The fiscal impact of trade liberalization and commodity price fluctuation: the case of Costa Rica, 1980-1998

Summary Following a period of economic growth, political stability and poverty reduction spanning two decades (1960-1979), Costa Rica experienced at the beginning of the 1980´s the worst recession in its most recent history. In 1981 and 1982 gross domestic product (GDP) fell by -2.3% and -7.3%. Analysts pinpoint to short term economic factors and long run structural problems as the main causes of the recession. Short term economic factors comprise the end of the coffee price bonanza and the second oil shock. Long run structural factors are rooted in the economic imbalances generated by the adoption of import substitution strategies. In 1985 the authorities undertook a change of regime which mixed free market with state intervention policies. Free market policies aimed at getting the prices right" by liberalizing trade through tariff and traditional export tax reduction, and by eliminating trade barriers. State intervention policies were encapsulated into non-traditional export promotion schemes and a target real exchange rate tending to favour export performance. These government policies were justified on the grounds of compensating the anti-export bias that guided the commercial policy of Costa Rica during the import substitution era. The implementation process was very gradual and began with export promotion policies followed by reduction of import and export barriers. From 1986 to 1994 trade liberalization policies were followed on a systematic basis. The tariff ceiling was substantially reduced, and tariff dispersion as well as effective protection diminished. Taxes levied on non traditional exports disappeared, while taxes on traditional exports were significantly lowered. Finally, most non tariff barriers were eliminated as quantitative import restrictions were replaced with tariffs in compliance with the Uruguay Round negotiations of the General Agreement on Tariffs and Trade. During 1995-1996, the country experienced temporary interruptions in its tariff reduction and trade liberalization commitments in part due to a recession caused by internal contractionary policies and external factors (i.e., "the Tequila effect"). In 1997 as GDP growth overcame its trough, the authorities continued their outward oriented efforts. The policy centered mostly on a national tariff reduction schedule that would comply with the Central American Common External Tariff. The country plans to reach this tariff schedule in the year 2000. While trade liberalization has eliminated import surcharges and lowered, to great extent, the weight of export taxes in fiscal revenue, the same cannot be said about import duties. Export taxes represented 23.3% of total revenue in 1983. By 1994-1998, they represented 2.1%. The reduction of fiscal dependence on export taxes has shielded the fiscal accounts from the volatility of primary commodity price fluctuation. Import duties have, however, increased their weight in fiscal revenue. They accounted for 5.6% of total revenue in 1983 and for 13.2% for 1994-1998. The greater dependency of fiscal equilibrium on import duties is due both an increase in the import tax base as a consequence of liberalization and perhaps to a shift in the propensity to import. If trade reform has allowed a better allocation of resources by liberalizing import prices, it has also placed a restriction on output growth by increasing the possibilities of a balance-of-payments constraint scenario. Export promotion policies materialized into tax exemption schemes such as the CAT (tax redemption certificates). CATs were equivalent to an income tax deduction and represented 1.9% of total expenditure in 1985 and 4.2% by 1994-1998. The government has stopped the issue of new CATs and their fiscal impact will vanish by the year 2000. This will certainly be a source a fiscal respite and a basis on which to further reduce import duties without compromising internal equilibrium.  "