Panama - Report on the economy (Vol. 2 of 4) : Technical notes on public finance

F ILE' CO -- Y DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. 275-PAN REPORT ON THE ECONOMY OF PANAMA (in four volumes) Volume II Technical Notes on Public Finance November 13, 1973 Regional Office Latin America and the Caribbean Country Programs Department I This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS 1.00 Balboa = 1.00 US$ 1.00 US$ = 1.00 Balboa Fiscal Year: January 1 to December 31  REP )RT ON THE ECONOMY OF PANAMA VOLUME II: TECHNICAL NOTES ON PUBLIC FINANCE Table of Contents Page No, 1. INTRODUCTION ....................................... 1 II. GOVERNNENT TAXES ................................... 2 A. Introduction ..................... 2 B. Central Government Taxes, 1936-1968 .... ....... 2 C. Central Government Taxes, 1968-1973 .... ....... 8 D. New Taxes ............ e .. 16 E. Future Revenue Projections .22 III. THE GOVERNMENT MANAGEMENT SYSTEM . .23 A. The Budgetary Systei. .23 B. The Internal Borrowing System .25 IV. THE PUBLIC AGENCIES' FUTURE TNVESTMENT PROGRAM and FINANCING .28 V. TECHNICAL ANNEX ON PUBLIC EXPENDITURE INCIDENCE AND INCOME DISTRIBUTION ................................ 32 0  0 0  I. INTRODUCTION In Volume I of this report - The Ma4n Volume - there are some key fiscal conclusions and projections that require further description, Justifi- cation, and anLalysis for those readers who wish to pursue the public sector Ln detail. This volume provides those details. It i's not a comprehensive retview of the nublic sector or public finances, rather it is a review of the key issues in public finance. The first issue stems from the Government's tax system. Panama has had a relatively buoyanrt tax system, especially in recent years. However, buoyancy is not the same as elasticity. The Government's extraordinary efforts to increase taXes have been successful. lhis success, however, does not mean that iL left unchanged the tax system will continually brirg in irncreasing revenues as a proportion of GDP. The key revenue findin-g of th.e nission is that the tax system has been and still is not elastic wnen compared to income growth. Unless the system is changed, the Government can only con- tinue to receive buoyant revenue growth if it continues to introduce new taxes. The mission, therefore, has analyzed the tax system to evaluate possible new taxes. The second issue is the need for a change in the Government's management systenms. The "Ordinary Budget" no longer meets Panama's needs. hle syste-m of internal borro-ing needs major changes. There is no reason why a Governrsent w-th over $1 billion in foreign deposits in its own banking svstem should borrow in foreign markets at high rates and relatively poor terms. These are major issues. Without better debt and accounting systems, Panantanian planners will be hampered in improving fiscal programs. The final fiscal issue is the method of financing the public invest- ment program. In the past,Panamanian planners were not in a position to consolidate the public sector, trace the transfers within it, calculate the real resources available to each public agency, and estimate the total sublic needs for the future. The mission's consolidations for 1960 and 1965-1973 provide a picture for the past. The Governinent has completed its w.n con- s.olidation for 1973 based on the budgets of all public avencies. Rather than continue to estimate the resource -needs based soiely on the executiox of projects, so9e of them requiring outlays from two or more agenciea, the yris- sion recommends that the Government pl.an specific prograns for each public agency. W4hen the prospective resources available to each agency are compiledu a decision can th-en be taken to determi.ne which program shou'd be accelerated oy receiving further resources from thjie Government's own general revenues. The mission's suggestions and assumptions of the revenue needs of maor public agencies is included in this volume. Official lending agencies could assist in a better fiscal program by requi-ring revenue producing agencies to atter. t tos meet counterpart needs by better management, higher tariffs, or independent buit orudent borrowing, before requiring that the Government guarantee the counterpart f-or their own project.  -2- A technical a-nnex that explains the mission's analysis of the effect on income distributiorn of public outlays completes this volume. II. GOVERNMENT TAXES A. Introduction The Covernament of Panama has traditionally been restricted in the taxes it could successfully implement. Sone of this limitation came from the proximlIty of the free trade area in the Panama Caa.al Zone and from treaty requiretments. Many of these deterrents have now been removed, but they have influenced the structure of the tax system. Further limitations were iMposed by Panama's traditional and growing impxortance as a hemispheric shopping center. Until 1936 the scope for goaernment revenues was limited by the in- fluence of the Panama Canal Lone. Forty percent of the urban labor force was employed in the Zone, import tariffs on most consuner durables and clothing were negligible, since a substantial