrorism? It is using taxes as a mechanism of political pressure, in a discretional manner. This is a new element in Nicaraguan political history. Somoza didn't engage in it, since he could use military repression instead. The Sandinistas didn't because they could use confiscation and expropriation. And the Chamorro government didn't because it was trying to reactivate the economy.
Within 48 hours after a businessperson or institution or organization makes a public declaration that annoys the government, or is found to be involved in an activity the government doesn't like, after any kind of expression of resistance to the government, the tax inspector shows up to review, demand, harass. The inspectors use any pretext to investigate the company, to search out its original, venal and mortal sins.
Fiscal terrorism has become a cancer within fiscal policy, which is eating away at the will to make institutionality and the rule of law prevail. The government has invested time and energy—with fiscal terrorism, among other weapons—to show that it will roll right over anyone who gets in its way. This has created a general fear in society of speaking up against the illegal actions of its officials and the inequities in its policies. Those on whom the tax inspector imposes any kind of fine—whether reasonable or arbitrary—look for a way to settle things under the table.
Most cases are now resolved under the table. This institutionalization of extra-legal kickbacks, encouraged by fiscal terrorism itself, is very serious; it has become the defining characteristic of fiscal policy in Nicaragua today. If resistance doesn't rise up against this, if businesspeople remain quiet and don't act, if the private sector doesn't challenge the government and propose alternative measures to its voracious fiscal policy, the situation will worsen. And if other sectors—the universities and NGOs, for example, which also pay unconstitutional taxes—also fail to act, the situation will deteriorate even more. In the end, we will all be accomplices. Joint acts of resistance as well as alternative proposals are urgently needed from all sectors affected by the fiscal policy. And that takes in virtually all sectors in the country.
There has been no change in the economic program throughout the 1990s or even any sign to indicate that the country is moving towards equitable taxation and a progressive fiscal policy. Nor has there been any energetic, effective effort to bring together civil society—businesspeople, academics, scientists, the university community, the municipal governments—in order to sit down with the IMF, which decides so many things in Nicaragua, and make it understand that we are the owners of Nicaragua, and the government is only an administrator.