C-AL3-00272: IMPORT DUTIES HAVE DECLINING

UNCLAS SECTION 01 OF 03 TEGUCIGALPA 000896

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: PINR EFIN ETRD ECON ELAB HO
SUBJECT: C-AL3-00272: IMPORT DUTIES HAVE DECLINING
IMPORTANCE IN HONDURAN CENTRAL GOVERNMENT BUDGET

REF: (a) STATE 76257

(b) TEGUCIGALPA 546 (c) TEGUCIGALPA 865
(d) TEGUCIGALPA 494
(e) TEGUCIGALPA 225
(f) TEGUCIGALPA 010


1. (SBU) Summary. Honduran trade liberalization over the
past 13 years has resulted in a declining dependence on
import duties and other taxes on international trade. In
2002, revenue from import duties had dropped to only 2.2
percent of GDP and an estimated 12.2 percent of total tax
revenue (excluding taxes on oil products). The gap has been
made up, primarily, by an increase in the sales tax rate.
Given that about 55 percent of Honduran imports come from
the United States, a CAFTA-related reduction in import
duties would be significant but manageable for the
government. There has been no discussion to date on the
likely way of compensating for the revenue from CAFTA (or
eventual FTAA) tariff reductions; measures are likely to
involve elimination of remaining tax exemptions or a small
increase in the sales tax rate. End Summary.

2.(SBU) Ref a requested reporting on the effect that a loss
of tariff revenue would have on government budgets following
the implementation of the U.S.-Central American free trade
agreement (CAFTA). Reftels b through f provide extensive
reporting on the 2003 budget (currently under substantial
revision),the government's fiscal difficulties and efforts
to confront them. In addition, a recent report by an IDB-
funded team on Honduran tax policy provides useful
historical data on the trends in customs duties receipts
over the past 13 years that can be used to project the
direct impact of tariff revenue losses, once the basic
parameters of the CAFTA agreement are agreed. These data
are provided below.


3. (SBU) Since the early 1990s, Honduras has transformed the
structure of its taxation of trade. Export taxes have been
eliminated, and substituted with export promotion policies
(including the granting of extensive investment incentives
such as tax exemptions). High tariff barriers to imports
have been progressively dismantled in conjunction with other
countries in the region and the Central American Common
Market. As of 2002, Honduras had 5,982 eight-digit tariff
schedule line items, of which 5,169 registered some imports.
There were 13 tariff levels in the tariff schedule, with an
average nominal rate of 6.5 percent (and a trade weighted
average of 8.4 percent in 2000). Most tariffs are now
between 0 and 15 percent. As of 2001, 73 percent of
Honduras's tariff schedule was harmonized with the rest of
Central America (and further harmonization was achieved in
2002). Tariff dispersion in 2002 was a relatively healthy
7.4 percent.


4. (SBU) Accordingly, customs duties in Honduras have
dropped progressively since 1990 as a percentage of both GDP
and total tax revenue. Import and export duties fell from
5.6 percent of GDP in 1990 to 2.5 percent of GDP in 2001 and
an estimated 2.2 percent of GDP in 2002. Similarly, import
and export taxes fell from 37.5 percent of total tax revenue
in 1990 to only 15.2 percent in 2001 (and 12.2 percent of
total tax revenue if oil import taxes are excluded). The
lowering of customs duties in Honduras in the 1990s was
accompanied by an increase in the sales tax rate to 12
percent for most products. As can be seen by the chart
below, by 2000, sales tax revenues had replaced import
duties as the most important source of government revenues.

Table 1
International Trade Tax Revenues

1990 1995 2000 2001 2002

(millions of nominal Lempira)
Total trade 707.2 1607.2 2088.2 2448.1 2437.7
Imports 493.2 1429.5 2082.8 2448.1 2437.7
Oil 58.4 323.5 297.0 598.4 708.0
Other 434.8 1106.0 1785.8 1849.7 1729.7
Exports 214.0 177.7 5.4 0.0 0.0

(percent of GDP)
Total Trade 5.6 4.3 2.4 2.5 2.2
Imports 3.9 2.8 2.4 2.5 2.2
Oil 0.5 0.9 0.3 0.6 0.6
Other 3.5 2.9 2.0 1.9 1.6
Exports 1.7 0.5 0.0 0.0 0.0

(percent of tax revenue)
Total Taxes 100.0 100.0 100.0 100.0 100.0
Income 22.8 28.5 19.9 22.0 22.7
Property 0.8 0.8 1.3 1.1 1.0
Cap.Gains 0.0 0.6 0.5 0.3 0.0
Sales 18.2 20.6 35.2 33.2 35.2
Selective 13.4 15.1 11.2 12.0 10.9
Services 4.8 3.8 17.6 16.2 17.6
Trade 37.5 24.8 14.3 15.2 12.5
Other 2.4 5.8 0.0 0.0 0.0


5. (SBU) Revenue projections from the GOH's 2003 Central
Government budget are shown below. These numbers are
expected to change significantly as a result of the adoption
of new tax measures on April 2 (see ref b). The GOH hopes
that these measures will add as much as 2 billion lempiras
(usd 118 million) to the budget in 2003 and 3.5 billion
lempiras (usd 206 million) in 2004 and thereafter.

Table 2
Central Government Revenue Projections
2003 Budget

Millions Pct of
lempira Total
Total Revenue 32944.0 100.0
Tax Revenue 19803.0 60.0
Income Tax 4315.0 13.0
Property Tax 212.0 .6
Sales and Consumption 9267.0 28.0
Services 3357.7 10.0
Import Duties 2608.0 8.0
Other 44.0 0.0
Non-Tax Revenue 1163.0 3.5
Goods and Services 16.0 0.0
Property Income 79.0 0.2
Aid and Donations 1447.0 4.5
Capital Revenues 3445.0 10.5
Financing 6988.0 21.0


6. (SBU) Approximately 55 percent of Honduran imports come
from the United States. Thus, the reduction in import
duties on imports from the United States expected after
CAFTA would be a significant revenue reduction during this
period of high deficits; however, it would be manageable. A
very rough estimate would indicate a revenue loss of about
usd 80 million per year if all tariffs were eliminated
immediately. During 2002 and 2003, the government has
attempted to offset the continued reduction in customs
duties receipts with measures aimed at broadening the tax
base (reducing exemptions from income and sales tax). There
has been no discussion to date on the likely way of
compensating for CAFTA (or eventual FTAA) tariff reductions.
It is possible that the GOH would propose an increase in the
sales tax rate.


7. (SBU) Comment: The IDB consultants, in a February
briefing for Econcouns and USAID economist, also noted their
belief that in addition to the reduction in customs duty
revenue, the trade liberalization in the CAFTA agreement
will provoke additional GOH spending or tax breaks as
"compensation" to sectors negatively affected by increased
competition. This is a possibility, as the Honduran
Congress has consistently shown its willingness to enact
special legislation for individual sectors. However, the
current critical fiscal problems and the likelihood of
fairly strict fiscal targets in a future IMF agreement will
probably limit the GOH's ability to provide trade adjustment
assistance to companies or individuals. On the plus side,
the positive impacts from a free trade agreement --
increased investment, faster growth, and increased
efficiency -- are expected to result in increased (non-
tariff) government revenues as well. As noted above, the
GOH also traditionally has provided significant export
promotion incentives in the form of exemptions from a range
of taxes. To the extent that the GOH agrees in the course
of the CAFTA negotiations to reduce some of these investment
incentives, this would also have a positive effect on the
government's tax revenues. End Comment.
PALMER