Bloomberg News

Chinchilla Says Costa Rica Tax Plan Imperiled, Urges Drug Debate

March 02, 2012

Costa Rican President Laura Chinchilla said her administration may not succeed in winning legislative approval of a tax system overhaul aimed at paring a deficit that has grown to more than 5 percent of gross domestic product.

If the latest push on tax increases fails, “there would not be enough time in my administration to do it and we would leave it to the next government,” Chinchilla said in an interview in her office in San Jose. “What we want to avoid is that what’s now only a fiscal crisis contaminates the rest of our economy.”

Chinchilla, 52, also said that legalizing drugs in Central America deserves a “serious” debate as a solution to the crime and violence coursing through the region even if it runs up against U.S. opposition.

“If we keep doing what we have been when the results today are worse than 10 years ago, we’ll never get anywhere and could wind up like Mexico or Colombia,” Chinchilla said in the Feb. 29 interview. While U.S. opposition to legalization is well- known, Central Americans “have the right to discuss it” because “we are paying a very high price.”

Costa Rica’s $40.3 billion economy, the second-biggest in Central America, is weighed down by a deficit equivalent to about $2 billion, approximately the amount the country earns from tourism. Central bank President Rodrigo Bolanos predicted in January that as a result, economic growth will slow to 3.8 percent this year from 4.2 percent in 2011.

Free-Zone System

Legislation proposed by the government would replace the current national 13 percent sales tax with a 14 percent value- added tax. At stake also is the continued presence of companies such as Intel Corp., based in Santa Clara, California, and Oracle Corp., based in Redwood City, California, that were attracted to Costa Rica by the free-zone system under which some foreign-owned companies pay no income taxes for the first 12 years of operation.

The tax bill would introduce a 15 percent withholding tax for companies entering free zones after 2015.

Two previous attempts to raise taxes died in the legislature last year. If the current overhaul is approved, the government estimates it would raise at least $600 million in annual revenue.

While Chinchilla said she still had hope that it would be approved, she added that there is no “Plan B” if it fails to pass.

“I want to point out that I am still optimistic that we are going to approve the fiscal reform,” she said. “However, because the approval has been debated so much, we are already feeling some of the effects in our economy. For example, interest rates have increased between 2 to 3 percentage points from the end of last year to today.”

Higher Rates

There is a strong possibility that 18 months from now, Costa Rica’s legislature may still not have approved the tax increases, said Boris Segura, a strategist at Nomura Securities International, in a telephone interview from New York. He said “a kind of dictatorship of the minorities,” referring to procedural maneuvers by small groups of legislators who can stall bills, is holding up the tax overhaul.

Foreign direct investment in Costa Rica rose 52 percent to a record $1.56 billion in the first nine months of 2011, and a record-high 2.2 million tourists visited the country last year. GDP per capita is $7,691, the highest in Central America.

High-tech companies such as Intel, the country’s highest revenue earner, Hewlett-Packard Co., based in Palo Alto, California, and Armonk, New York-based International Business Machines Corp. have Costa Rican operations. High-tech companies brought in $9 out of every $10 in revenue from free zones during the last decade, according to Gabriela Llobet, director general of the Costa Rican Investment Board.

Tax Benefits

Chinchilla said in the interview that she met with Intel management and reassured them that they would not lose their tax benefits because the new levies only apply to newcomers.

Increased government spending and stalled tax legislation prompted Standard & Poor to cut Costa Rica’s local-currency credit rating on Feb. 13 by one level to BB, two levels below investment grade and one level below Guatemala.

The yield on Costa Rica 6.548 percent bonds due in 2014 fell 25 basis points, or 0.25 percentage point, to 2.908 percent this year, according to data compiled by Bloomberg yesterday.

The colon weakened 0.2 percent to 512 per U.S. dollar yesterday, trading nearly unchanged in the year to date. That compares with a 9.5 percent appreciation of Mexico’s peso in the same period. In Panama, the balboa is pegged to the dollar.

Part Company

On the drug issue, Chinchilla isn’t the only leader to part company with the U.S. by calling for consideration of alternatives to military action to counter Mexican cartels. They have unleashed a fresh bout of violence in the region as they establish new routes to smuggle cocaine to the U.S., the world’s largest consumer of narcotics, according to a United Nations report.

Guatemala’s President Otto Perez, a former army general, said Feb. 13 that “if drug consumption isn’t reduced, the problem will continue,” and suggested legalizing the use and transport of drugs even while proposing a military crackdown. Seeking to win over other nations to give the legalization proposal more heft, he was turned down by Panama and El Salvador.

Trafficking in Central America has reached “alarming and unprecedented” levels as cocaine passing through the region may equal about 5 percent of the countries’ gross domestic product, the UN International Narcotics Control Board said in a Feb. 27 report.

Murder Rate

“Despite efforts to counter drug trafficking in Costa Rica, Honduras and Nicaragua, in 2010, those countries were, for the first time, identified as major transit countries,” according to the UN board.

In Costa Rica, murders jumped to 11 per 100,000 inhabitants in 2010 from 7 in 2006, according to the UN Office on Drugs and Crime. That rate compares with 13 per 100,000 in Nicaragua, 41 in Guatemala and 82 in Honduras.

Having dismantled its army in 1948, Costa Rica has had to tackle drug-related violence differently from its neighbors, Chinchilla said. For example, last year the country ratified a law to decriminalize drug possession in recreational quantities.

Chinchilla has added 1,500 police officers since taking office in May 2010. This year her government plans to add at least 400 more patrol cars to reduce response time for reported crimes, Security Minister Mario Zamora said in December. Chinchilla met with U.S. Homeland Security Secretary Janet Napolitano three days ago and Guatemala’s deputy president, Roxanna Baldetti de Paz, on Feb. 29. Napolitano, who this week has been meeting with the region’s leaders, reiterated on Feb. 28 the U.S. position that legalization “is not the way” to stop drug traffic.

Reduce Demand

In Washington, the spokesman for White House Drug Policy Director Gil Kerlikowske, Rafael Lemaitre, said President Barack Obama’s goal is to reduce the demand for drugs in the U.S. Even so, Lemaitre said, “Neither a law-enforcement only ‘war on drugs’ approach or outright drug legalization are policies that are realistic, humane, or grounded in research.”

When she won the 2010 elections, Costa Rica’s first female president became leader of a country with Central America’s lowest murder rate and whose 4.3 million citizens are on average the region’s wealthiest. Still, crime was on the rise and the previous administration’s spending saddled her with a 2010 budget deficit of 5.2 percent, the highest in the region.

The former security minister is struggling to preserve Costa Rica’s self-image, enshrined in a popular song entitled “The Switzerland of Central America.” Her approval rating slumped to a record low of 23 percent in January, according to a quarterly poll published by San Jose-based research firm Unimer, which had a margin of error of 2.8 percent. Chinchilla is barred by the constitution from seeking a second, successive term.

Public Policy

Married and mother of a 15-year-old son, Chinchilla studied public policy at Georgetown University in Washington and is among a recent crop of first-time Latin American female leaders. Dilma Rousseff was elected president of Brazil in 2010, Cristina Fernandez de Kirchner was re-elected president of Argentina last year and Michelle Bachelet governed Chile for four years between 2006 and 2010.

“Costa Rica is far from the Central American oasis that it used to be,” said Michael Shifter, president of Washington- based research group Inter-American Dialogue, in an e-mailed message. “Its vulnerability is real and it has little experience in dealing with the drug problem.”

To contact the reporters on this story: Flavia Krause-Jackson in San Jose at fjackson@bloomberg.net; Adam Williams in San Jose at awilliams111@bloomberg.net

To contact the editor responsible for this story: Joshua Goodman at jgoodman19@bloomberg.net


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