Costa Rica – Narrowing Fiscal Options

When President Luis Guillermo Solís presented his government’s draft budget for 2016, he justified the very stingy spending increase of less than 1% as necessary to prevent the already large fiscal deficit from running out of control. Although the shortfall is on track to widen slightly, to 5.9% of GDP, this year, the draft budget for 2017 unveiled in September proposes a 12% increase in spending, which Finance Minister Helio Fallas explained is necessary to keep pace with the cost of debt payments, pension benefits, and other non-discretionary spending commitments.
Perhaps the most troubling aspect of the budget plan is the fact that fully 46% of the total proposed spending of $15.9 billion is to be financed by taking on new debt. The total public-sector debt is already close to 50% of GDP, having nearly doubled since 2008, and it will continue to rise at a steep rate—with debt payments in turn consuming a progressively larger portion of budgets—unless steps are taken to increase state revenues. The IMF noted has warned that the public-debt-to-GDP ratio is on an unsustainable trajectory, and is approaching levels that historically have been associated with a high risk of a “disorderly adjustment.”
Solís has warned that a credit-rating downgrade will become unavoidable in the absence of substantive steps to create a foundation for long-term fiscal stability by early next year. Unfortunately, the president has been unable to break the legislative impasse that has stalled a tax-reform package that the government estimates would boost revenues by the equivalent of about 2% of GDP.
The so-called Panama Papers that were leaked in April lent credence to the Finance Ministry’s claim that annual losses from tax evasion amount to upwards of 8% of GDP, and lawmakers approved an anti-fraud bill in September. However, the legislative parties, including the governing PAC, have conditioned approval of any tax increases on commensurate cuts in spending. Solís has agreed to adjust the formula for implementing public-sector wage increases, but it is unclear whether lawmakers are prepared to approve the measure, which would provoke a fight with the unions, let alone assent to any tax hikes.
The budget must be approved, with or without spending cuts and tax increases, by November 29. It appears that the best that can be hoped for in the near term is a compromise that results in minor tweaks to both tax rates and spending levels. But the prospects for achieving a long-term solution to the country’s fiscal trap are as dim as ever, and the chances of success will decrease markedly after the middle of next year, as attention turns to the presidential and legislative elections scheduled for February 2018.
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