DOMINICAN STANDOFF ON REPEAL OF PROTECTIONIST TAX

UNCLAS SECTION 01 OF 04 SANTO DOMINGO 006699 SIPDIS SENSITIVE STATE FOR WHA/CAR, WHA/EPSC, WHA/USOAS, EB/TPP/BTA, EB/IFD/OMA;NSC FOR SHANNON AND MADISON;LABOR FOR ILAB; USCINCSO ALSO FOR POLAD; TREASURY FOR OASIA; USDA FOR FAS (SHEIKH, GRUNENBAUM);STATE PASS USTR FOR VARGO, RYCKMAN, MALITO, CRONIN USDOC FOR 4322/ITA/MAC/WH/CARIBBEAN BASIN DIVISION USDOC FOR 3134/ITA/USFCS/RD/WH; DHS FOR CIS-CARLOS ITURREGUI E.O. 12958: N/A TAGS: PGOV PREL ETRD EFIN DR SUBJECT: DOMINICAN STANDOFF ON REPEAL OF PROTECTIONIST TAX REF: SANTO DOMINGO 6609 ¶1. (SBU) Summary: President Fernandez on December 14 implied he would veto a bill to repeal a the protectionist 25% tax on fructose-sweetened beverages if the Dominican Senate does not remove all of the "compensatory" tax breaks for agribusiness and industry that have been added to the original draft submitted by the executive. Fernandez warned that the country cannot not afford to lose either the free trade agreement with the United States and Central America (CAFTA) or to disrupt the agreed terms for a new IMF standby. The senators preparing the legislation have asserted to the Embassy that the bill with slightly modified tax breaks represents the "last chance" to repeal the 25% tax and keep the Dominican Republic in CAFTA. The senate special commission conducted lengthy meetings today with administration fiscal officials and business interests; they have adjourned after deciding to appoint a subcommittee to negotiate with the administration and other interests. There will be no vote today, December 15, and it is not clear when a text will be ready for consideration by the general Senate. End summary. Against Tax Breaks: President Fernandez and the IMF -------------- -------------- ¶2. (SBU) President Fernandez in public remarks December 14 strongly reiterated his support for CAFTA and warned that "compensatory" tax breaks that have been added to a bill to repeal a protectionist 25% tax on fructose-sweetened beverages must be removed to gain his approval of the final legislation. He said that the tax breaks place special interests above the national interest, which, he asserted, "I will not permit." As an example, he cited a proposed exemption from a 10% foreign exchange surcharge of capital goods for all domestic industries. Fernandez emphasized that the 25% tax must be removed to clear the way for ratification of the Dominican Republic's free trade agreement with the United States and Central American countries(CAFTA). He reminded the press that the country sends 80% of its exports to the United States and cannot afford to stay out of CAFTA. Congress must repeal the 25% tax to ensure Dominican participation in CAFTA, he said. ¶3. (SBU) Internal Revenue Director General Juan Hernandez and Customs Director General Miguel Cocco met with key senators, including Senate President Andres Bautista (PRD),on December 15 for three hours, seeking to iron out the differences. A close advisor to Hernandez said the government was sticking to its guns: tax repeal yes, tax breaks no. Cocco is advocating that compensation for industry should be dealt with separately, and perhaps later. Senate president Bautista told Charge Kubiske late on December 14 that he needed to work with the government to find out the limits of how much the bill could offer in tax breaks without compromising IMF targets. ¶4. (SBU) On December 13-14 IMF representative Ousmene Mandieng publicly opposed the "compensatory" tax breaks, which, he said, would result in an unacceptable loss of revenue to the government. Mandieng told us on December 15 that anything causing deviation from agreed fiscal targets means trouble for the tentatively agreed IMF standby agreement. He said the bill submitted last week (reftel) included such wide-open tax exemptions that it it was impossible to quantify the fiscal impact. If revisions to the bill result in measures with calculable fiscal costs, the Dominicans will have to identify other measures to offset the fiscal impact. He said that the financing gap projected for 2005 for the non-financial public sector of 0.7 percent of GDP is already a problem and expressed skepticism that funding offsets could be found. Mandieng commented that the IMF does not renegotiate its technical agreements or micromanage governments. For Tax Breaks: Senate and Business -------------- ¶5. (SBU) Embassy officers met December 14 with Senator Juan Morales (PRD),chairman of the special committee considering the tax repeal bill, and committee members Senator Alejandro Santos (PRD) and Angel Perez (PRD). The senators spoke with one voice: the Senate had failed four times to pass the government's original bill, because many senators have obligations or links to the traditionally powerful sugar industry. Only with "compensating" tax breaks would a majority of Senators vote to repeal the 25 percent tax enacted in September. The repeal bill including the tax breaks, which passed a first reading March 7, was designed to help the sugar sector and other industries prepare to compete effectively in a free trade environment. The senators shared a calculation of the fiscal impact of the tax exonerations on imports of capital equipment, prepared by former Technical Secretary of the Presidency Carlos Despradel, of RD $831.5 SIPDIS million (US $28 million) per year -- not a showstopper, in their view. Senator Santos, who also chairs the Senate's industry and trade committee, subsequently told the press that the IMF representative's criticism of the bill had been "disrespectful and precipitate." ¶6. (SBU) The senators December 14 outlined proposed revisions to the draft bill (previously faxed to State, Treasury, and USTR) to mitigate the fiscal impact while leveling the playing field for Dominican businesses: -- In Article 5, the exemption from the 10% foreign exchange surcharge on imports (set to rise to 13% in 2005) would be limited to machines, equipment, and replacement parts for industry; the application to "inputs for the sugar industry" would be deleted as open to abuse. This "inputs" provision had provoked revenue chief Hernandez's recent off-the-cuff estimate of annual revenue losses of RD $4.5 billion (US $158 million). The bill's author, Senator Ramon Alburquerque (PRD),has argued that Article 5 as a whole will maintain incentives for investors, in competition with alternative foreign destinations. The exchange surcharge mechanism, voted by the Monetary Board instead of approved by Congress, is being challenged in the courts as unconstitutional. -- In Article 4, Paragraph IV, the compensation for value-added (ITBIS) paid to suppliers would not be automatic (the government deems this to be unworkable),but the law would require the government to adjudicate it and deliver the accounting two monoths after the deposit of ITBIS (VAT). Business interests maintain that the government is in arrears on these reimbursements to the tune of RD $1.2 billion (US $42 million). Except for the reduction of a considerable "float" in retained payments, the proposed improvement in administration of existing tax law would be essentially revenue-neutral for the government, but would reduce costs to business. -- In Article 2, sub-para 2.1., the cap of 5 percent of assets on deductions for capital depreciation and improvements in agroindustry would be removed. This, they said, would move in the direction of establishing a level playing field in CAFTA for Dominican businesses, since Central American counterparts have no limits on such deductions. Senator Alburquerque has stated that this provision would benefit thousands of small and medium sugar growers ("colonos"),not just "three or four rich families." ¶7. (SBU) The senators emphasized their desire to level the playing field. They displayed a chart, reflecting business sentiment, comparing the tax levels businesses pay in the production process in the Dominican Republic and the five Central American nations. Total taxes on production (including VAT),import duties on machinery, and foreign exchange surcharges),according to this analysis: Dominican Republic 31 percent, Costa Rica 1 percent, Guatemala 12 percent, El Salvador 13 percent, Nicaragua 15 percent, and Honduras 2 percent. ¶8. (SBU) Business associations, previously divided on the repeal of the 25% tax (sugar sector against, free zone exporters in favor) have begun to converge behind the current package of repeal plus compensation. The prestigious National Associaion of Private Enterprise (CONEP) and Association of Industries of the Dominican Republic (AIRD) have both issued supportive statements in recent days, as has the country's largest sugar exporter, Central Romana. However, the Chamber of Commerce and Production of Santiago -- the nation's second largest city, which depends on free-zone manufacturing for export -- criticized the controversy over repeal of the 25% tax as "lamentable, inopportune, and counterproductive." Next Steps -------------- ¶9. (SBU) After a long day of meetings with fiscal authorities and businesses, the Senate commission appointed a subcommittee and adjourned. The private sector leaders intend to meet with President Fernandez. The outcome of these various engagements, brokered as possible by the subcommtiee will determine the timing of a Senate special committee meetings and the session of the full Senate to consider the bill, and subsequent consideration by the Chamber of Deputies (lower house of Congress). ¶10. (SBU) Chamber of Deputies president Alfredo Pacheco (PRD) told Charge Kubiske early on December 15 that he expected the obstacles to removal of the 25 percent tax to be resolved that day, even though the actual voting process in both houses would take longer. Chamber finance committee chairman Marino Collante (PRSC) said to us December 14 that once the Senate approves the repeal bill, he could move it though his committee to the Chamber floor in 2-3 days. He, Pacheco, and a solid majority of the deputies favor repeal. Collante said that they would have to consider the fiscal impact of the "compensation," and he would prefer to omit it from the bill. But if the impact is "mild," he believes the measure will be approved. Senate president Bautista commented that he hopes to achieve final legislative approval by December 24; Congress will adjourn January 12, but could be called back into special sesion by the President. ¶11. (SBU) In the event the Chamber of Deputies amends the bill as passed by the Senate, the modified bill would have to go back to the Senate for its approval of the changes, according to Article 40 of the Dominican Constitution. Then the approved bill would go to President Fernandez for approval. KUBISKE