Colombia - Third Programmatic Fiscal and Institutional Structural Adjustment Loan Project

Page 1 PROGRAM INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB1120 Operation Name PROGRAMMATIC FISCAL AND INSTITUTIONAL STRUCTURAL ADJUSTMENT LOAN III Region LATIN AMERICA AND CARIBBEAN Sector Central government administration (60%);Sub-national government administration (20%);Law and justice (10%);General education sector (10%) Project ID P084762 Borrower(s) REPUBLIC OF COLOMBIA Implementing Agency MINISTRY OF FINANCE AND PUBLIC CREDIT Environment Assessment OD 4.01 applies? [ ] Yes [x] No Date PID Prepared October 18, 2004 Estimated Date of Appraisal Authorization November 8, 2004 Estimated Date of Board Approval December 16, 2004 1. Key development issues and rationale for Bank involvement Colombia is a country of 43 million inhabitants with a long history of sustained economic growth. During the last 40 years, however, investment and growth has been tapered by an internal armed struggle and high levels of violence that have made the country one of the most unsafe in the hemisphere. In 1991, a new Constitution was approved which sought to bring broad sectors of society into participatory decision-making, strengthened decentralization, and placed significant social welfare obligations on the State. One of the consequences of this new framework has been a constant growth in public expenditure to attend the mandates of the Constitution, which was not coupled with a structural tax reform and other measures that would ensure sustainable public finances. The deteriorating fiscal situation led the country to sign a Stand-By Agreement with the IMF in January 2003. Since then, the current government has carried out two tax reforms, has enacted a Fiscal Responsibility Law, and has attempted constitutional reform to contain the growth of expenditures. In addition, public sector reform measures have been undertaken to contain the growth of the bureaucracy and to add value-for-money to public expenditure, including measures in procurement reform, asset management, performance incentives, and containment of the growth in contingent liabilities. To support this reform process, the government sought the support of the Bank and the IDB through both development policy lending and technical assistance. The Bank put together a program of four single-tranche loans, amounting to a notional total of US$900 million, to support measures in tax policy and administration, fiscal responsibility, budget reform, asset management, legal defense of the state, procurement reform, improvements to the royalty transfer system, and a pilot exercise in performance contracts with government agencies. 2. Proposed objective(s) The specific objectives of the FIAL program are to: (i) increase tax revenue and reduce distortions in the tax system; (ii) modernize the tax administration; (iii) promote the development Page 2 of a sound fiscal responsibility legal framework; (iv) reduce losses and generate revenues through improved asset management; (v) prevent massive losses to the State from judicial claims; (vi) improve budget management with modern tools and legal reforms; (vii) develop incentives for efficiency gains in sub national entities; (viii) strengthen the public sector procurement system; (ix) improve performance through management contracts for agencies; and (x) support a coherent and comprehensive reform implementation process. 3. Preliminary description The proposed operation constitutes the third loan of the FIAL program (FIAL III) for an amount of US$150 million in a single tranche. Each of the loans in the FIAL program has a particular thrust within the overall scope of the reform. FIAL I was heavily weighted toward tax policy as the initial and most urgent effort toward fiscal sustainability. FIAL II focused on initiating the legal and normative reforms of key elements of public sector reform, including procurement, royalty transfers, and fiscal responsibility, and the implementation of management contracts with two government agencies and the definition of the budget reform strategy. The thrust of the third FIAL loan proposed in this document is on ongoing adjustments to and results of the tax policy framework, actual results of the tax administration efforts, the implementation of the reforms in the areas of royalty, asset, and procurement management, and the launching of the legal reforms to the budgeting system. Specifically, the proposed third loan of the program is focused on delivering the following policy reforms: (a) submission to Congress of a new tax reform bill expanding the VAT base, reducing exemptions and implementing a progressive tax system for pensions; (b) decrease in tax evasion below X% and in DIAN administrative costs per peso collected to below X%; (c) submission of a new budget law to Congress, complementary to the Fiscal Responsibility Law; (d) improvements in royalty allocations through the restructuring of the National Royalty Commission; (d) implementation of the legal defense of the State policy; (e) establishment of regulatory bodies for both procurement and asset management; (f) compliance with the pilot management contracts with ICBF and SENA; and (g) further progress in the monitoring system for the public sector reform process 4. Environment Aspects There is one issue regarding the tax reform supported by the program that needs to be addressed. Law 788 eliminated the capital gains (or