US embassy cable - 04SANTODOMINGO6699

UNCLAS SECTION 01 OF 04 SANTO DOMINGO 006699 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR WHA/CAR, WHA/EPSC, WHA/USOAS, EB/TPP/BTA, 
EB/IFD/OMA;NSC FOR SHANNON AND MADISON;LABOR FOR ILAB; 
USCINCSO ALSO FOR POLAD; TREASURY FOR OASIA; USDA FOR FAS 
(SHEIKH, GRUNENBAUM);STATE PASS USTR FOR VARGO, RYCKMAN, 
MALITO, CRONIN 
USDOC FOR 4322/ITA/MAC/WH/CARIBBEAN BASIN DIVISION 
USDOC FOR 3134/ITA/USFCS/RD/WH; DHS FOR CIS-CARLOS ITURREGUI 
 
E.O. 12958: N/A 
TAGS: PGOV, PREL, ETRD, EFIN, DR 
SUBJECT: DOMINICAN STANDOFF ON REPEAL OF PROTECTIONIST TAX 
 
REF: SANTO DOMINGO 6609 
 
1. (SBU) Summary:  President Fernandez on December 14 implied 
he would veto a bill to repeal a the protectionist 25% tax on 
fructose-sweetened beverages if the Dominican Senate does not 
remove all of the "compensatory" tax breaks for agribusiness 
and industry that have been added to the original draft 
submitted by the executive.  Fernandez warned that the 
country cannot not afford to lose either the free trade 
agreement with the United States and Central America (CAFTA) 
or to disrupt the agreed terms for a new IMF standby.   The 
senators preparing the legislation have asserted to the 
Embassy that the bill with slightly modified tax breaks 
represents the "last chance" to repeal the 25% tax and keep 
the Dominican Republic in CAFTA.  The senate special 
commission conducted lengthy meetings today with 
administration fiscal officials and business interests; they 
have adjourned after deciding to appoint a subcommittee to 
negotiate with the administration and other interests. There 
will be no vote today, December 15, and it is not clear when 
a text will be ready for consideration by the general Senate. 
 End summary. 
 
Against Tax Breaks: President Fernandez and the IMF 
--------------------------------------------- ------ 
 
2. (SBU) President Fernandez in public remarks December 14 
strongly reiterated his support for CAFTA and warned that 
"compensatory" tax breaks that have been added to a bill to 
repeal a protectionist 25% tax on fructose-sweetened 
beverages must be removed to gain his approval of the final 
legislation.  He said that the tax breaks place special 
interests above the national interest, which, he asserted, "I 
will not permit."  As an example, he cited a proposed 
exemption from a 10% foreign exchange surcharge of capital 
goods for all domestic industries.  Fernandez emphasized that 
the 25% tax must be removed to clear the way for ratification 
of the Dominican Republic's free trade agreement with the 
United States and Central American countries(CAFTA).  He 
reminded the press that the country sends 80% of its exports 
to the United States and cannot afford to stay out of CAFTA. 
Congress must repeal the 25% tax to ensure Dominican 
participation in CAFTA, he said. 
 
3. (SBU) Internal Revenue Director General Juan Hernandez and 
Customs Director General Miguel Cocco met with key senators, 
including Senate President Andres Bautista (PRD), on December 
15 for three hours, seeking to iron out the differences.  A 
close advisor to Hernandez said the government was sticking 
to its guns:  tax repeal yes, tax breaks no.  Cocco is 
advocating that compensation for industry should be dealt 
with separately, and perhaps later. Senate president Bautista 
told Charge Kubiske late on December 14 that he needed to 
work with the government to find out the limits of how much 
the bill could offer in tax breaks without compromising IMF 
targets. 
 
4. (SBU) On December 13-14 IMF representative Ousmene 
Mandieng  publicly opposed the "compensatory" tax breaks, 
which, he said, would result in an unacceptable loss of 
revenue to the government.  Mandieng told us on December 15 
that anything causing deviation from agreed fiscal targets 
means trouble for the tentatively agreed IMF standby 
agreement.  He said the bill submitted last week (reftel) 
included such wide-open tax exemptions that it it was 
impossible to quantify the fiscal impact.  If revisions to 
the bill result in measures with calculable fiscal costs, the 
Dominicans will have to identify other measures to offset the 
fiscal impact.  He said that the financing gap projected for 
2005 for the non-financial public sector of 0.7 percent of 
GDP is already a problem and expressed skepticism that 
funding offsets could be found.  Mandieng commented that the 
IMF does not renegotiate its technical agreements or 
micromanage governments. 
 
For Tax Breaks:  Senate and Business 
------------------------------------ 
 
5. (SBU) Embassy officers met December 14 with Senator Juan 
Morales (PRD), chairman of the special committee considering 
the tax repeal bill, and committee members Senator Alejandro 
Santos (PRD) and Angel Perez (PRD).  The senators spoke with 
one voice:  the Senate had failed four times to pass the 
government's original bill, because many senators have 
obligations or links to the traditionally powerful sugar 
industry.  Only with "compensating" tax breaks would a 
majority of Senators vote to repeal the 25 percent tax 
enacted in September.  The repeal bill including the tax 
breaks, which passed a first reading March 7, was designed to 
help the sugar sector and other industries prepare to compete 
effectively in a free trade environment.  The senators shared 
a calculation of the fiscal impact of the tax exonerations on 
imports of capital equipment, prepared by former Technical 
Secretary of the Presidency Carlos Despradel, of RD $831.5 
 
SIPDIS 
million (US $28 million) per year -- not a showstopper, in 
their view.  Senator Santos, who also chairs the Senate's 
industry and trade committee, subsequently told the press 
that the IMF representative's criticism of the bill had been 
"disrespectful and precipitate." 
 
6. (SBU) The senators December 14 outlined proposed revisions 
to the draft bill (previously faxed to State, Treasury, and 
USTR) to mitigate the fiscal impact while leveling the 
playing field for Dominican businesses: 
 
-- In Article 5, the exemption from the 10% foreign exchange 
surcharge on imports (set to rise to 13% in 2005) would be 
limited to machines, equipment, and replacement parts for 
industry; the application to "inputs for the sugar industry" 
would be deleted as open to abuse.  This "inputs" provision 
had provoked revenue chief Hernandez's recent off-the-cuff 
estimate of annual revenue losses of RD $4.5 billion (US $158 
million).  The bill's author, Senator Ramon Alburquerque 
(PRD), has argued that Article 5 as a whole will maintain 
incentives for investors, in competition with alternative 
foreign destinations.  The exchange surcharge mechanism, 
voted by the Monetary Board instead of approved by Congress, 
is being challenged in the courts as unconstitutional. 
 
-- In Article 4, Paragraph IV, the compensation for 
value-added (ITBIS) paid to suppliers would not be automatic 
(the government deems this to be unworkable), but the law 
would require the government to adjudicate it and deliver the 
accounting two monoths after the deposit of ITBIS (VAT). 
Business interests maintain that the government is in arrears 
on these reimbursements to the tune of RD $1.2 billion (US 
$42 million).  Except for the reduction of a considerable 
"float" in retained payments, the proposed improvement in 
administration of existing tax law would be essentially 
revenue-neutral for the government, but would reduce costs to 
business. 
 
-- In Article 2, sub-para 2.1., the cap of 5 percent of 
assets on deductions for capital depreciation and 
improvements in agroindustry would be removed.  This, they 
said, would move in the direction of establishing a level 
playing field in CAFTA for Dominican businesses, since 
Central American counterparts have no limits on such 
deductions.  Senator Alburquerque has stated that this 
provision would benefit thousands of small and medium sugar 
growers ("colonos"), not just "three or four rich families." 
 
7. (SBU) The senators emphasized their desire to level the 
playing field.  They displayed a chart, reflecting business 
sentiment, comparing the tax levels businesses pay in the 
production process in the Dominican Republic and the five 
Central American nations.  Total taxes on production 
(including VAT), import duties on machinery, and foreign 
exchange surcharges), according to this analysis:  Dominican 
Republic 31 percent, Costa Rica 1 percent, Guatemala 12 
percent, El Salvador 13 percent, Nicaragua 15 percent, and 
Honduras 2 percent. 
 
8. (SBU) Business associations, previously divided on the 
repeal of the 25% tax (sugar sector against, free zone 
exporters in favor) have begun to converge behind the current 
package of repeal plus compensation.  The prestigious 
National Associaion of Private Enterprise (CONEP) and 
Association of Industries of the Dominican Republic (AIRD) 
have both issued supportive statements in recent days, as has 
the country's largest sugar exporter, Central Romana. 
However, the Chamber of Commerce and Production of Santiago 
-- the nation's second largest city, which depends on 
free-zone manufacturing for export -- criticized the 
controversy over repeal of the 25% tax as "lamentable, 
inopportune, and counterproductive." 
 
Next Steps 
---------- 
 
9. (SBU) After a long day of meetings with fiscal authorities 
and businesses, the Senate commission appointed a 
subcommittee and adjourned. The private sector leaders intend 
to meet with President Fernandez.  The outcome of these 
various engagements, brokered as possible by the subcommtiee 
will determine the timing of a Senate special committee 
meetings and the session of the full Senate to consider the 
bill, and subsequent consideration by the Chamber of Deputies 
(lower house of Congress). 
 
10. (SBU) Chamber of Deputies president Alfredo Pacheco (PRD) 
told Charge Kubiske early on December 15 that he expected the 
obstacles to removal of the 25 percent tax to be resolved 
that day, even though the actual voting process in both 
houses would take longer.  Chamber finance committee chairman 
Marino Collante (PRSC) said to us December 14 that once the 
Senate approves the repeal bill, he could move it though his 
committee to the Chamber floor in 2-3 days.  He, Pacheco, and 
a solid majority of the deputies favor repeal.  Collante said 
that they would have to consider the fiscal impact of the 
"compensation," and he would prefer to omit it from the bill. 
 But if the impact is "mild," he believes the measure will be 
approved.  Senate president Bautista commented that he hopes 
to achieve final legislative approval by December 24; 
Congress will adjourn January 12, but could be called back 
into special sesion by the President. 
 
11. (SBU) In the event the Chamber of Deputies amends the 
bill as passed by the Senate, the modified bill would have to 
go back to the Senate for its approval of the changes, 
according to Article 40 of the Dominican Constitution.  Then 
the approved bill would go to President Fernandez for 
approval. 
KUBISKE