Guest Blogger Dr. James E. Mahon Jr. is a Professor of Political Science at Williams College, GFDD Fellow, 2013-14 and author of GFDD/Funglode publication entitled The 2012 Dominican Tax Reform in Historical and Regional Context.
Significant tax reforms in any country are rare (and interesting) because they are politically difficult. In the United States, for example, the last important reform of taxation took place in 1986. The Dominican tax reform of November 2012 (Law 258-12) was a significant step in some ways, and the circumstances of its birth open a window onto contemporary politics in the country.
The reform was innovative in its design, but relatively timid in its revenue goals and disappointing in its results. Passed and implemented by a PLD-dominated Congress and a newly elected President, it set the national value-added tax (ITBIS) on course to unify rates and include items of popular consumption, initiated the source withholding of capital income, and revised the national real estate tax. Although neither Danilo Medina nor the PLD legislative candidates included tax reform in their campaign platforms, several political considerations drove the reform: the bad publicity surrounding public works and other spending during the election season, with a large estimated fiscal deficit; promises of additional spending by candidate Medina (e.g., meeting the 4 percent of GDP target for education funding laid out in the National Development Strategy, END); and the desire to get a good report card from the IMF in the annual Article IV consultations.
The politics of the reform reflected ruling-party dominance but a broader dissatisfaction with government spending and public administration. Passage of the reform in the Congress was always assured. However, in the other forum prescribed by the Constitution and the END for the shaping of fiscal policy—the Economic and Social Council (CES), made up of business, labor, and civil-society representatives—the government’s policy was less favorably received, as members asked for information about recent spending and sought transparency requirements in exchange for additional tax revenue. After laying out the framework of the reform, the government met with the IMF and various business leaders, but repeatedly postponed and then cut short its sessions with the CES, then delivering the project to swift passage in Congress in November.
The reform was relatively limited in its goals, especially in view of the lack of opposition to the PLD in government. Comparing it to other tax reforms in recent Dominican history, the main reason for this timidity appears to be the lack of a crisis that would disturb the equilibrium of PLD political support via public spending. A glance at the interest rate premium for Dominican government debt as of late 2012 supports this interpretation. Despite the much-discussed fiscal deficit, the market for new borrowing was calm. It was not signaling to the Medina administration that this was the moment when it would need to raise taxes significantly.
The performance of the Dominican tax system since the reform confirms this impression of relative weakness. Excluding extraordinary revenues from amnesties and Barrick Gold prepayments, tax revenue as a proportion of GDP did not budge, despite rapid real GDP growth in 2013 (4.6 percent) and 2014 (5.0 percent). The estimate for 2012 was 13.47 percent; for 2014, it was 13.5, even though the ITBIS was now bringing in a higher proportion of the total (4.7 percent of GDP instead of 3.9). Alongside an increase in the estimated revenue loss from tax exemptions and incentives—now about 6.7 percent of GDP—these figures suggest an unwelcome possibility. The “buoyancy” of the Dominican tax system might now be close to unity, largely because of these tax breaks, along with widespread evasion. That is, Dominican growth now does not increase Dominican national tax revenue more than proportionally, as it does in most countries. This might be happening because the economy is growing disproportionately in those sectors favored with tax breaks. This, of course, was one of the main purposes of those breaks when they were given. They have just become too numerous.
Happily, this problem was already recognized in the document where we can find most of the reform agenda for Dominican fiscal policy: the National Development Strategy (END) of January 2012. Its main points include the reduction and elimination of tax exemptions; a shift toward direct (income and property) taxation; and a sustained and substantial rise in the ratio of tax revenue to GDP. All of these would be balanced by increased transparency and accountability in spending and administration. The last major item follows the examples of other countries in the hemisphere that, like the DR, have liberalized trade in the last decades: the unification of the internal tax authority (DGII) and the customs (DGA). This move aims to cut evasion based on misinvoicing, as it recognizes that almost half of the income from the ITBIS is collected at customs.
However, we should not expect additional fiscal reforms soon. Although the fiscal deficit will probably grow in the election year of 2016 and the financial vulnerability of the government will grow accordingly, bond markets are currently fairly calm and no political opposition looks poised to challenge PLD continuity in the presidency or legislature. And the much-awaited fiscal pact in the CES will probably end up postponed until the next presidential term, as the electricity pact negotiations look to continue into late 2015 or early 2016.