State of war
President Noboa sent last night the third urgent economic bill, which has one purpose only: to raise the VAT from 12% to 15%. The rationale for the decision is the need to raise financing for expenditures associated with security and for the state of war dictated last Monday in response to nation-wide terrorist attacks following the escape from prison of alias "Fito", one of the most dangerous criminals associated with one of the deadliest gangs in the country.
In 2016, then-President Correa raised the VAT tax from 12% to 14% to finance the reconstruction of the coastal provinces after the earthquake of that year. That measure was temporary, but in Noboa’s bill, apparently, it will be permanent. The Assembly has 30 days to approve it or it will become effective by mandate of the law that regulates urgent economic projects.
Many analysts expected that the tax reform passed last December would include an increase of the VAT as there is not much room for tax increases other than individual income tax. A deficit of around $5.7 billion in 2023, to be followed by a similar one in 2024, screamed for such a measure. It is efficient and will represent close to $1b in additional collections that could start as soon as March this year.
However, it is not a neutral measure. It will have a cost for Noboa’s political capital, which he has been carefully preserving both to increase the probability of success in the referendum that may come within two months, and to maintain the probability of his re-election in 2025. Raising the VAT is probably easier in the current situation than raising the price of derivatives. In any case, we must wait to see what happens in the Assembly because if there is deep disagreement, there is also the risk of a rupture of the current alliance which, although not ideal, is necessary at least during this first semester.
The high deficit is not the only problem contributing to the fiscal blues. The inflexibility of the structure of the General Government Budget leaves little room for adjustment. In the past, capital expenditure was the adjustment variable when money was scarce. However, this is no longer the case as only 26% of this item is really available for flexible disposal by the government; the remaining 74% has to be transferred to local governments and to retired public servants by mandate of law.
An increase in taxes might solve the quantitative problem. However, it increases moral hazard and the danger that those monies could disappear in the hands of corrupt public servants and private corporations, as happened with the 2% increase of 2016.
President Noboa has the obligation not only to fight corruption, organized crime, and violence, but also to improve fiscal account registrations, transparency and accountability in all public transactions. That has been gone for a very long time now. Minister of Finance Juan Carlos Vega meets with the IMF at the end of this month. We all hope that this costly measure can start an agreement with the Fund. But any new agreement should have strong provisions to demand from the government the above-mentioned transparency and accountability.
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