US embassy cable - 04GUATEMALA1641

UNCLAS SECTION 01 OF 02 GUATEMALA 001641 
 
SIPDIS 
 
SENSITIVE 
 
TREASURY FOR OASIA: TOLUI AND PARODI 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, GT 
SUBJECT: FISCAL PACKAGE PASSED:  LESS THAN IDEAL, BUT 
PROGRESS NONETHELESS 
 
 
1. (U)  SUMMARY: The Guatemalan Congress passed on June 21 
and 23 the Temporary and Extraordinary Tax to Support the 
Peace Agreements (IETAP), reforms to the Corporate Income 
Tax, and reforms to the Tax on the Distribution of 
Alcoholic Beverages.  Reform of the value added and 
personal income taxes, and a new tax on bunker fuel, did 
not prosper.  The new tax measures are expected to increase 
tax revenues by Q2,200 million, but this is insufficient to 
cover the projected gap in the 2004 budget if the 
government were to do everything it says it wants to do. 
The government can still reach its 2004 deficit target of 2 
percent of GDP with continued austerity and improved 
collection plus deferral of big-ticket plans.  END SUMMARY. 
 
The Fiscal Proposal: Background 
------------------------------- 
 
2. (U)  The Fiscal Pact Technical Commission (FPTC) 
submitted a tax proposal to the executive at the end of 
April 2004 that included reforms to the income tax, a 
"Temporary and Extraordinary Tax to Support the Peace 
Agreements" (IETAP), reforms to the value added tax (IVA), 
a tax on the distribution of alcoholic beverages, and a tax 
on the distribution of bunker fuel. The key components of 
the package for revenue purposes were the income tax 
reforms, the IETAP (which essentially replaces the IEMA 
alternative minimum tax that was declared unconstitutional 
at the end of 2003), and reforms to the IVA to eliminate 
exemptions and, in theory, improve collection. 
 
3.  (U)  The FPTC's intention was to broaden the tax base 
by reducing evasion, eliminating exemptions, and including 
more individual taxpayers by creating new tax brackets at 
lower income levels.  A provision in the IVA reform called 
for large scale wholesalers and retailers to pay an extra 
three percent withholding tax on their purchases on the 
theory that it would encourage them to collect all taxes 
from sales to their customers to offset the extra amount 
withheld.  A wide variety of civil society organizations 
protested the personal income tax reforms on grounds that 
the burden would fall on middle and low-income families. 
Low margin wholesalers and retailers protested vigorously 
that they could not cover the additional three percent IVA 
withholding through taxes collected from their customers 
and that the reform amounted to an interest-free forced 
loan to the government.  The Chamber of Industries 
protested that the tax on bunker fuel would make several 
large companies uncompetitive.  After consulting with 
social, labor, and business groups, Congress decided to 
exclude personal income tax, the IVA reforms and the new 
tax on bunker fuel tax. 
 
Only Three Taxes Approved 
------------------------- 
 
4. (U)  On June 21 and June 23, 2004, the Guatemalan 
Congress passed IETAP, reforms to the Corporate Income Tax, 
and reforms to the Tax on the Distribution of Alcoholic 
Beverages.  The three taxes will enter into effect on July 
1, 2004 (the beginning of the next tax year, which does not 
coincide with the government's Jan. 1 - Dec. 31 fiscal 
year).  The IETAP will be a minimum tax on commercial, 
agricultural, and other juridical enterprises based on one 
fourth of net assets or one fourth of gross income, 
whichever is larger.  It will be applicable for two and a 
half years, and the rates will gradually decline from 2.5 
percent in 2004, to 1.25 percent in 2005 and 1.0 percent in 
2006.  Main reforms to the corporate income tax include the 
removal of the reinvestment allowance exemption and the 
establishment of new a fixed rate of 5 to 7 percent of 
gross income if companies chose not to apply the 31 percent 
rate on net income.  The tax year for the income tax will 
be shifted from a January 1 -December 31 fiscal year 
beginning in 2005.  Companies who continue to use the 31 
percent rate on net income must comply with additional 
auditing requirements, which might discourage them from 
using this option.  Companies that opt for the fixed rate 
on gross income will be exempted from paying the IETAP. 
 
5.  (U)  The first draft of legislation made the IETAP the 
primary tax on income for businesses subject to it. 
Businesses would then reduce their corporate income tax 
liability by the amount of IETAP paid.  EconCouns 
intervened with the Minister of Finance on behalf of the 
U.S. business community to allow the corporate income tax 
to be the primary tax, as the U.S. tax code would not 
recognize the IETAP as an eligible foreign income tax that 
could be credited against U.S. tax liabilities.  We have 
not seen the final language, as it has not yet been 
published, but we believe the matter has been fixed. 
 
6. (U)  The Tax on the Distribution of Alcoholic Beverages 
establishes a rate of 6 percent on beer, 7.5 percent on 
wines and other fermented beverages and 8 percent on other 
alcoholic distilled beverages.  The rate will be applied to 
the "suggested sales price" and not to the alcoholic 
content, as was originally proposed by the Executive.  A 
member of the FPTC shared concerns that the suggested price 
might be subject to local influence peddling aimed at 
lowering the taxable value and that imported beverages 
could be adversely affected. 
What is the Impact? 
------------------- 
7.  (U)  The new taxes will provide additional resources to 
the government, but they will not be enough to cover the 
fiscal gap of the 2004 budget as initially presented by the 
Berger Administration.  Early this year, the Finance 
Ministry had estimated a gap of Q9,717 million (Q8 = 
approx. $1), which would increase to Q13,713 million if 
other expenditures not considered in the 2004 Budget were 
added.  With the fiscal proposal sent by the Executive to 
Congress, tax revenues were expected to increase by Q3,162 
million in 2004.  However, since reforms to the personal 
income tax and to the IVA were excluded, the revenue 
increase is estimated to be Q2,200 million, or 1.02 percent 
of GDP. 
 
8.  (U)  The FPTC estimates that the Tax on Beverages will 
contribute around Q100 million, and the combined 
contribution of the IETAP and the corporate Income Tax 
reforms is expected to amount to Q1,300 million in 2004. 
The remaining Q800 million will be provided by 
administrative improvements carried out by the SAT. 
According to the FPTC, those Q800 million might also 
include part of the effect of the new fixed rate of the 
income tax, which was difficult to estimate separately from 
the IETAP. 
 
9.  (U)  Congress also passed a law that authorizes the 
placement of Q4,400 million in government bonds, which 
added to the Q2,200 million that would be collected as a 
result of the new tax measures gives a Q6,600 million, 
which would be insufficient to cover the projected fiscal 
gap.  Moreover, this amount does not include requirements 
to roll over maturing debt.  The public sector deficit will 
need to be around Q3,300 million, or half of the amount to 
be raised through new taxes and bonds, if the government is 
to meet its target of a public sector deficit of 2 percent 
of GDP.  That will require a combination of austerity and 
aggressive collection. 
 
Comment 
------- 
10.  (SBU)  The government's deficit projections have been 
intentionally alarmist as it pursued fiscal reform in an 
inexperienced and unfocused Congress that showed early 
signs of not necessarily wanting to cooperate.  The 
government clearly hoped to make more progress than it did, 
but it made progress nonetheless.  Income tax and IVA 
collections were up for the five months through May 2004, 
compared with the same months in 2003, and total revenues 
fell a modest 0.4 percent as IEMA collections dropped off 
sharply.  The decline in IEMA collections alone was more 
than 13 times the decline in total revenues.  The IETAPS 
will now replace what was lost with the IEMA, so there is 
every reason to expect collections for the full year to be 
better than last year.  In short, the situation is not 
ideal, but continuing improvement in collections and 
austerity in government operating costs, together with 
deferral of some big-ticket items such as compensation for 
former militias (ex-PACS) suggest that an overall deficit 
target of 2 percent of GDP is still within the government's 
reach. 
 
HAMILTON