Panama: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.
Publication Date:
21 Apr 2020
eISBN:
9781513541679
Language:
English
Keywords:
ISCR; CR; Panama; bank; government; lending; regime; CFT regime; academia Panamá para el Futuro; property price; innovation Panama; labor productivity growth; bank resolution framework; CFT statistics; CFT cross-agency cooperation; Mortgages; Housing prices; Real estate prices; Global; Central America; Caribbean; Europe; expenditure growth; country tax administration; GDP ratio; compare mining taxes data tool; central government; Fiscal risks; Fiscal governance
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Selected Issues

Abstract

Selected Issues

Fiscal Policy in Panama: Background, Challenges and Policy Options1

A. Background

1. Fiscal policy remains the main instrument for economic management in Panama. As a fully dollarized economy with an open capital account, no central bank, no independent monetary policy and little use of macroprudential tools, fiscal policy is de facto the only macroeconomic stabilization tool available. At the same time, fiscal policy is restricted by a fiscal rule, the Social Fiscal Responsibility Law (SFRL), anchored at an indicative target of net debt to GDP ratio of 40 percent which is operationalized through a limit on the deficit of the non-financial public sector (NFPS). While the rule introduced in 2009 has supported fiscal discipline and reduced debt, it can be prone to unintended pro-cyclicality of fiscal policy.

2. The 2019 shortfall in fiscal revenue poses challenges to a government which collects already little revenue relative to other emerging economies. Tax revenue amounted to 9½ percent of GDP on average between 2014 and 2018, significantly lower than the average for Central America and Latin America peers, at 15 percent and 17½ percent, respectively. In 2019, tax revenue plummeted to 8.2 percent of GDP following the economic slowdown, but also for structural reasons as some of the most dynamic sectors face lower tax burdens. Although non-tax revenue makes up for some of the low tax efforts (Table 3), it also declined. Only the canal contributions (toll fees and dividends) continued to grow, reaching 2.6 percent of GDP, and this is due to the expansion of the Panama Canal in 2016.

Table 1.

Panama: Tax Expenditure

article image
Source: Country tax administrations and Ministries of Finance.
Table 2.

Panama: Central Government Fiscal Operations, 2015–19

(In percent of GDP)

article image
Sources: Comptroller General; Ministry of Economy and Finance; and IMF staff calculations.

Includes public service fees.

Staff adjustment to account for the accrual of previously unrecorded expenditure for 2015–18.

Current revenues and grants less current expenditure.

For 2015 – 2017, includes spending allowed under Article 34 of Law 38 of 2012.

Table 3.

Panama: Non-financial Public Sector Fiscal Operations, 2015–19

article image
Sources: Comptroller General; Ministry of Economy and Finance; and IMF staff calculations.

Official presentation excludes the operations of the ACP as it is not part of the NFPS.

Includes the balances of the nonconsolidated public sector and revenue of the decentralized agencies.

Different from Table 3 as it excludes the transfers to other agencies.

Staff adjustment to account for the accrual of previously unrecorded expenditure for 2015–18.

For 2015 – 2017, includes spending allowed under Article 34 of Law 38 of 2012.

Figure 1.
Figure 1.

Panama: Higher Deficit Increased Public Debt

Citation: IMF Staff Country Reports 2020, 125; 10.5089/9781513541679.002.A001

Source: National authorities, IMF staff calculations.1/ Fiscal impulse is calculated as the change in the cyclically-adjusted primary balance of the NFPS; positive means fiscal loosening.

3. Despite the unexpected deterioration of the fiscal position in 2019, the authorities stabilized the deficit at 3.1 percent of GDP in 2019. To avoid an abrupt tightening, the authorities amended the SFRL in October 2019 establishing new ceilings for the deficit of the NFPS.2 Although the revision would have permitted a deficit of up to 3.5 percent of GDP, the authorities managed to stay below the ceiling. The law foresees a gradual tightening starting from a deficit of 2.75 percent of GDP in 2020, 2.5 percent in 2021 and 2.0 percent from 2022 onwards.

Comparison of Tax Rates 1/

article image
Source: Global KPMG Tax Rates Database (GKTR)

Average for CA, LAC and OECD comparators; latest available (mostly 2015).

4. The fiscal framework has been key to entrenching fiscal discipline and maintaining debt sustainability. The overall deficit of the non-financial public sector (NPFS) averaged 2½ percent of GDP during the last 5 years. At times, the rule led the authorities to prioritize fiscal prudence over economic stabilization, leading to unintended pro–cyclicality of fiscal policy. For example, the fiscal stance in 2019 ended broadly neutral despite a significant negative output gap and the modification of the deficit ceiling. But fiscal prudence has also helped to keep debt levels at historical lows. Since the introduction of the rule in 2009 until 2018, gross debt of the NFPS remained well below 40 percent of GDP. To prevent losing the fiscal track record built over the last decade in light of the frequent revisions to the rule and the latest increase of gross debt to 40.8 percent of GDP in 2019, the fiscal framework needs to be strengthened further.

5. Despite recent fiscal deficits, Panama continues to enjoy access to international capitals markets at record-low spreads. Since attaining investment grade status in 2010, Panama has tapped international capital markets at relatively low costs. Sovereign spreads (EMBIG of 114 basis points in December 2019) are among the lowest in Latin America, supported by strong economic fundamentals and the solid fiscal framework. In April 2019, the authorities issued US$1.0 billion Treasury Notes under Panamanian law linked to Euroclear giving access to international buyers which achieved a spread of 140 basis points at a 7-year maturity. Most recently (end-November 2019), the authorities issued US$1.3 billion in Global Bonds at historically low rates, a 2030 bond and a 2053 bond at spreads of only 105 and 135 basis points relative to the respective U.S. instruments. However, a revision to negative outlook in February 2020 by Fitch Ratings citing downside risks amid rising public debt highlights the importance of fiscal prudence.

Figure 2.
Figure 2.

Panama: Composition of Tax Revenue and Expenditure

Citation: IMF Staff Country Reports 2020, 125; 10.5089/9781513541679.002.A001

Sources: National Authorities and IMF staff calculations.1/ Covers the Non-financial Public Sector following the national definition, accrued spending is staff’s adjustment to account for accrual of previously unrecorded expenditure.2/ Data refer to the Central Government.

B. Revenue Measures

6. Low tax revenue limits space for financing development. Panama reached high-income status in 2018 (according to the World Bank) but economic development also requires that other socio-economic indicators improve. Public finances play a central role in ensuring the availability of sufficient financial flows to invest in continued development – such as infrastructure, health and education – and to foster social inclusion. To permit the state to provide public services appropriate for Panama’s income level, revenue levels will have to increase. As levels of non-tax revenue, mainly from the canal, grow at a slower rate than national GDP, the bulk of the additional revenue will need to come from taxes.3

7. Low tax revenue reflects weaknesses in tax policy and administration. The tax system plays an important role in determining the relative attractiveness of Panama for investors. The authorities want to explore tax and customs administration as a first avenue to increase tax revenue due to serious structural weaknesses in this area. Main areas of concern include governance, internal controls (and vulnerabilities to corruption), IT infrastructure, information and risk management, auditing capacity, and the tax compliance program. Some measures, like the electronic invoicing, which is currently being tested in a pilot, are promising, but wider reforms will be needed. These could include a strengthening of the management of large taxpayers, improving customs controls and enforcing tax arrears collection instead of relying on frequent tax amnesties.

8. Tax policy reform should be considered at some point. If the cyclical recovery together with tax administration reform does not yield sufficient revenue, a comprehensive reform of the tax system should be an option. The last reform was done in 2009–14. A previous IMF study found that the efforts improved the progressivity of the tax system, but nonetheless fell short of their objectives.4 Future reforms should rely on a mix of curbed tax exemptions (especially VAT, CIT), increased compliance with tax obligations (especially for VAT, CIT, PIT) and possibly some increases in tax rates (including VAT and environmental taxes).

9. Tax expenditure is relatively high compared to the region. In 2016, tax expenditure accounted for around 3.6 percent of GDP or about ⅓ of total tax revenue collection. The share of revenue is above the regional average of ¼. VAT accounted for most of the tax expenditure. Reviewing and streamlining the system of tax exemptions will help tax administration by simplifying collection, curb tax expenditures that are inadequately targeted and help to reverse the downward trend in revenue even without raising tax rates.

10. Revenue from VAT is one of the lowest in Latin America and the Caribbean (LAC). Panama raised on average 2.5 percent of GDP through VAT receipts in the past five years while the averages for LAC and OECD economies are 6.3 and 6.7 percent of GDP respectively. The low revenue stems from a combination of low rates, many exemptions and evasion. The OECD estimates that Panama only collects 62 percent of the VAT’s potential revenue.5 Staff estimates that measures to limit VAT tax expenditure and the inclusion of services provided from abroad in the tax base could increase revenue by about ½ percent of GDP.

11. Corporate tax rates are on par with LAC and advanced economy counterparts but are among the lowest in Central America. The tax system is based on a territorial principle, rates are relatively low, and exemptions and incentives are widespread (granted under a variety of schemes). Compared to Singapore with a similar business model, however, CIT tax rates in Panama are higher. Nevertheless, Singapore reached tax revenues of 14.1 percent of GDP in 2017, well above Panama’s 9.4 percent of GDP. A cost-benefit analysis can reveal if tax incentives achieve the desired outcomes. Moreover, regular checks need to ensure that firms comply with the conditions of exemptions.

12. Reviewing environmental tax rates can yield additional revenue while helping Panama to reach its climate commitments. For example, the selling price of gasoline and diesel in Panama is lower than the region. A gradual increase in taxes on the consumption of petrol would give households and firms time to adapt and incentivize the investment in energy-efficient machinery and vehicles. Moreover, environmental taxes should be combined with social spending that limits the negative impact on the consumption of petrol for poorer households.

Policy Options

  • Upgrade governance, institutional capacity and human capital of the tax and customs administration to increase revenue collection

  • Strengthen compliance with tax obligations

  • Re-establish a Large Taxpayer Unit to better manage large taxpayers

  • Improve provision of public services, transparency and accountability to strengthen citizens’ willingness to pay taxes.

  • Undertake a cost-benefit analysis of tax exemptions and incentives.

  • Review tax rates, especially for VAT and environmental taxes.

13. The fiscal contribution of the new copper mine will be small. The government granted the concessions to Minera Panama through a special legislation, Law No. 9 of 1997, which was declared unconstitutional by the supreme court in late 2018. The uncertainty relating to the legality of the large copper mine’s contract is still unresolved, but production has started as planned in mid-2019. However, given that copper production will become a significant contributor to the economy, it will be important to eliminate the uncertainty by reaching an agreement on this issue.6 A survey documented in Mitchell (2009) suggests that tax considerations are key to attracting and retaining investors. At the same time, tax rates in Panama are low by international standards. An estimate based on the IMF’s framework for Fiscal Analysis of Resource Industries (FARI) suggests that the Average Effective Tax Rate (AETR) is 26 percent and falls to 2 percent once tax credits and tax holidays are considered.7 With this, Panama’s fiscal regime for copper mining is relatively generous among other copper-producing countries.

Selected Mineral Taxation Features of Leading Copper Producers

article image
Source: PWC “Compare mining taxes data tool”.

Policy Options

  • Take action to remove the uncertainty created by the nullified Law No. 9.

  • Develop technical and administrative capacity to understand the complexity of the mining sector and be able to supervise, monitor and tax the sector.

C. Expenditure Measures

14. Despite fiscal consolidation, the government needs to maintain resources for public investment and social spending. In 2018, current primary spending (driven by wages and transfers and subsidies), accounted for 66 percent of total expenditure of the central government, up 10 percentage points from 5 years ago, as the share of capital spending went down to 34 from 44 percent, due to the deceleration of public infrastructure projects.8 Roughly 2/3 of the higher wage bill is explained by higher public sector wages, including the increase in teacher salaries agreed in 2014.9 The share of interest expense has been roughly stable. As low levels of revenue combined with the deficit ceiling limit expenditure growth, expenditure should be rebalanced to give sufficient space in the budget for public investment and social spending.

15. Strengthening the public financial management system can help to reduce current expenditure. The uncovering of unrecorded arrears linked to unrecorded spending as well as delays in the payment of subsidies highlight the need to improve budget and expenditure controls. Moreover, timely payments to suppliers can reduce procurement costs.

Figure 3.
Figure 3.

Panama: Efficiency of Education Spending is Low Compared to the Region

Citation: IMF Staff Country Reports 2020, 125; 10.5089/9781513541679.002.A001

Sources: IMF Expenditure Assessment Tool (EAT)1/ Dash lines are the average of LAC. Latest available data for Panama corresponds to 2017

16. The effectiveness of social and investment spending needs to be improved. Even without significant increases in spending, greater effectiveness can improve outcomes. To achieve this, project selection for investment spending and effective execution need to be strengthened. Social spending is often not sufficiently targeted at the most vulnerable population. For example, in 2019 the government spent around US$218 million (0.3 percent of GDP) on the electricity subsidy introduced in 2009 to prevent price increases for 99 percent of consumers instead of targeting the measures to more vulnerable members of society.

Composition of Central Government Spending

Citation: IMF Staff Country Reports 2020, 125; 10.5089/9781513541679.002.A001

Sources: National Authorities and IMF staff calculations.

17. A new law for private-public partnerships (PPP) was introduced in 2019. The new administration hopes to leverage additional financing for public infrastructure projects from the private sector. While some ideas have been collected, no concrete projects have been discussed so far. PPPs can be useful to access private sector expertise and efficiency, but they also come with risks. The selection process needs to be transparent, with clear rules on the accounting for risks as well as the monitoring of the execution of the projects.

Energy Subsidies by Product1/

(In percent of GDP, latest value available)

Citation: IMF Staff Country Reports 2020, 125; 10.5089/9781513541679.002.A001

Sources: IMF FAD Expenditure Assessment Tool (EAT), IMF Energy Subsidy estimates.1/ Daslines are the median for countries in the region. Latest available for Panama corresponds to 2017.

Policy Options

  • Undertake an expenditure review (e.g. PIMA for infrastructure governance).

  • Strengthen budget and expenditure control.

  • Provide rationale for transfers and subsidies and ensure adequate targeting and effectiveness

  • Slow down wage growth to create room for social spending and strengthen link between pay and productivity.

D. Strengthening of the Fiscal Framework

18. The accumulation of fiscal buffers could help to reduce unintended pro-cyclicality of the fiscal policy under the SFRL Over the medium term, as the debt to GDP ratio falls and taking advantage of the expected sustained period of low global interest rates, this will gradually lower the average interest rate of the public debt portfolio, interest payments as a percent of GDP are expected to decrease. Instead of widening the primary balance, the government could save this additional space as fiscal buffers under a self-imposed “shadow fiscal rule”. This space could be used for fiscal stimulus in cyclical downturns while always keeping the deficit within the ceiling. In practice, this would mean a fiscal policy that maintains the primary balance of the NFPS at -0.15 percent of GDP after 2022. By 2025, under the baseline scenario the fiscal buffer could reach a ¼ percent of GDP and will continue to grow. However, since the shadow fiscal rule would not override the SFRL, its successful implementation requires political commitment and effective communication of the rule to the public.

Fiscal Buffers

(In percent of potential GDP)

Citation: IMF Staff Country Reports 2020, 125; 10.5089/9781513541679.002.A001

Sources: IMF staff calculations

19. Early appointment of the members of the fiscal council can enhance transparency and credibility of fiscal policy. The recent amendments to simplify the fiscal framework and make it more transparent and the approval of the law creating an independent Fiscal Council (FC) are encouraging. The FC will comprise three independent professionals, with experience in public finance, or macroeconomics. Members will be appointed by the government on a 7–year term. Supported by a technical secretariat in the Ministry of Economy and Finance, the FC will evaluate macro-fiscal policy, and issue a non-binding opinion, according to the areas of its mandate.10 Its assessment should include fiscal plans and performance, the evaluation of macroeconomic and budgetary forecasts and the FC should ensure that the medium-term fiscal framework facilitates compliance with the SFRL. The FC is expected to promote public awareness and stimulate debate on macro-fiscal issues. Moreover, as part of its assessment, the FC could estimate the cyclically adjusted deficit to facilitate decision-making on the accumulation or use of fiscal buffers.

Policy Options

  • Appoint the members of the Fiscal Council and provide adequate resources.

  • Avoid further changes to the SFRL to protect the credibility of the fiscal framework.

  • Fortify the accountability framework and enforcement mechanisms for the SFRL.

  • Reduce fiscal policy pro–cyclicality, for example by accumulating buffers under a shadow fiscal rule.

20. Fiscal reporting and transparency continue to be hampered by the use of turnkey projects and the limited coverage of the national NFPS definition. While there is room to improve the quality and timeliness of fiscal accounts, the use of turnkey contracts, which is unusual given Panama’s income and also in comparison with the rest of the region, complicates fiscal statistical reporting. Under this model, contractors are responsible for obtaining project financing and expenditures are recognized in the fiscal accounts only when payment is made upon completion of work. In effect, it permits the separation of the timing of construction, the recognition of the corresponding liability, and the recording of expenditure in the public accounts. The deferred recognition of capital expenditure undermines the transparency of fiscal commitments and accurate assessment of fiscal policy. Moreover, it is not clear why the model continues to be used given the government’s ample market access at favorable conditions. Another issue is the institutional coverage of the non–financial public sector, which is limited in scope11, and as such assessing the true fiscal position is a challenge12. While the public enterprises outside the definition of NFPS have strong fundamentals and strong credit ratings, the authorities could be assessing the fiscal risks. Efforts are ongoing by CAPTAC to assist with some of these issues.

Policy Options

  • Adopt best practices on accounting methods.

  • Review and phase out the use of turnkey contracts.

  • Prepare consolidated accounts of the NFPS according to international standards (GFSM 2014).

21. Analysis and management of fiscal risks. Better analysis of fiscal risks to which Panama is exposed can help ensure a solid fiscal position. Sources of fiscal risks in Panama include unfunded pension liabilities, turnkey projects, contingent liabilities of public companies, extreme weather events (El Nino) and the sizable financial sector. An actuarial assessment of the public pension system suggests that, without parametric reforms, the system is projected to deplete its reserves by 2035 (See IMF Country Report No. 16/337).13 A comprehensive assessment of all contingent liabilities of the consolidated public sector is therefore needed to ensure adequate support for fiscal policy’s exclusive stabilization role in the absence of monetary and macroprudential policies.

Policy Options

  • Enhance capacity to analyze and mitigate fiscal risks.

  • Prepare and regularly publish a fiscal risks report.

  • Reforms the public pension system.

E. Concluding Remarks

22. Panama stands at a crossroad between taking the leap to become an advanced economy or getting stuck in the middle-income trap. While Panama crossed the World Bank’s high-income threshold in terms of GDP in 2018 following its exceptional growth in the last decades, socio-economic indicators that set apart advanced economies have not kept up with the economic pace. Fiscal policy is at the heart of the needed improvement in the delivery of public services and investment. Overcoming the challenges posed by low revenue and demands for higher standards of public services in an environment of slowing growth will be crucial in determining Panama’s path in the next decade.

23. The beginning of a new administration provides a window of opportunity to initiate and implement ambitious reforms. This note takes stock of fiscal issues in Panama and proposes policy options. The new administration’s fiscal agenda should feature a comprehensive reform of tax and customs administrations, a review of tax incentives and exemptions and consider steps towards a broader tax policy reform. A review of the existing framework for mineral taxation should be done to ensure adequate tax revenue in future projects, while encouraging investment and maintaining international competitiveness. Important progress in administration reform will be critical to creating fiscal space to finance productive investment and social spending. Efforts to further strengthen the fiscal framework with the appointment of the members of the Fiscal Council should continue going forward. Panama should adopt best practice fiscal accounting and reporting methods. A comprehensive assessment and management of fiscal risks is necessary to create buffers and safeguard public finances given fiscal policy’s exclusive stabilization role.

References

  • IMF Country Report No. 16/337.

  • IMF FAD Expenditure Assessment Tool (EAT) – Updated 10/2019.

  • IMF Framework for Fiscal Analysis of Resource Industries (FARI).

  • Mitchell, P. (2009): Taxation and Investment Issues in Mining, in Advancing the EITI in the Mining Sector, A consultation with stakeholders edited by Edited by Christopher Eads, Paul Mitchell and Francisco Paris.

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  • NI 43–101 Technical Report (2019), Cobre Panamá Project, First Quantum Minerals Ltd.

  • OECD (2019), Multi-dimensional Review of Panama: Volume 3: From Analysis to Action, OECD Development Pathways, OECD Publishing, Paris

  • PWC “Compare mining taxes data tool”.

  • Vtyurina, S. (2013): “Panama: Taking Stock of a Decade of Tax Reforms”, in Panama Selected Issues, IMF Country Report No. 13/89, March 2013.

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1

Prepared by Julia Faltermeier (WHD).

2

The previous administration modified and simplified the SFRL in October 2018, simplified the rule and set the NFPS deficit at 2 percent of GDP in 2018–19, 1¾ percent in 2020–21, and 1½ percent of GDP after 2021, with the target over the medium-term broadly in line with the limit under the previous law. Congress also approved an adjustment of the accrual rules for the accumulation of savings into Panama’s Sovereign Wealth Fund (FAP), specifically to saving half of the excess Canal contribution (over the threshold of 2½ percent of GDP) to the budget.

3

The Canal transfers to the central government are expected to decline as a percent of GDP as the Panamanian economy is projected to grow at a faster rate than world trade.

4

Vtyurina (2013), “Panama: Taking Stock of a Decade of Tax Reforms”, IMF, Selected Issues Paper 2013,

5

Potential VAT revenue is estimated by applying the generalized VAT tax rate on final consumption.

6

Under the special contract with the government, Minera Panama must pay 2 percent royalty on the “Negotiable Gross Production”, defined as the gross amount received from the sale (of concentrates) after deduction of all smelting costs, penalties, transportation costs, insurances and other costs incurred in their transfer from the mine to the smelter. Also applied are a land rental tax of US$3.00 per hectare per year for the total concession area (less than US$41 thousand a year), and a corporate income tax of 25 percent on taxable earnings, with exemption for the period during which the Company has outstanding debt relating to the construction and development of the project (see NI 43–101 Technical Report 2019).

7

The Average Effective Tax Rate (AETR) or “government take” is defined as the ratio of cumulative government revenue to the project’s pre-tax net cumulative cash flows.

8

Capital expenditure by the central government does not include investments of the Panama Canal Authority for the canal expansion in 2016.

9

The agreement foresaw an increase in monthly teachers’ salaries by US$900 in three rounds. The first two increases doubled teacher salaries in six years. The third increase of US$300 was announced in December 2019 and will be applied in 2020. With a median monthly salary of around US$1,200, schoolteacher is one of the highest paid occupations in 2019, well above the median salary of US$700.

10

If the government does not adopt the FC’s advice it has to issue an explanation for not doing so.

11

According to national definition, three public enterprises are not part of the NFPS. They include the Tocumen International Airport, ETESA (an electricity distribution company), and ENA (the National Highway company). The accounts of the Panama Canal are also not consolidated with the government accounts.

12

The authorities are mandated by law to report deferred payment schemes (e.g. turnkey projects) in the budget, which has been a challenge in practice.

13

This estimate treats the reserves of the two publicly managed defined benefit subsystems in a consolidated manner. The old system (System Exclusivamente Beneficio Definido) has dwindling contributions. Its reserves are estimated to deplete by 2027 and subsequently start generating fiscal pressures.

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Cover IMF Staff Country Reports
Panama: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2020: Issue 125
Publisher:
International Monetary Fund
ISBN:
9781513541679
ISSN:
1934-7685
Pages:
88
DOI:
https://doi.org/10.5089/9781513541679.002

Panama: Higher Deficit Increased Public Debt

Panama: Composition of Tax Revenue and Expenditure

Panama: Efficiency of Education Spending is Low Compared to the Region

Composition of Central Government Spending

Energy Subsidies by Product1/

(In percent of GDP, latest value available)

Fiscal Buffers

(In percent of potential GDP)