Impunity, tax privileges, and weak institutions threaten fiscal policy in Central America’s Northern Triangle

Reunión de Trabajo de los Presidentes del Triangulo Norte de Ce
Commentary by Icefi – August, 2017
The Central American Institute of Fiscal Studies (Icefi) is concerned about recent actions taken by the governments and federal courts of Guatemala, El Salvador, and Honduras. Icefi finds that these actions undermine legitimate efforts to fight corruption, rehabilitate public finance, and create just, appropriate, and sustainable fiscal policy. Icefi reiterates the need to change course, so that fiscal policy in Central America can be an effective instrument for eradicating corruption, achieving justice, and generating democratic and inclusive development.

In Honduras, Icefi recommended in a July 24 press release that the National Congress reject the proposed “Law for the Promotion of Tourism” (Ley de Fomento al Turismo). Icefi warned that it would do harm and injustice by aggravating existing conflict and the country’s already precarious social situation. Honduran President Juan Orlando Hernández backed the legislation, however. It concerns Icefi that the Honduran executive favors policies that aim to attract investment and create jobs using tax privileges that have been criticized in various studies for their limited success (1).

…these privileges will cause a drop in tax revenue that will further limit the Honduran government’s opportunities to offer public goods and services that increase social well being and bolster both medium-term economic growth and democracy.

To Icefi, the proposed expansion and extension of tax privileges for the tourism sector contrasts dramatically with the current social situation. In 2014 nearly 1.1 million children and adolescents received food aid in school. This figure fell to just 638,000 in 2016. The deterioration of the education system is so acute that in the Gracias a Dios state of Honduras, only one in four classrooms has a chalkboard, and only one in three schools has bathrooms. Honduras has the second highest murder rate in Latin America (59 murders per 100,000 inhabitants), while several studies (2) show that public and private sector entities work in close connection with criminal networks in a system of institutionalized corruption.

Tax incentives cannot help investors avoid the factors that aggravate the social, political, and economic risk and uncertainty that Honduras faces. On the contrary, these privileges will cause a drop in tax revenue that will further limit the Honduran government’s opportunities to offer public goods and services that increase social well being and bolster both medium-term economic growth and democracy. Icefi believes that the Honduran government must renounce the unfounded and unjust defense of tax privileges, and prioritize the common good and an agenda of democratic and inclusive economic and social development. That is why Icefi continues to urge the Honduran legislature and executive to study and consider in their fiscal decisions the conclusions and recommendations made recently by the various organizations of the Alliance for a Fiscal Pact in Honduras (Alianza por un Pacto Fiscal en Honduras) about a potential fiscal pact.

In Guatemala, Icefi is concerned by the complaints of various officials, including President Jimmy Morales, who blame anticorruption controls – especially those implemented in the “State Contracts Law” (Ley de Contrataciones del Estado) – for complicating the implementation of the federal budget. When Icefi analyzed official data, it found in July that the areas that are not subject to the controls set out in the law have the lowest rates of implementation. This was the case in spending funded by foreign loans and donations, which had implementation rates of 8% and 9%, respectively. Icefi also identified some of the most acute cases of lack of implementation: the school scholarship program for students in elementary school under the Ministry of Education (2% implemented); the maintenance and repair of road infrastructure under the Ministry of Communication, Infrastructure and Housing (20% implemented); and social programs under the Ministry of Social Development (11% implemented). Budget implementation in these cases is significantly behind the Central Administration’s average (48%).

Icefi is concerned by the complaints of various officials, including President Jimmy Morales, who blame anticorruption controls – especially those implemented in the “State Contracts Law” (Ley de Contrataciones del Estado) – for complicating the implementation of the federal budget.

The data show that, until the 2015 reform of the “Contracts Law” (Ley de Contrataciones), most public acquisitions in Guatemala were done through direct purchases and irregular channels exempt from transparency and competency controls (3), methods that the officials responsible for acquisitions adopted as normal practice. The 2015 reform eliminated purchases through unjustified irregular channels and penalized the abuse of direct purchase, requiring officials to use open, transparent, and competitive bidding for purchases and contracting. During 2016 and through the first half of 2017, however, some acquisitions officials have had trouble adjusting to the new status quo. This informs Icefi’s conclusion that budget implementation problems can be attributed institutional weakness and a lack of training to help officials abide by new transparency norms and procedures.

The Public Ministry (MP) and the International Commission Against Impunity in Guatemala (Cicig – Comisión Internacional Contra la Impunidad en Guatemala) recently announced that their “Construction and Corruption” (Construcción y Corrupción) investigation found that a criminal network of government officials and contractors defrauded the Ministry of Communication, Infrastructure, and Housing through construction and road maintenance projects. This case and others, like the “State Capture” (Cooptación del Estado) and “Health Profiteers” (Negociantes de la Salud) cases, demonstrate that the public acquisitions system has been methodically captured by criminal structures and is an area of public spending that is especially vulnerable to corruption.

This political landscape supports the theory that fiscal policy in the Central American Northern Triangle is facing serious threats from measures that encourage impunity, from the expansion of unjustified tax privileges, and from actions that compromise democratic governance.

To Icefi, the intentions of the executive to weaken or even reverse controls included in the reforms, achieved as a result of the popular movements of 2015, are a very serious threat that could cause Guatemala to regress to systems that encourage corruption and impunity. Icefi therefore recommends that the executive and the legislature undertake efforts to improve the civil service. This means training officials in the use of transparency mechanisms for public acquisitions already stipulated in current law, and strengthening the process already underway to holistically reform the public acquisitions system.

In El Salvador, Icefi has similar concerns about support for proposals and measures that could lead to impunity and compromise anticorruption efforts. In June, Icefi announced its opposition to the passage by the Salvadoran legislature of the “Provisional Law to Regulate the Tax Situation of Taxpayers and Facilitate Payment of Tax Obligations to the State” (Ley transitoria para regularizar la situación tributaria de los contribuyentes y facilitar el pago de obligaciones tributaries a favor del Estado). Icefi denounced the law for being unjust and harmful to already vulnerable public finances because it contains tax privileges and measures that encourage tax impunity. Fortunately, this law was vetoed by President Salvador Sánchez Cerén. This was an appropriate decision that the president unfortunately did not repeat in the case of the Special Law of Asset Seizure and Administration of Goods of Illicit Origin or Destination (Ley especial de extinción de dominio y de la administración de los bienes de origen o destinación ilícita), passed on July 18th, which encourages corruption and limits the Salvadoran government’s actions against impunity.

Icefi is also concerned about parts of a recent decision by the Constitutional Chamber of El Salvador’s Supreme Court. The Chamber declared the totality of the General Budget Law (Ley de presupuesto general) for fiscal year 2017 unconstitutional, though it opted to defer the effects until October, 2017. Icefi does not question the legal grounds of the Constitutional Chamber ruling, and recognizes that the ruling should be obeyed. Icefi is concerned, however, because the decision included orders to cabinet agencies and other public institutions on issues related to public spending for the sake of ensuring a balanced budget. This institutionalizes a constitutional preference for austerity.

Independent of whether or not these orders are necessary, Icefi believes that the fact that they came from the Constitutional Chamber, far from favoring harmonious collaboration between the different branches of government, may generate conflict and weaken the democratic process, by dictating measures that belong in the arena of fiscal policy and not in the strictly legal arena.

To Icefi, this decision confirms a clear tendency also present in Guatemala, Honduras, and Costa Rica: Constitutional courts are accumulating greater and greater power and influence in fiscal policy, without sufficient understanding of the subject matter. This undermines fiscal policy authorities, which the countries’ Constitutions and ordinary legislation place in the ministries of finance or the interior.

The seriousness of El Salvador’s fiscal situation underscores the urgent need for a discussion between the government, opposition political parties, and the public about an agreement that would go beyond the Constitutional Chamber’s decision, and that would create sufficient, sustainable, and transparent fiscal policy so that fiscal policy can become an effective tool for guaranteeing the rights of all the people of El Salvador.

In sum, Icefi believes that this political landscape supports the theory that fiscal policy in the Central American Northern Triangle is facing serious threats from measures that encourage impunity, from the expansion of unjustified tax privileges, and from actions that compromise democratic governance. Icefi reiterates the need to change course to make fiscal policy in Central America an effective instrument for eradicating corruption, achieving justice, and generating democratic and inclusive development.

For more information, contact Juan Pablo Ozaeta at +502 2505 6363, +502 5901 5945 (cel.), or juanpablo.ozaeta@icefi.org.

References:

1 See, for example: Bernardi, L., Barreix, A., Marenzi, A., & Profeta, P. (2007). Tax Systems and Tax Reforms in Latin America. IDB

Klemm, A. (2009). International Monetary Fund. Retrieved 04 09, 2017, from Causes, Benefits, and Risks of Business Tax Incentives. Source: https://www.imf.org/en/Publications/WP/Issues/2016/12/31/Causes-Benefits…

http://www.imf.org/en/Publications/WP/Issues/2016/12/31/Empirical-Eviden…

Easson, A., & Zolt, E. (2002). Tax Incentives. Retrieved 04 10, 2017, from World Bank. Source: http://siteresources.worldbank.org/INTTPA/Resources/EassonZoltPaper.pdf

https://publications.iadb.org/bitstream/handle/11319/6902/FMM_DP_La_efic…

http://www.cepal.org/es/publicaciones/5361-politica-tributaria-mejorar-l…

On June 23, 2017, the UN Committee on Economic, Social and Cultural Rights, charged with overseeing the implementation of the International Covenant on Economic, Social and Cultural Rights (binding in over 160 countries), published General Comment 24. It is the most recent official statement on state obligations related to business activities under the Covenant, derived from the UN Guiding Principles on Business and Human Rights. In section 37, it states, “Lowering the rates of corporate tax solely with a view to attracting investors encourages a race to the bottom that ultimately undermines the ability of all States to mobilize resources domestically to realize Covenant rights. As such, this practice is inconsistent with the duties of the States parties to the Covenant.”

2 See, for example: InSight Crime (s.f.). Élites y crimen organizado en Honduras. En: http://es.insightcrime.org/images/PDFs/2016/Elites_Crimen_Organizado_Honduras; y Carnegie Endowment for International Peace (2017). When corruption is the operating system. The case of Honduras.

3 See http://icefi.org/publicaciones/diagnostico-breve-y-propuesta-metodologica-mesa-de-trabajo-de-reforma-sistema-de.

Jimmy Morales, Salvador Sánchez Cerén, and Juan Orlando Hernández, the presidents of Guatemala, El Salvador, and Honduras, the countries of the Northern Triangle. Photo courtesy of the Presidencia de El Salvador.