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Panama Tax System and Fiscal Policy Summary

Core Content

This document presents an analysis of Panama's tax system and fiscal policy, focusing on its structure, performance, and areas for reform. It is part of the International Monetary Fund (IMF) staff report for periodic consultations with the country, completed on February 8, 2023.

Main Features of the Tax System

• Low Tax Revenue: Panama's tax revenue is historically low, at 8.2% of GDP in 2019, significantly below Latin America and the Caribbean (LAC) and OECD averages.
• Tax Incentives and Exemptions: The tax system heavily relies on incentives and exemptions, which affect both fairness and efficiency.
• Progressivity and Transparency: There is potential to modernize the system by increasing its progressivity, transparency, and alignment with international best practices.
• Fiscal Deficits and Social Spending: Low taxation leads to chronic fiscal deficits and limits fiscal space for social inclusion policies.

Key Taxes and Their Performance

A. Consumption Taxes

• ITBMS (Tax on Transfer of Tangible, Mobile Goods and Service Rendering):

  • Standard rate: 7%, with higher rates for specific goods (e.g., cigarettes, alcohol).
  • ITBMS revenue is low (2.2% of GDP) and C-efficiency is 0.49, indicating a weak base due to exemptions and non-compliance.
  • Exemptions disproportionately benefit the wealthy, with the top decile receiving 42.6% of total benefits, while the lowest decile receives only 7.6%.
  • Exemptions on digital services and low-value imported goods (LVIGs) create unfair competition and revenue losses.
  • The half-yearly $1,000 exemption for purchases from the Colon Free Port is inefficient and should be eliminated.

• VAT (Value-Added Tax):

  • Panama's VAT rate is one of the lowest in the world (7% standard rate).
  • The C-efficiency of VAT is 0.49, similar to ITBMS, indicating significant base erosion.
  • The VAT system is more effective in encouraging compliance and formalization compared to a single excise tax.

• Excise Taxes:

  • Applied on selected goods with negative externalities (e.g., cigarettes, alcohol, fuel).
  • Excise revenue decreased from 1.16% to 0.96% of GDP between 2016 and 2019.
  • Revenue from excises on cigarettes is particularly low (0.04% of GDP), partly due to smuggling.
  • Specific excise rates for alcoholic beverages and fuel products have not been updated since 2000 and may not be aligned with efficiency and inflation.

B. Taxation of Labor Income

• Personal Income Tax (PIT):

  • Standard rate is 25% for the top decile, with progressive brackets.
  • PIT revenue is 1.8% of GDP, lower than similar developed countries like Uruguay, Mexico, and Brazil.
  • High levels of labor informality and deductions/exemptions contribute to lower tax revenues.

• Social Security Contributions (SSC):

  • Composed of three branches: old-age and invalidity, health, and occupational health insurance.
  • SSC rates are relatively high, with employee contributions at 9.25% and employer contributions at 8.00%.
  • These contributions account for about 6.0% of GDP.

• Education Security Levy (ESL):

  • A tax on labor income, with a rate of 25% for those earning above US$50,000.
  • 27% of ESL revenue is allocated to a special education fund, while the rest goes to the Ministry of Education.
  • The presence of both PIT and ESL is seen as redundant and inefficient; unification is recommended.

Main Viewpoints and Policy Implications

• Fiscal Sustainability: The current tax system is not sustainable due to low revenue and high non-compliance.
• Fairness and Efficiency: Tax exemptions and non-compliance disproportionately benefit the wealthy and reduce overall efficiency.
• Reform Priorities:
  • ITBMS Reform: Eliminate exemptions that benefit the rich, reduce non-compliance, and improve VAT refund systems for exporters.
  • Excise Reform: Increase excise rates on goods with negative externalities, especially cigarettes and fuel, and strengthen border controls to prevent smuggling.
  • PIT and ESL Unification: Merge the PIT and ESL to eliminate redundancy and improve efficiency.
• International Comparison: Panama's tax system is underperforming compared to regional and OECD peers, especially in terms of VAT and excise revenues.

Key Information

• Tax Revenue by Source:

  • PIT: 1.8% of GDP
  • CIT: 1.9% of GDP
  • VAT: 2.2% of GDP
  • Excises: 0.96% of GDP
  • Social Security Contributions: 5.8% of GDP

• Non-Compliance Levels:

  • Estimated at around 40% in Panama, significantly higher than in countries like Uruguay, Chile, Poland, and Latvia.

• Tax Expenditures:

  • Panama does not publish a comprehensive tax expenditure review annually, and legal provisions to curtail such expenditures are lacking.

• VAT and Excise Efficiency:

  • The VAT system is more effective in promoting compliance and reducing cascading effects compared to a single excise tax.
  • Excise taxes on goods with negative externalities should be increased to align with international standards and address smuggling.

Conclusion

Panama's tax system is characterized by low revenue, extensive use of tax incentives, and high non-compliance. These factors hinder fiscal sustainability and fairness. Reforming the system to increase progressivity, reduce distortions, and align with international best practices is essential. The focus should be on improving the VAT and excise systems, addressing non-compliance, and unifying the PIT and ESL to enhance efficiency and equity.