Central America pays the price for fiscal failure

Central Americans have good reason to flee to the US in ever greater numbers. Record-setting homicide rates and lack of economic opportunity plague much of the region. A main cause of these and other ills is the failure of governments to provide for the health, education and welfare of their citizens.

El Salvador, Guatemala and Honduras—the countries that accounted last year for most apprehensions at the US southern border—are poor. Even so, they could make far better use of the resources they do have. For this to happen, they need to reform their approach to taxes and public spending.

Saddled with some of the world’s highest rates of poverty and inequality, these countries gather relatively little in tax. In 2015 Guatemala’s revenues equaled about 12 percent of GDP well below the Latin American average of 23 percent (to say nothing of developed countries’ 34 percent). Guatemala’s spending on health, education and social security was, therefore, also among the world’s lowest, at about 8 percent of GDP.

Even poor countries can be doing much better than this. A smarter approach to collecting revenue could raise more money for essential public services without unduly burdening workers or producers. A recent United Nations report highlights the opportunities.

Central America relies on personal income taxes for a tiny proportion of revenues. Top marginal rates are low (7 percent in Guatemala), and they kick in only at high levels of income. Exemptions, deductions and assorted loopholes narrow still further the base to which these meager rates apply. And what little is raised comes almost exclusively from the rich. The top decile of households accounts for nearly 100 percent of personal income tax in Guatemala and Honduras; the middle classes aren’t even in the picture. The sound fiscal principle that most people should make a contribution to the cost of good public services is absent.

Meanwhile, spending taxes raise most of the revenue—but they’re plagued by evasion. In 2015 this cost El Salvador about a billion dollars of revenue, roughly 3 percent of GDP. Moreover, if consumption taxes aren’t well-targeted—and they usually aren’t—they can hit the poor hardest and negate the benefits of small but promising programs of cash transfers. A 2016 study estimated that seen as a whole, El Salvador’s system of taxes and public spending actually increased the number of people in poverty.

Broadening the income-tax base and cracking down on evasion could raise substantially more revenue for education and other vital public services. Greater transparency would boost taxpayers’ confidence and their willingness to pay into the system. Higher cash transfers, more precisely targeted at the poorest, would get more bang for the antipoverty buck.

Right now, El Salvador, Guatemala and Honduras are, in effect, outsourcing the uplift of their poorest by exporting undocumented immigrants. In 2015 each took in remittances equal to more than 10 percent of GDP—a strategy that may be crimped by the US immigration crackdown. The willingness of the US and other aid donors to continue helping countries that refuse to help themselves is not limitless. Central America’s governments need to get their fiscal houses in order.

Bloomberg Editorial



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