Honduran Congress Adopts New Fiscal Package;

UNCLAS SECTION 01 OF 03 TEGUCIGALPA 000865 SIPDIS SENSITIVE STATE FOR WHA/CEN, WHA/ESPC, DRL/IL, AND EB/IFD/OMA STATE PASS AID FOR LAC/CEN STATE PASS USTR FOR ANDREA GASH DURKIN TREASURY FOR JOHN JENKINS DOL FOR ILAB E.O. 12958: N/A TAGS: EFIN ECON PGOV EAID ETRD ELAB HO SUBJECT: Honduran Congress Adopts New Fiscal Package; Emphasis on Eliminating Corporate Exemptions and Loopholes Ref: (A) Tegucigalpa 826 (B) Tegucigalpa 494 and previous ¶1. (SBU) Summary. On April 2, the Honduran Congress considered and adopted in one reading a second fiscal package (the first was adopted in May 2002) designed to broaden the tax base, help reduce chronic budget deficits and move the government on the road to an IMF agreement. Congress modified several of the government-proposed provisions in order to lessen the impact on low and medium income Hondurans (the majority) and to avoid political backfire from influential unionized public sector workers (particularly teachers). Increased taxes on tobacco and alcohol were added in order to compensate for lost revenues. The government and the IMF are working together to develop projections of the effect of the final tax proposals on the government's annual revenues. The target had been an annual increase of 3.5 billion lempiras, (USD 200 million) - of which about 2 billion lempiras (USD 118 million) would be collected in the remaining months of 2003 - but IMF sources are concerned that the final result will be lower. The GOH has continued with its planned austerity measures and work to strengthen the financial sector. The most problematic issue remains: getting the public sector wage bill under control for the medium and long term. The GOH is engaged in negotiations with striking doctors on a needed change to the law on mandated salaries for medical personnel (if successful, the "estatuto" for teachers will be tackled next). The GOH also continues to promise to introduce a new civil service framework law that provides the GOH with control over wage policy for the majority of public sector workers. End Summary. ¶2. (SBU) After two months of negotiation and fine-tuning, the Honduran government submitted to Congress a package of tax measures (called the Law of Tax Equity) designed to broaden the tax base and eliminate a number of special tax exemptions. To ease its quick passage, the bill had already been watered down from an initial proposal discussed with the IMF, but Congress modified it further during the marathon legislative session on April 2. The key measures include: -- Reduction of the income tax exemption for bonuses and representation expenses for individuals with income above 600,000 lempiras (USD 35,294) annually. Taxation of insurance premiums paid by companies and executives. Application of the income tax to capital gains from the sale of securities and property. Application of the income tax to rental income (for executives and professionals). The first 90,000 lempiras (USD 5,294) will be exempt from income tax. -- Application of the income tax to the "14th month" salary (a bonus paid to employees in June of each year) and other benefits such as vacation, for taxpayers with annual income greater than 225,000 lempiras (USD 13,235). The "13th month" Christmas bonus remains exempt from income tax. -- Corporate income tax was unified at a rate of 25 percent of net taxable income. -- A "temporary solidarity tax" of five percent was established for corporate taxpayers with taxable income greater than one million lempiras (USD 58,824). It will be applied to tax bills for the 2002, 2003 and 2004 tax years. Hotels and companies working under special export regimes are exempted from this measure. -- Tobacco products and alcoholic beverages will be subject to a 15 percent sales tax. An internal tax on cigarettes was increased from 32.25 percent to 45 percent, aligning it with practice in the rest of Central America. The calculation of sales tax on beer, soft drinks and alcoholic beverages was modified. -- Establishment of withholding taxes to ensure more corporate taxpayer compliance. The law requires a payment of 12.5 percent of wholesale transactions that will be applied against corporate income tax bills. Similarly, companies and self-employed individuals will pay withholding taxes of 2.5 percent of net taxable income. -- Elimination of tax exemptions for nongovernmental organizations, cooperatives, churches and nonprofit organizations. Exemptions remain for activities by NGOs related to health, education and charity. Rules on the exemptions from customs duties on automobiles imported by NGOs are also tightened up. These provisions are designed to stop tax avoidance by Honduran companies. USAID is in discussions with the GOH on the need to avoid taxing U.S. assistance provided through NGOs. -- The number of products exempt from sales tax was reduced from 800 to about 200 (mostly foodstuffs, pharmaceuticals, books and publications and school supplies). -- Creation of a one percent tax on the value of net assets for companies involved in wholesale or retail trade. -- Elimination of the tax exemption for fuels used in the generation of electricity. Power generation firms may present their invoices to the state-owned electricity company ENEE for reimbursement of these taxes and customs duties. (Note: this measure was taken to control widespread abuses of the tax exemption, in which bunker and diesel fuel were imported supposedly for power generation but in fact sold on the market. End Note.) -- Reinstatement of the ten percent consumption tax on cars including "luxury pickups". -- Tightening up of the rules on free trade zones and special warehouses. Only true export operations will be eligible for related tax breaks. -- Tightening up of methods to measure inventory and corporate expenses routinely deducted to calculate net taxable corporate income. -- Procedural changes to improve sales and income tax compliance, including the control of receipts, electronic filing and channeling payments through credit card companies. ¶3. (SBU) The fiscal package also contained the following expenditure measures: -- Cancellation of 60 percent of government positions that were vacant on December 31, except in education, health and security. Overtime pay is limited. -- Wage freeze for public employees not covered by collective bargaining agreements. -- Instruction to proceed with retirement for all employees not meeting legal requirements (generally age). -- Austerity measures such as limitation of monthly use of cellular phones by public officials and establishment of caps on overtime hours. ¶4. (SBU) The IMF is working with the GOH to develop projections of the effect of the final tax proposals on the government's annual revenues. The target had been an annual increase of 3.5 billion lempiras (USD 200 million) - of which about 2 billion lempiras (USD 118 million) would be collected in the remaining months of 2003 - but IMF sources are concerned that the final result could be significantly lower. The Congress rejected three important tax measures in the original government proposal: taxation of the Christmas and June bonuses for a much larger group of taxpayers; elimination of the exemption from income tax for secondary school teachers and university professors (primary teachers have a tax exemption written into the Constitution),and taxation of electricity for the largest residential users and for commercial users. The increase in the sales tax for tobacco and alcohol was added to compensate for these cutbacks. ¶5. (SBU) The GOH has continued with its planned austerity measures and work to strengthen the financial sector. The most problematic issue remains: getting the public sector wage bill under control. The GOH is currently in negotiations with the doctors over changes to the special law, or estatuto, which governs pay for medical personnel. GOH negotiators have distributed results of their analysis of the Honduran medical establishment's comparability with other countries in the region. By any measure, Honduran doctors are the highest paid in the region, while medical indicators for the country are some of the worst in Latin America. The result of the negotiation (which has the possibility of turning into a labor confrontation and a doctor's strike) will set the stage for attacking the bigger, although not quite as egregious, problem of the growth in the wage bill for teachers. (See ref A for more on the GOH's dispute with the doctors.) ¶6. (SBU) Comment: From the IMF's point of view, the fiscal package was watered down from the original proposal, bowing unduly to political pressure. The Fund is concerned that (1) teachers and other unionized public sector workers will continue as privileged groups, and (2) widespread tax exemptions distorting the economy and reducing potential tax income will continue. To the GOH's credit, however, the fiscal measures do attack some notable tax loopholes that have allowed Honduran companies and wealthy individuals to pay very little in taxes over the years. The question remains to be answered if the measures will deliver the hoped-for tax revenues. President Maduro has requested a meeting with the Managing Director of the IMF during his April 9-11 visit to Washington to review the progress made to date. Embassy is tracking the progress of GOH-IMF negotiations closely. If no agreement is reached, Honduras will need to pay certain overdue payments on DOD loans by July and September of this year or risk triggering Brooke Amendment sanctions. End Comment. Palmer