US embassy cable - 03TEGUCIGALPA896

UNCLAS SECTION 01 OF 03 TEGUCIGALPA 000896 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR WHA/CEN, WHA/ESPC, DRL/IL, AND EB/IFD/OMA 
STATE PASS AID FOR LAC/CEN 
STATE PASS USTR FOR ANDREA GASH DURKIN 
TREASURY FOR JOHN JENKINS 
DOL FOR ILAB 
 
E.O. 12958: N/A 
TAGS: PINR, EFIN, ETRD, ECON, ELAB, HO 
SUBJECT: C-AL3-00272: IMPORT DUTIES HAVE DECLINING 
IMPORTANCE IN HONDURAN CENTRAL GOVERNMENT BUDGET 
 
REF: (a) STATE 76257 
 
     (b) TEGUCIGALPA 546     (c) TEGUCIGALPA 865 
     (d) TEGUCIGALPA 494 
     (e) TEGUCIGALPA 225 
     (f) TEGUCIGALPA 010 
 
1. (SBU) Summary.  Honduran trade liberalization over the 
past 13 years has resulted in a declining dependence on 
import duties and other taxes on international trade.  In 
2002, revenue from import duties had dropped to only 2.2 
percent of GDP and an estimated 12.2 percent of total tax 
revenue (excluding taxes on oil products).  The gap has been 
made up, primarily, by an increase in the sales tax rate. 
Given that about 55 percent of Honduran imports come from 
the United States, a CAFTA-related reduction in import 
duties would be significant but manageable for the 
government.  There has been no discussion to date on the 
likely way of compensating for the revenue from CAFTA (or 
eventual FTAA) tariff reductions; measures are likely to 
involve elimination of remaining tax exemptions or a small 
increase in the sales tax rate.  End Summary. 
 
2.(SBU) Ref a requested reporting on the effect that a loss 
of tariff revenue would have on government budgets following 
the implementation of the U.S.-Central American free trade 
agreement (CAFTA).  Reftels b through f provide extensive 
reporting on the 2003 budget (currently under substantial 
revision), the government's fiscal difficulties and efforts 
to confront them.  In addition, a recent report by an IDB- 
funded team on Honduran tax policy provides useful 
historical data on the trends in customs duties receipts 
over the past 13 years that can be used to project the 
direct impact of tariff revenue losses, once the basic 
parameters of the CAFTA agreement are agreed.  These data 
are provided below. 
 
3. (SBU) Since the early 1990s, Honduras has transformed the 
structure of its taxation of trade.  Export taxes have been 
eliminated, and substituted with export promotion policies 
(including the granting of extensive investment incentives 
such as tax exemptions).  High tariff barriers to imports 
have been progressively dismantled in conjunction with other 
countries in the region and the Central American Common 
Market.  As of 2002, Honduras had 5,982 eight-digit tariff 
schedule line items, of which 5,169 registered some imports. 
There were 13 tariff levels in the tariff schedule, with an 
average nominal rate of 6.5 percent (and a trade weighted 
average of 8.4 percent in 2000).  Most tariffs are now 
between 0 and 15 percent.  As of 2001, 73 percent of 
Honduras's tariff schedule was harmonized with the rest of 
Central America (and further harmonization was achieved in 
2002).  Tariff dispersion in 2002 was a relatively healthy 
7.4 percent. 
 
4. (SBU) Accordingly, customs duties in Honduras have 
dropped progressively since 1990 as a percentage of both GDP 
and total tax revenue.  Import and export duties fell from 
5.6 percent of GDP in 1990 to 2.5 percent of GDP in 2001 and 
an estimated 2.2 percent of GDP in 2002.  Similarly, import 
and export taxes fell from 37.5 percent of total tax revenue 
in 1990 to only 15.2 percent in 2001 (and 12.2 percent of 
total tax revenue if oil import taxes are excluded).  The 
lowering of customs duties in Honduras in the 1990s was 
accompanied by an increase in the sales tax rate to 12 
percent for most products.  As can be seen by the chart 
below, by 2000, sales tax revenues had replaced import 
duties as the most important source of government revenues. 
 
                         Table 1 
             International Trade Tax Revenues 
 
             1990       1995      2000      2001      2002 
 
                (millions of nominal Lempira) 
Total trade 707.2     1607.2    2088.2     2448.1   2437.7 
Imports     493.2     1429.5    2082.8     2448.1   2437.7 
  Oil        58.4      323.5     297.0      598.4    708.0 
  Other     434.8     1106.0    1785.8     1849.7   1729.7 
Exports     214.0      177.7       5.4        0.0      0.0 
 
                      (percent of GDP) 
Total Trade   5.6        4.3       2.4        2.5      2.2 
Imports       3.9        2.8       2.4        2.5      2.2 
  Oil         0.5        0.9       0.3        0.6      0.6 
  Other       3.5        2.9       2.0        1.9      1.6 
Exports       1.7        0.5       0.0        0.0      0.0 
 
                  (percent of tax revenue) 
Total Taxes  100.0     100.0     100.0      100.0    100.0 
 Income       22.8      28.5      19.9       22.0     22.7 
 Property      0.8       0.8       1.3        1.1      1.0 
 Cap.Gains     0.0       0.6       0.5        0.3      0.0 
 Sales        18.2      20.6      35.2       33.2     35.2 
 Selective    13.4      15.1      11.2       12.0     10.9 
 Services      4.8       3.8      17.6       16.2     17.6 
 Trade        37.5      24.8      14.3       15.2     12.5 
 Other         2.4       5.8       0.0        0.0      0.0 
 
5. (SBU) Revenue projections from the GOH's 2003 Central 
Government budget are shown below.  These numbers are 
expected to change significantly as a result of the adoption 
of new tax measures on April 2 (see ref b).  The GOH hopes 
that these measures will add as much as 2 billion lempiras 
(usd 118 million) to the budget in 2003 and 3.5 billion 
lempiras (usd 206 million) in 2004 and thereafter. 
 
                           Table 2 
           Central Government Revenue Projections 
                         2003 Budget 
 
                        Millions         Pct of 
                        lempira          Total 
Total Revenue            32944.0          100.0 
 Tax Revenue             19803.0           60.0 
   Income Tax             4315.0           13.0 
   Property Tax            212.0             .6 
   Sales and Consumption  9267.0           28.0 
   Services               3357.7           10.0 
   Import Duties          2608.0            8.0 
   Other                    44.0            0.0 
 Non-Tax Revenue          1163.0            3.5 
 Goods and Services         16.0            0.0 
 Property Income            79.0            0.2 
 Aid and Donations        1447.0            4.5 
 Capital Revenues         3445.0           10.5 
 Financing                6988.0           21.0 
 
6. (SBU) Approximately 55 percent of Honduran imports come 
from the United States.  Thus, the reduction in import 
duties on imports from the United States expected after 
CAFTA would be a significant revenue reduction during this 
period of high deficits; however, it would be manageable.  A 
very rough estimate would indicate a revenue loss of about 
usd 80 million per year if all tariffs were eliminated 
immediately.  During 2002 and 2003, the government has 
attempted to offset the continued reduction in customs 
duties receipts with measures aimed at broadening the tax 
base (reducing exemptions from income and sales tax).  There 
has been no discussion to date on the likely way of 
compensating for CAFTA (or eventual FTAA) tariff reductions. 
It is possible that the GOH would propose an increase in the 
sales tax rate. 
 
7. (SBU) Comment: The IDB consultants, in a February 
briefing for Econcouns and USAID economist, also noted their 
belief that in addition to the reduction in customs duty 
revenue, the trade liberalization in the CAFTA agreement 
will provoke additional GOH spending or tax breaks as 
"compensation" to sectors negatively affected by increased 
competition.  This is a possibility, as the Honduran 
Congress has consistently shown its willingness to enact 
special legislation for individual sectors.  However, the 
current critical fiscal problems and the likelihood of 
fairly strict fiscal targets in a future IMF agreement will 
probably limit the GOH's ability to provide trade adjustment 
assistance to companies or individuals.  On the plus side, 
the positive impacts from a free trade agreement -- 
increased investment, faster growth, and increased 
efficiency -- are expected to result in increased (non- 
tariff) government revenues as well.  As noted above, the 
GOH also traditionally has provided significant export 
promotion incentives in the form of exemptions from a range 
of taxes.  To the extent that the GOH agrees in the course 
of the CAFTA negotiations to reduce some of these investment 
incentives, this would also have a positive effect on the 
government's tax revenues.  End Comment. 
PALMER