While there is widespread consensus in Costa Rica that the fiscal situation is unsustainable and must be addressed urgently, reaching an agreement on the core elements of a comprehensive reform has been an elusive task. Multiple governments have failed to secure the necessary support to implement much-needed measures in order to contain the fiscal hemorrhage. Indeed, labor unions are currently striking against the fiscal reform and have pledged to keep protesting until the government withdraws the reform bill from congress. The latest official proposal, which has been put forth by the new Alvarado administration, seeks to eliminate loopholes, introduce a new tax on corporate profits, revise the capital gains tax, and more importantly, widen the tax base by replacing the current sales tax with a proper value-added tax. On the expenditure side, the plan aims to freeze new hirings and some wages, cap public sector bonuses, and introduce a fiscal rule that would restrict spending starting in 2019.
Even though ongoing efforts to raise revenues and contain expenditures could ease fiscal pressures going forward, the latest iteration of the government’s reform bill, which has been diluted from its original form by a congressional finance committee, is viewed by most pundits as insufficient to restore fiscal order, with its impact likely to be limited to only 1.5% of GDP or so. The trouble is that tax reform is also a pre-condition to securing legislative approval for external financing for as much as $4 billion in the near term. Without such financing, it is unclear whether the domestic market would be able (or willing) to keep funding the fiscal deficit indefinitely. Moreover, large fiscal shortfalls could result in lower economic growth and increased external vulnerabilities, which could in turn trigger rating downgrades, pushing the cost of servicing the public debt even higher.
The bottom line is that Costa Rica’s fiscal stance has deteriorated materially in recent years to become the country’s most pressing economic challenge. While the new Alvarado administration has made “fixing the fiscal” its top policy priority, it is uncertain whether it will be able to muster enough popular and political support to implement the necessary measures to restore fiscal sustainability. Failure to do so may prove quite costly not only for Costa Rica’s fiscal prospects, but also for the general economic wellbeing of its citizens.
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