Tax increases in Honduras, and linking aid to fair, effective tax policies

Taxes are big news in Honduras, as the outgoing Congress pushes through a bunch of last-minute increases.

The Congress is controlled by the National party, which won the November election. The increases are a way to get the unpopular deeds done before the new president takes over in two weeks.

It doesn’t look much like good governance, mostly because there are apparently no studies of the impact of the increases, or whether they are the best way to raise more revenue.

Taxed into poverty?

I was going to write about the increases anyway, but a Guardian blog post this week added an interesting element by arguing that donor countries should cut aid to at least some countries with lousy tax policies. (I’ve become a bit of a development geek, after two years as a Cuso International volunteer. The issues are complex, interesting and important.)

The blog post, by Kieran Holmes, is based on a British Commons committee report that recommended chopping aid to Pakistan unless the government started collecting more in taxes from its own people. 

Why should British taxpayers subsidize the government if Pakistan’s citizens - especially the rich - won’t pay up?

It’s an easier argument to make in the case of Pakistan, which is a middle-income country able to find money for a giant military budget, but seeks foreign aid for education and basic services. In poorer countries - like Honduras - an end to aid would mean disaster.

But the principle is interesting.

Honduras collects about 16 per cent of GDP in tax revenue, more than Pakistan but not enough to cover expenses. Government debt is up to 42 per cent of GDP, at high interest rates because there’s a lack of confidence in future repayments. The accepted ceiling seems to be about 35 per cent.

Holmes argues in his blog post that big donors - organizations and governments - should also consider how the tax revenues are raised and whether the system is equitable and supports poverty reduction and development.

The latest round of Honduran increases would not likely meet that test.

The government is already much more dependent on consumption taxes - sales taxes - then taxes on income. Sales taxes were expected to bring in about $1.1 billion last year. Income taxes about $865 million.

That’s out of whack with many countries. In Canada, the government takes in $3.50 in income taxes for every $1 in sales taxes.

And most economists would agree that the dependence on sales taxes serves the interests of the rich. Income taxes are generally progressive - the more an individual or business earns, the more paid in taxes.

Consumption taxes - sales taxes - are at best flat, and often regressive. Low-income people see a higher proportion of their income taken in taxes than the much more affluent. (The Honduran sales tax regime includes exemptions for some necessities - the “canasta basica,” or basket of necessary goods. That theoretically reduces burden on the poor.)

The latest round of tax increases in Honduras increases the burden on the poor and middle class. The basic sales tax rate jumps from 12 per cent to 15 per cent. That’s pushed up the cost of almost all goods and services by about 2.6 per cent. The list of tax exemptions designed to protect low-income consumers was dramatically - and apparently incompetently - trimmed.

The inflation rate was about five per cent before the tax increase. Price increases - including for the buses that people need every day - will make life harder for the poor. (That is to say, for Hondurans. About 74 per cent of the population live in poverty, and 47 per cent in extreme poverty.) 

The leading social watchdog group predicts the tax increases will push another 100,000 people into poverty over the next four years. A spokesman for the government says it’s impossible to predict what will happen as a result of the increases, which serves to show the lack of research on the impact on the economy and families.

It’s all made more confusing because the tax system is a total mess. Tax evasion of all kinds is the norm, with estimates of 20 to 40 per cent of taxes owed going uncollected. There are a huge number of exemptions - fast food restaurants pay no taxes under a tourist-promotion tax break. The tax collection agency doesn’t work, according to the incoming director.

Holmes says funders have a right to push governments toward fair, effective tax systems in return for aid, and the ability to help them achieve those goals.

Based on the tax chaos and unfairness in Honduras, he might have a point.