BUDGET/TAX REFORM VOTE VICTORY FOR COLOM

UNCLAS GUATEMALA 001506 SENSITIVE, SIPDIS E.O. 12958: N/A TAGS: ECON EFIN SOCI PGOV GT SUBJECT: BUDGET/TAX REFORM VOTE VICTORY FOR COLOM ¶1. (SBU) Summary: On November 21, Congress passed President Colom's "solidarity tax" (ISO) and 2009 budget of Quetzales 49.7 billion (approximately $6.5 billion). The successful passage of these measures is a significant victory for President Colom and demonstrates his ability, at least for now, to put together a coalition to pass controversial measures in Congress over the opposition of Guatemala's powerful private sector. The legislation capped a year-long effort to promote raising taxes and increasing overall spending by 17 percent -- focused mainly on security (25.5 percent increase),health (24.6 percent),and education (16.7 percent). In addition, Colom's controversial conditional cash transfer program "Mi Familia Progresa" was positioned to receive a six-fold increase in funding. The budget was funded by a modest increase in taxes and higher international borrowing (the 2009 deficit is projected to be 2.3 percent of GDP). The increased spending aligns with Colom's vision of providing more state assistance to alleviate Guatemala's chronic poverty and malnutrition and supports USG goals of increasing investment in health and education in Guatemala. The Ministry of the Interior and Ministry of Defense also received additional funds that will provide Guatemala with a stronger base to take advantage of Merida Initiative programs planned for 2009. End Summary. -------------- Fiscal Reform -------------- ¶2. (U) From the outset of his administration, President Colom has pursued comprehensive reform of the tax system to raise the revenues necessary to fund the security, social and rural development programs promised during his campaign. The basic outlines of the plan were drafted before he took office on January 14. After taking office, Colom's economic team, led by Finance Minister Juan Alberto Fuentes Knight, refined the plan within the administration, with select members of Congress, and with international financial institutions (particularly the IADB). ¶3. (SBU) In May, Colom unveiled a plan that would reform much of the tax system and increase tax revenues by 1.7 percent of GDP once fully phased in. Colom invited representatives from the public and private sectors, civil society, and the diplomatic community to attend the unveiling. The private sector, upset at having been excluded from the drafting phase, boycotted the ceremony (Note: Fuentes Knight told Econoff that the private sector was excluded to ensure that the Administration would be able to develop a technically sound plan that was not subject to private sector parochial interests. End note). ¶4. (SBU) The boycott reminded the administration that private sector concerns and possible opposition could imperil passage of the reform. The government responded by organizing a series of briefings for various private sector groups on the merits of the reform. The private sector groups, however, were not persuaded. In June, Fuentes Knight asked the Embassy to intervene with private sector leaders. During subsequent meetings with private sector leaders, Embassy officials raised the message that Guatemala's resource-starved state needed additional tax revenue for security and development programs and that the private sector should engage constructively to ensure the best possible tax reform plan. At the time, most private sector leaders agreed to negotiate with the government and no public denunciations of the plan were issued by private sector representatives. ¶5. (SBU) During the summer Congressional recess, oil and food prices spiked and the Guatemalan economy, especially the construction sector, showed signs of a sharp slowdown. As the economy slowed, business leaders became increasingly uneasy with the prospect of higher taxes and began to manifest their opposition privately with the Colom Administration. The Administration continued to negotiate with the private sector and also began to worry about the politics of passing controversial legislation in a fractious Congress. To gain successful passage of the reform, Colom needed 80 of the 158 votes in Congress. Colom was concerned about his ability to garner sufficient support in Congress given the difficulty the administration had in the Spring in winning approval for relatively non-controversial funding measures that were required to finance the previously approved 2008 budget. To begin building support within Congress, members of Colom's fiscal reform team fanned out to key municipalities controlled by the ruling UNE party (49 votes) as well as the smaller parties such as GANA (24 votes) and FRG (14 votes). Administration officials held public seminars on the merits of the tax plan and private meetings with mayors (which, according to several sources, were horse-trading sessions where local projects were discussed). Mayors were then asked to contact bench leaders in Congress to lobby for support for the tax plan. ¶6. (U) Meanwhile, private sector leaders and the Colom Administration reached a grand bargain on tax reform. Private sector leaders agreed to withhold opposition to the tax plan if the Colom administration removed the proposed income tax reform provisions of the tax plan. The Colom administration agreed with two conditions: the first that income tax reform would be revisited in early 2009 and the second that a one percent tax to replace the expiring IETTAP (equivalent to an Alternative Minimum Tax) be instituted on a permanent basis until the income tax issue was resolved. ¶7. (SBU) With the private sector compromise and the grass-roots efforts underway to build a coalition to support the tax reform in Congress, the pieces were in place by early September to pass the tax reform. Although the Administration submitted the tax reform plan to the Finance Committee concurrently with the budget in early September, subsequent tactical errors and aggressive budget goals nearly led the consensus on tax reform to unravel. -------------- 2009 Budget -------------- ¶8. (SBU) In early September, the Ministry of Finance submitted the budget proposal to Congress with a deadline of November 30, 2008. The Colom administration's proposed budget included an overall increase of 17 percent from Q42.5 billion in 2008 (approximately $5.6 billion) to Q49.7 billion for 2009 ($6.5 billion). Press, private sector leaders and opposition parties questioned the wisdom of large across-the-board increases given the economic slowdown and its subsequent impact on tax collection. In addition, the budget for executive secretariats and other executive expenditures is not subject to the same standard of transparency as cabinet ministries. The Social Cohesion Council and the "Mi Familia Progresa" program are administered by First Lady Sandra Torres de Colom (a controversial figure widely rumored to have presidential aspirations),and some observers feared the concentration of budget resources in the executive to be administered by a non-elected official with little Congressional oversight would lead to the diversion of funds for political purposes and possibly corruption. ¶9. (SBU) The large increases in spending were to be financed in part by additional borrowing and by the tax reform proposal. Central to the funding assumptions was substitution of the IETTAP with the new "solidarity tax" (ISO) as previously agreed to by the private sector. However, the administration decided to request a 1.25 percent tax in its submitted proposal rather than the 1 percent it had agreed to with the private sector. Although the administration wanted the extra revenue, the change in the previously agreed rate was a tactical ploy to ensure the tax burden due to the ISO exceeded what businesses would have paid under the originally proposed income tax regime. The administration hoped to position themselves favorably for subsequent negotiations in 2009 on reforming the income tax. The move backfired. The private sector, worried about increased taxes and spending during an economic downturn, concerned about transparency in an executive only moderately friendly to business interests, and incensed by the surprise change in the ISO, moved to oppose the budget and tax package. ¶10. (SBU) With the November 30 deadline looming, both sides took their arguments public -- the Colom Administration arguing the virtues of increased spending on the poor and the private sector arguing that increased spending was reckless and contained few transparency safeguards. Colom and his UNE party convinced most parties to support or remain silent in the budget debate but the opposition found an advocate in the 26-member Partido Patriota (PP) that used every parliamentary procedure possible in an unsuccessful attempt to delay the vote. The debate denigrated into mutual recriminations, with UNE bench leader Mario Taracena lashing out at the PP's Anabella de Leon calling her "fat and old" and the government organizing transportation and paying between Q50 to Q75 to thousands of protesters to march on Congress to support the tax measure (the Administration denied their involvement). Although the debate was delayed and the mobilization of the protesters highlighted the importance of the vote for President Colom, the final result was not close. All major parties with the exception of Partido Patriota supported both the ISO tax and budget measures, giving Colom a decisive victory. ¶11. (U) The approved 2009 budget increased spending on security 25.5 percent from Q2.6 billion to Q3.2 billion (approximately $340 million to $430 million),health 24.6 percent from Q3.0 billion to Q3.7 billion ($390 million to $491 million),education 16.7 percent from Q6.5 billion to Q7.5 billion ($846 million to $998 million),and infrastructure 53.1 percent from Q3.0 billion to Q4.5 billion ($390 million to $604 million) that included new spending and some construction debt inherited from the previous Administration. In addition, presidential secretariats and other executive agencies received a 35.7 percent increase to Q2.7 billion ($355 million) and the Ministry of Defense increased by 2.8 percent to Q1.3 billion ($171 million). Agriculture, Foreign Affairs, and Public Finance are the only ministries to receive reductions in their budgets. The budget also provided the Finance Ministry with wide latitude to make interagency transfers. Final numbers were not ublished for President Colom's signature conditiona cash transfer program -- "Mi Familia Progresa,"but the September request included a nearly six-fold increase from Q145 million in 2008 to Q1 billion in 2009 ($19 million to $132 million). ¶12. (U) A major portion of the revenues for 2009 were approved, including the new ISO tax at 1 percent and a few international loans. However, two parties that supported the budget (GANA and Bancada Guatemala) proposed lowering the new first-time car registration fee from 26 percent of the car's value to 22 percent and a number of international loans remained pending in Congress. The final tax and loan revenue measures were not passed by the November 30, 2008 end of the fiscal year deadline and remain pending in Congress. ¶13. (SBU) Comment: The long fight for increased spending and tax revenues reflects President Colom's ability, at least for now, to manage a fractious Congress and use his political muscle to push through controversial programs. The increased resources for Guatemala's chronically underfunded state will help President Colom implement his programs to invest more in the health and education of poor Guatemalans as well as strengthen security institutions. By increasing taxes and spending, Colom has deviated slightly from Guatemala's traditional approach of following sound macroeconomic policy, maintaining low taxes, and pursuing conservative fiscal management that kept the fiscal deficit at or below 2 percent of GDP. The traditional approach helped Guatemala avoid some of Latin America's worst hyper-inflation and debt crises of the past thirty years, however, it resulted in weak state institutions unable to provide basic security, education, healthcare and physical infrastructure to its citizens. The stage has been set for the debate to continue in 2009 with a major reform of the tax system the goal of the Administration. The alienation of the private sector during the late stages of the tax reform debate, however, will complicate Colom's relationship with this powerful constituency and may derail attempts to increase revenues and spending again next year. We hope that expanded resources in the 2009 approved budget will begin to address pressing social and security needs and compliment the investment the USG is making through its development programs and the Merida Initiative. Lindwall