The proposed reform poses fairness in the tax burden distribution and more efficiency in public spending, in order to generate the resources needed to increase social investment and reduce poverty; in summary, to improve the quality of life of Panamanian citizens

“. . . this system we propose will be a more equitable system, wherein expenses and revenues are seen in function of a real investment program, that should achieve the aspirations of the Panamanian people and, in particular, of the 1.2 million Panamanians that live in poverty, . . .“

Martin Torrijos

In exercising its accountability and responsibility to inform the nation about the initiatives aimed at complying with its plan, the national Government introduces in this document information that responds in great measure to concerns discussed during the consultation process that has taken place to this date and presents a summary of the contents of the fiscal reform under consideration.

Why a reform?

Because most of our people have needs that cannot be put off and can only be met with additional economic resources.

Of the country’s total population, 40 out of 100 persons live below the poverty line and half of those live in extreme poverty. In the non-indigenous rural areas, this number rises to 59 out of 100 and in the indigenous areas, it reaches 98 out of 100 persons.

The infant mortality rate, in the poorest areas, is twice the rate registered in the Province of Panama, and in other cases, three times as high. Medical attention during childbirth, in rural areas, covers 85% of births, and in areas of extreme poverty, it only covers half. Infant malnutrition affects 22% of students between 6 and 9 years of age.

The State has the responsibility to meet these social needs and the resources available are simply not enough. In fiscal year 2004, the fiscal deficit exceeded B/. 700 million, President Torrijos’ administration received accounts payable of more than B/. 300 million, the Social Security debt pertaining to government fees was over B/. 125 million and the government’s financial position was unsustainable. The source of funds used was traditionally “more debt.” This cannot continue because interest payment would make it impossible to comply with creditors and with the country’s growing needs.

Hence, it is necessary to start a FISCAL FAIRNESS PROGRAM that allows capturing greater revenues from those who have them and at the same time directing public spending towards the improvement of the conditions of the poorest and most disadvantaged individuals.

Why is there no fairness in the distribution of existing resources and the tax burden? Panama is the second country in America with the worst wealth distribution.

In Panama, families with the highest income level receive 40 times more income than the poorest families. At the same time, families with the lowest income level have a tax burden that is four times greater than that paid by the top income groups.

The State pays approximately $200 million a year in subsidies but corporations pay less than $180 million in taxes. Panama’s tax system is unfair; most of the income tax paid is withheld at the source from salaried workers. In fact, individual people pay more income tax than the corporations, with salaried workers being responsible for two thirds of this tax.

The subsidy benefits that are now directed to specific groups are defrayed by those who effectively pay their taxes or that need social programs the most.

Why a fiscal and not a tax reform?

Panama’s fiscal situation cannot be sustained. The government’s payroll expenses, the debt service and transfers exceed the State’s revenues. Adjustments are therefore needed in revenues and expenditures to generate government savings and execute public investment programs in schools, health centers, housing, roads and drinking water systems. These programs have been deferred and demand immediate attention.

Summary of the ‘public spending’ component

The Government started with a policy of austere spending and transparent actions. Hence, the proposed reform is based on the norm that the effort will be shared as it relates to public sector savings and spending control.

1) By January 2008, the public sector personnel structure should not be greater than it was on December 31, 1999. The institutions are, therefore, called upon to submit their spending adjustment program for the Cabinet Council’s approval at the latest on June 30, 2005. Exceptions to this requirement are health, education and security services. Those institutions will need to provide supporting evidence that there is a greater demand and demographic growth of the sector.

2) Personal service contracts should not exceed 2% of the total payroll amount of personal operating services. This 2% limit will also apply to total investment amounts.

3) Starting January 1st, 2006, the percentage increase applied to the budget of current expenses, excluding interests and other taxes, shall not be greater than the percentage increase of the previous year’s current revenues.

4) The Executive Branch, through the MEF, will regulate everything pertaining to the use of cellular phones, acquiring and renting cars, hiring consultants, trips outside the country, among other items.

During the time period between January 2005 and December 2007, a percentage reduction will be applied to the payroll expense on the basis of the amount stemming from the vacancies that are a product of resignations and retirements–30% (2005), 20% (2006) and 10% (2007)

Summary of the tax component

The fiscal reform proposal has the following tax elements:

An increase in the annual single rate for corporations and private interest foundations

A $100.00 increase to $350.00 per year is proposed for the single rate. The reactivation surcharge is also increased for corporations that have been suspended because of lack of payment, from $250.00 to $500.00 and the payment of the first fee becomes mandatory at the time of registration.

Alternative Minimum Income Tax (corporations)

A parallel method is set for calculating Income Tax. Costs, expenses, incentives or fiscal credits are not deducted or imputed from taxable income (gross revenue minus foreign source revenue) and a 2% rate is applied. The taxpayer must pay the Treasury the result from applying this formula or the result obtained by applying the traditional Income Tax calculation method, whichever sum is greater.

Alternative Minimum Income Tax (natural persons)

In a similar way as the case of people with more than one income source and in excess of B/. 60 thousand per year, the income tax will be determined as the greatest of 10% of gross income and the tax calculated by the traditional method.

Estate tax

A progressive combined alternative tax is set, much lower than the current one, with steps of 0.70%, 0.90% and 1.0%. In order to apply for the alternative tariff, the taxpayer must be in good standing relative to payment of arrear taxes (with a condonation of surcharges and interests) and must submit a new appraisal of his/her property that is accepted by the MEF.

Also, the Treasury’s capacity to decree a seizure and to attain a later repossession on delinquent properties is speeded up. Casinos and games

A selective consumption tax on the prizes paid by way of slot machines will be applied with a 5% rate and with a tax-exempt minimum of B/. 5.00.

Exceptions – Foreign source incomes

This item includes 15% withholdings on amounts paid for contracts that, regardless of the country wherein they were executed, benefit people or corporations located in Panama. Furthermore, the norm prevents the possibility of declaring a foreign source for people who have remained outside of Panama less than 30% of their income-producing time.

Elimination or change of incentives

Instead of open and undefined incentives, the incentives applicable in the future would be limited by a specific application amount and time period. For example, the case of the B/. 2,000 subsidy for housing valued at less than B/. 15,000 per unit that has been implemented starting this year.

In general terms, the temporary incentives such as CAT’s and others will expire on the date set for such purpose. Other incentives that have not been executed yet are left without effect.

The incentives for the handicapped, first job, AIDS prevention, Panama’s Casco Antiguo and Colon are maintained indeterminately and under the same current conditions. The tourism incentive is also maintained indeterminately, limited to the hotel activity.

All other incentives that do not have an expiration date can only be used until the 2007 fiscal period, after which they will be rescinded.

The investment credit in bridge technology, created by article 6 of Law 28 of 1995 (Universalization Law) can only be used to pay up to 5% of the tax owed and until the 2010 fiscal period, after which it will not be applicable and will be eliminated.

The purpose of these measures is not to leave sectors unprotected, such as export and industry sectors. For these sectors, we are designing new aid mechanisms that are better focused and are more effective. For this purpose, the Government is designing a competitiveness program through which corporations devoted to exports can be capitalized.

The elimination of incentives goes hand in hand with a gradual decrease of the income tax rates for artificial persons. For 2005, the rate will be 27.5%.

Modifications to RETT (real estate transfer tax)

Free transfers will be taxed, unless they are done between people related in a first degree blood relationship or between spouses.

Taxes to be rescinded:

  • Telephone calls and cable communications to support exports and international commerce.
  • Professional licenses
  • Insurance companies (art. 1014 A Fiscal Code)
  • Tickets (stamp tax)
  • ITBMS tax

The service of food sales in places that do not serve alcoholic beverages is exempt from the ITBMS tax. Penalties for tax evasion.

The current prison penalty from one month to a year will change to a penalty from two years to five years.

An affidavit is created for the proper use of the foreign source concept and for reporting income, costs and expenses in the income statements. The consignment of false data on that statement will result in penalties for tax evasion.

The special fiscal treatment is eliminated for “representation expense” income.

This measure affects the public as well as the private sector and it implies that the sums received in this manner will be given the same tax treatment as the salary. The deductibility of mortgage interests and donations to non-profit organizations is reduced.

The deductible amount for mortgage interests will be reduced from B/. 15,000.00 to B/. 7,500.00 for the 2005 income statements.

Regarding donations, they are limited to B/. 50,000.00 per year per taxpayer.