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TAX EXPENDITURES IN PANAMA, 1975:
AN EMPIRICAL STUDY

By

Victoriano Moreno Vargas

A DISSERTATION

Submitted to
Michigan State University
in partia] fuifiliment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Department of Economics

1978

67 ”033/70

ABSTRACT

TAX EXPENDITURES IN PANAMA, 1975:
AN EMPIRICAL STUDY

By

Victoriano Moreno Vargas

This dissertation presents an estimate of tax expenditures
in the income tax system of Panama for 1975. There is a need to
measure the contribution of the government to corporations and
individuals through the different forms of tax incentives and other
forms of tax preferences. These preferences affect the vertical and
the horizontal equity of the tax system. On the other hand, the tax
base of system has been eroded due to the indirect measures to
promote certain economic and social activities and have affected the
market resources allocation.

Tax expenditures may be defined as those special provisions
of the income tax system which represent government expenditures made
through the tax system to achieve specific social and economic objec-
tives. These special provisions involve deductions, credits,
exclusions, exemptions, deferrals, and preferential tax rates to
taxpayers.

An overview of Panamanian economic development during l970
to 1975 is presented, including a descriptive outline of the public

sector and the tax system. During the 1960's Panama's economy

Victoriano Moreno Vargas

achieved a high rate of growth, but the distribution of income and
wealth was markedly unequal. The public sector, at the same time
emphasized a policy of tax incentives to promote private investment.

During the 1970's, the tax system was unable to raise the
required resources for the government's programs. This problem
caused public sector investment to be financed largely through
foreign loans. Therefore, public debt services as a proportion of
the gross domestic product reached much higher levels. Moreover,
the tax system is generally regressive with a narrow taxable base.
Almost every tax has extensive exemptions, deductions and exclusions,
and the income tax discriminates in favor of non-labor income.

This study reviewed the theory of tax expenditures and
their effects on the tax system. It has been observed that tax
expenditures affect the equity and efficiency of the tax system,
and unlike direct government spending, they are not subject to
budgetary controls. Consequently, these special tax provisions have
become major loopholes for avoidance and evasion in the personal and
corporate income tax.

The analysis of a random sample of 2,237 individuals'
income tax returns revealed that the deduction of mortgage interest
payments on owner-occupied homes, and property tax deductions were
the major tax expenditures. Almost 89 percent of total individual
tax expenditures are accounted for by these two deductions. These
tax expenditures are concentrated basically in the private ownership

of homes by middle- and high-income groups. That is to say, the

Victoriano Moreno Vargas

benefits due to individual income tax deductions are quite unequally
distributed.

The Panamanian income tax system excludes from taxation
certain non-labor incomes such as prizes from the national lottery,
interest payments from savings accounts, gains from the race track,
etc. Close to B/.l8.0 million was the estimated loss of revenue in
1975 for these tax provisions.

Corporate tax expenditures were estimated to be B/.3.5
million in l975. The study of a random sample of the corporate
income tax returns revealed that 11.3 percent of total corporate
tax expenditures are due to special deductions allowed by the
income tax law. These deductions are highly favorable to large
corporations. Manufacturing, commerce, real estate and banking
benefit the most from these tax expenditures.

It is concluded that Panamanian individual and corporate tax
expenditures are very unequally distributed among taxpayers. Tax
savings from the special provisions are highly pro-rich. Moreover,
tax incentives to promote economic and social objectives are con-
tributing to tax evasion, avoidance, and inefficiency in the use of
resources. The study recommends that the extensive use of tax

expenditures should be a special concern in the country.

Dedicated to

Noemi, Nani, Olito and Cristian

ii

ACKNOWLEDGMENTS

I am indebted to a number of pe0ple who in various ways
helped me to conclude this study.

My principal debt is to Milton Taylor, who has always shown
an interest in my work, supported my effort, and as my thesis advisor
guided me during the study. I am also grateful to Dan Saks, Ron
Fisher, and A. Gurwitz,as members of the thesis committee, for their
liberal assistance and orientation during the stages of writing.

I am grateful to Nicolas Ardito Barletta, Ministry of Plan-
ning and Economic Policy of Panama, who allowed me the opportunity to
conclude this demanding program. I am indebted to the Agency for
International Development (USAID, Panama) for the financial assistance
which allowed me to carry on this study. I also appreciate the
assistance of Luis M. Adames P., Ministry of the Treasury of Panama,
for granting me the income tax information and Miguel Welsh from the
Computer Department and Daisy Ampudia from Norms and Planning Depart-
ment for their help during the tax survey. For typing of innumerable
drafts, I am grateful to candida Fuentes.

Finally, my special gratitude to my family for their moral
support. My wife, Noemi, has been a continual source of encourage-
ment, and with her, my little ones: Cristian, Olito, and Nani, have

born well the burden and endured my absence from home, required during

the time of my graduate study. Without these special contributions

it is doubtful that I would have completed this demanding task.

iv

TABLE OF CONTENTS

Page

LIST OF TABLES . . . . . . . . . . . . . . . vii
Chapter

I. THE PURPOSE AND SCOPE OF THE STUDY . . . . . . l

The Purpose of the Study . . . . . . . . . 1

Procedures Used in the Study . . . . . . . 9

The Scope of the Study . . . . . . . . . l0
II. THE PANAMANIAN ECONOMY, THE PUBLIC SECTOR, AND THE

TAX SYSTEM . . . . . . . . 12
The Economic Development of Panama from l969 to
1975. . . . . . . . . . . . . l3
The Public Sector . . . . . . . . . . . 22
The Public Debt . . . . . . . . . . . . 24
The Tax System . . . . . . . . . . . . 28
Summary . . . . . . . . . . . . . . 42
III. THE THEORY OF TAX EXPENDITURES . . . . . . . 44
Tax Incentives . . . . . . . . . 45
Individual Tax Expenditures . . . . . . . . 58
Capital Gains . . . 60
Exclusion of Interest on State and Local Bonds . 63
Other Individual Tax Expenditures . . . . . 64
Corporate Tax Expenditures . . . . . . . . 65
Depletion Allowances . . . . . . . 67
Excess Depreciation Allowances . . . . . . 67
Investment Credits . . . . . . . . . . 68
Summary . . . . . . . . . . . . . . 72

IV. SAMPLE DESIGN TO DETERMINE THE INDIVIDUAL AND
CORPORATE TAX EXPENDITURES FROM PANAMA'S INCOME

INCOME TAX RETURNS . . . . . . . . 75
Individual Sample . . . . . . . . . . . 75
Corporate Sample . . . . . . . . . . . 80

V. INDIVIDUAL TAX EXPENDITURES . . . . . . . . 84

Chapter

Measurement of Individual Tax Expenditures .
Estimate of Individual Tax Expenditures
from Non- Reported Income, 1975

Tax Expenditure Estimates from Social Security .

Benefits, 1975. . .
Tax Expenditure Estimates from Income Derived
from Individual Properties . . . .
Individual Tax Expenditures Derived from
Income Tax Returns
Summary

VI. CORPORATE TAX EXPENDITURES .

Investment Tax Credits

Export Tax Credits . .

Corporate Tax Expenditures Derived from Income
Tax Returns

Summary

VII. SUMMARY AND CONCLUSIONS .
BIBLIOGRAPHY

vi

Page
85
89
91
93

96
100

102

102
104

107
114

115
124

Table

10.

11.

12.

13.

14.

LIST OF TABLES

Distribution of Income in Panama and Other Latin
American Countries

Gross Domestic Product by Sectors, 1970 to 1976
(in Millions Balboas at Constant 1960 Prices)

Aggregate Demand and Supply, 1970 to 1976 (in
Millions of Balboas at Constant 1960 Prices)

Central Government Expenditures by Departments,
1970 to 1975 (in Millions of Balboas) . .

Public Sector Expenditures and Gross Domestic
Product, 1970 to 1975 (in Millions of Balboas
at Constant 1960 Prices) . . . . . . .

Central Government Operations and the Public Debt,

1970 to 1975 (in Millions of Balboas) .

Ordinary Government Revenues of the Republic of
Panama, 1970 to 1976 (Millions of Balboas)

Distribution of Tax Expenditures, 1972

Corporations Paying No Federal Income Taxes, 1974
(Millions of Dollars)

Net Income and Federal Income Tax of a Corporate
Tax Sample, 1973 and 1974 (Billions of Dollars)

Federal Government Direct Expenditures and Tax
Expenditures, 1976 (Billions of Dollars

Estimated Distribution of Total Tax Expenditures
of Individuals, Calendar Year 1974 .

The Effect of Capital Gains Provisions, Fiscal
Year 1974

Tax Expenditures from Interest on State and Local
Debt Government, Fiscal Year 1974 . .

vii

Page

17

19

21

23

25

27

36
50

52

53

57

59

61

64

Table
15.

16.

17.

18.

19.

20.

21.

22.

23.

24.

25.

26.
27.

28.

29.

Other Individual Tax Expenditures, Fiscal Year
1974 . . . . . . . . . . . . . .

Corporate Special Tax Expenditures, Fiscal Years
1974 to 1977 (Millions of Dollars) . . .

Distribution of Benefits by Income Class for
Special Provisions, Fiscal Year 1974 . . .

Population and Sample of the Survey to Determine
the Individual Tax Expenditures from Panama's
Income Tax Returns, 1975 . . . . . . . . .

Population and Sample of the Survey to Determine
the Corporate Tax Expenditures from Panama's
Income Tax Returns, 1975 . . . . . . . .

Distribution of Income Tax Returns by Income
Brackets for 1975 . . . . . . . . . . .

Distribution of Income by Income Brackets, 1975
(Percentages) . . . . . . . . . . . . .

Estimate of Individuals' Tax Expenditures from
Non-Reported Income, 1975 (in Millions of
Balboas) . . . . . . . . . . .

Tax Expenditures Estimates from Social Security
Benefits, 1975 (Thousands of Balboas). . .

Tax Expenditures Estimate from Property Income,
Years 1973 to 1975 (Millions of Balboas). .

Estimate of Individual Tax Expenditures from the
Individual Income Tax Returns, 1975 (in Balboas)

Individual Tax Expenditures by Income Groups, 1975

Dividends Capitalized Due to Investment Tax Credit,
1977 (in Thousands of Balboas) . . . . . .

Total Exports of Goods and Exports Subject to
Export Tax Credits, 1975 to 1977 (Millions of
Balboas) . . .

Exports Promoted by Tax Credits, 1975 to 1977

(in Balboas) . . . . . . . . . . . .

viii

Page

66

69

70

76

81

86

88

90

92

95

97
99

103

105

106

Table Page

30. Tax Expenditures Due to Exports Tax Credit
Certificates, 1975 to 1977 (in Balboas) . . . . 108

31. Estimate of Corporate Tax Expenditures from
Corporate Income Tax Returns, 1975 (in Balboas) . 110

32. Corporate Tax Expenditure by Income Groups, 1975 . . 112

33. Corporate Tax Expenditures by Economic Activity,
1975 (in Thousands of Balboas) . . . . . . . 113

34. Panama Individual and Corporate Tax Expenditures
from Income Tax Returns, 1975 (in Balboas) . . . 118

35. Summary of Panama Tax Expenditures, 1975 (in
Millions of Balboas) . . . . . . . . . . 121

ix

CHAPTER I

THE PURPOSE AND SCOPE OF THE STUDY

The Purpose of the Study

 

This study is an attempt to measure the tax expenditures in
Panama for the year 1975. The tax expenditure concept is applied to
an income tax, taking into consideration that such a tax is built on
two structural elements. One element affects the structural provi-
sions required for the application of a normal income tax, that is,
the determination of net income, the use of annual accounting
periods, the specification of the entities subject to tax, and the
rate schedule and exemption levels. These elements shape the
revenue-raising factors of the tax. The other structural element
represents the special preferences found in every income tax.
These special preferences, generally called tax incentives or tax
subsidies, are departures from the normal tax structure designed to
favor a particular industry, activity or class of persons. These
special provisions take many forms, such as deferrals of tax liabili-
ties, deductions, permanent exclusions from income, and credits
against taxes or special rates. It is important to say that no
matter what the form is, the provisions represent government spend-
ing for the benefited activities of groups, made through the tax
system rather than through loans, direct grants, or any other forms

of direct government assistance.

Traditionally, the impact of the public sector in the
economy has been analyzed by the multiple budget theory developed
by Richard Musgrave, which emphasizes the allocative, stabilization

and distributive functions.1

Even though, in practice, governments
do not budget separately for the various functions they perform, the
analysis of the effects of government intervention in the economy
frequently follow this framework.

The first function of the public sector deals with the
problem of allocating resources. Classical economic theory assumed
that the price mechanism of the market secured an optimal allocation
of resources, and public policy need not concern itself with matters
of allocation except in a limited sense. However, it is now recog-
nized that there are many situations where the market forces fail
to secure optimal results. In such cases, the allocation function
of the public sector, through public policy, intervenes in order to
secure a more efficient resource allocation.

For example, the market mechanism can have inefficiency in
resource allocation in the following situations: (1) the supply of
public goods--consumer preferences are not known and no one can be
excluded from the benefits of public goods; (2) in imperfect market
situations, where both monopoly and the existence of institutional
restrictions inhibit a firm's free entry into the industry, causing

resource allocation to diverge from that obtained under purely

competitive conditions; (3) decreasing cost industries, which lead

 

1Richard A. Musgrave, The Theory of Public Finance (New
York: McGraw-Hill, 1959), Chapter 1.

 

to losses and to a non-optimal output; (4) the presence of externali-
ties with economies or diseconomies in a production and consumption;
and finally (5) when there is a high risk in undertaking investment
because of uncertainty.

Public policy, because of market failures, is used to secure
necessary adjustments in the allocation of resources. These adjust-
ments may be implemented through the instruments of direct sub-
sidies, indirect subsidies through taxation, and legislation for
control and regulation.

A second function of the public sector is to alter the dis-
tribution of income, which has been created by the free activities
of market forces, so that the new distribution is more consistent
with what is desired by society. In general terms, the goal of
distribution is to transfer income to those social groups which have
not succeeded in attaining a minimum income for subsistence. The
usual methods of changing the distribution of income is through the
application of progressive taxes on high-income groups and pro-poor
expenditures and transfers.

Lastly, the stabilization function of the public sector
involves the implementation of policies to attain objectives such
as: (l) a full employment of productive resources and the avoidance
of involuntary labor unemployment; (2) a relatively stable price
level; (3) economic growth; and (4) an equilibrium in the balance
of payments.

In many countries, a fiscal policy to maintain the objective

of full employment has been promoted through a direct increase in

government investment and the encouragement of private investment.
In economies dominated by the private market sector, it is important
to prevent a reduction in private investment as the public sector
investment is expanded.

The tax system also constitutes a principal instrument
through which the government administers its policies for growth,
distribution and stabilization. However, probably the main concern
of government policy in many Latin American countries is the achieve-
ment of a high rate of economic growth. This last policy implies,
if neoclassical economics is to be followed, a full and efficient
utilization of resources, and an optimum functioning of the market
economy. The government would also use the tax system as an
instrument in order to facilitate the activities of the private
sector.

Many Latin American economies also attempt to achieve
economic growth through indirect measures in the form of tax incen-
tives given to the private sector. However, the use of tax incen-
tives for growth interferes with income distribution. Joseph A.
Pechman2 and other analysts have found that tax incentives operate
as a subsidy for individuals and corporations, thus benefiting the
rich, while the low-income groups receive little or nothing from
the subsidies.

During the decade of the 1960's, Panama had an average

annual real growth rate of about 8 percent, which was one of the

 

2Joseph A. Pechman, ed., Comprehensive Income Taxation
(Washington, D.C.: The Brookings Institution, 1977), pp. 57-62, 116.

highest rates in Latin America. As a market-oriented economy, tax
incentives were used in Panama to stimulate the private sector in
order to promote investments for import-substitution industries. As
a result, the structure of taxation since that period has depended
on regressive indirect taxes as a principal source of government
revenues. Besides promoting a regressive tax system, the use of tax
incentives reduced the income tax base. The reduction of the tax
base, in turn, affected income distribution. In addition, the
reduction of the tax base made it difficult for the government to
finance necessary government programs, such as in education, health
and housing.

As a consequence of these policies, Panama developed a
marked unequal distribution of income and wealth, with a narrow band
of wealthy and a relatively large group of poor. Panama may have
had a high rate of growth during the 1960's, but there is little
doubt that the use of tax incentives exacerbated the mal-distribution
of income.

In Panama, as in most developing countries, the tax system
is considered to be an instrument for the achievement of a higher
standard of living for the population. The tax system is geared
towards promoting social and economic welfare through the encourage-
ment of expenditures by the private sector, expenditures to be made
with income saved through a series of tax incentives. The govern-
ment, then, plays an essentially passive role and relinquishes con-

trol of economic and social programs to individuals and firms in the

private sector, who are to use their tax benefits towards public
welfare.

Unfortunately, however, this passive role of the government
in encouraging private sector involvement through the provision of
tax incentives has not been an unqualified blessing. Tax incentives
for development in Panama have facilitated tax and avoidance and
evasion. Moreover, the costs of the tax incentive is unknown, as
they have never been measured. In addition, the deductions, credits,
and preferential treatment of certain economic activities allowed by
the tax incentives policies have reduced the tax base and increased
the difficulties of raising adequate revenue to finance needed
government programs.

Developed nations also share these dilemmas. In fact, it
has been estimated in the United States that federal tax incentives
totaled about $92 billion in 1976.3 Even before such facts became
known, Assistant Secretary of the Treasury for Tax Policy, Stanley
S. Surrey, took a new look at government subsidies as "tax expendi-
tures" in 1968. At that time, Surrey was examining the relationship
between a comprehensive, efficient, equitable, and simple tax system
and a tax system based on the promotion of reductions in tax
liabilities to encourage certain activities by the private sector.
He discovered that the tax system in the United States discriminated

against those who earn income from labor and benefits the rich,

 

3George F. Break and Joseph A. Pechman, Tax Reform: The
Impossible Dream? (Washington, D.C.: The Brookings Institution,
1975). P. 12.

large corporations, and the owners of property. In other words, he
found that the tax system was inhibiting seriously the principle of
vertical equity.

The effects of taxation policy on the distribution of income
is usually determined by comparing income distributions before and
after the impact of taxes. This requires a general equilibrium
analysis, for any government policy involving a new tax, the sub-
stitution of a new tax for another of equal yield, or the introduc-
tion of a tax incentive will affect the whole of the economy. Also,
any tax measure in one market of the economy is not likely to be
confined to that market alone. It is likely to produce repercus-
sions in other markets and bring about possible feedback effects in
the market initially affected.

It is important to note that the distributive and substitu-
tion effects of a tax measure can affect any household. This
results from changes in the prices for the productive services on
wages, interest rates, rents and profits. 0n the other hand, any
of these changes is likely to lead to changes in the equilibrium
quantities of productive resources that households are willing to
supply to the relevant markets. In addition, the households may
find themselves confronted with a new set of relative prices for
the outputs they consume. Given the household preference patterns,
such changes in the relative prices of outputs in turn alters the
equilibrium demanded of those outputs.

As a result of all of these interactions, the taxpayers will

face a new distribution of income and wealth which reflects the

burden of the new tax measures. The effect of such tax policies can
be measured in the change of real or nominal income of the popula-
tion, expressed through the use of a Lorenz curve.

In Panama, as in most developing economies, the distributive
effect of government tax policies has been neglected. The policies
of the public sector were dominantly oriented to the stabilization
and allocative functions, due to the fact that the main thrust of
tax policies and tax incentives were directed toward economic
growth.

On the other hand, this study is concerned with inquiring
into the degree to which the tax system of Panama is redistributive.
Two studies have been undertaken on the distribution of income and
the incidence of taxation in Panama. In the first of these studies
completed in 1969, McLure noted that "income in Panama was distribu-

"4

ted quite unevenly . . . His reasoning in part was based on the

monopoly position enjoyed in many industries.5 More specifically,
he states:

This (distribution) results from an essentially dual

economy in which one group receives relatively high

incomes originating in the advanced sector while a much

larger group lives on substantially lower incomes derived

from farming, domestic service and minor commerce.6

In a second study undertaken in 1973, Arun Shourie claimed that the

 

4Charles E. McLure, Jr., The Distribution of Income and Tax
Incidence in Panama, Summary and Conclusions (Panama: Agency for
International Development, 1969), p. 10.

5

 

Ibid., p. 6.

61bid., p. 10.

inefficiency of the Panamanian tax system contributed to the pattern
of inequality of income distribution.7

Basically, these two studies were primarily concerned with
the incidence of taxation. In the present study, the principal
concern is with tax expenditures. More specifically, this study
will attempt to quantify the degree to which personal and corporate
income taxes have been used for subsidy purposes to induce economic
growth in Panama.

This study of tax expenditures is significant for the fol-
lowing reasons: (1) there have been no studies undertaken to
measure the impact of tax expenditures on personal and corporate
income taxes in Panama; (2) there have been no studies to determine
quantitatively the equity and the efficiency of tax incentives in
Panama; (3) at this point in time, no one knows the amount of
revenue the government of Panama spends through tax incentives or
tax expenditures; and (4) this study will make it possible for the
government to formulate policy concerning the distribution of

income.

Procedures Used in the Study

 

In order to identify and measure tax expenditures in Panama,
this study first includes a brief review of the theory of tax
expenditures. An examination of the Panamanian tax code will then

be undertaken in order to list the principal deductions allowed as

 

7Arun Shourie, Ways of Helping the Poor of Panama: Some
First Impressions (Panama: Ministry of Planning and Economic
Policy, 1973), p. 28.

 

10

incentives for the personal and corporate income taxes. In addition,
an analysis of Panama's tax structure and its performances in the
development of the economy during the period 1970 to 1975 will be
presented in an effort to identify the economic impact of indirect
subsidies.

A principal goal of the study will be an examination of a
random sample of personal and corporate tax returns from Panama in
order to measure the amount of tax expenditures that existed in
1975. An analysis of these tax expenditures will be undertaken,
using economic activity and income brackets, in order to appraise
the fairness of the tax system, and the patterns of income distribu-
tion in corporate and personal income. The principal criterion for

this analysis will be the principle of ability to pay.

The Scope of the Study

The study is based on tax information for 1975. This year
was chosen because data for personal and corporate tax returns are
more readily available for this period than for more recent years.
It is assumed that the number of those persons and corporations that
were required to declare tax returns for 1975 have already been
presented and reviewed by the Ministry of the Treasury of Panama for
this year.

As the remaining chapters in this study have been developed,
Chapter II includes an analysis of the Panamanian economy for the
period from 1970 to 1975. This chapter also briefly describes the

expenditures of the public sector and the tax system. Chapter III

11

presents the theory of tax expenditures, and also includes an outline
description of the tax expenditures which have been used in Panama.
Chapter IV includes the study sample design, while Chapters V and VI
present an analysis of personal and corporate tax expenditures in
Panama, and in particular, shows the effects of tax expenditures on
the distribution of income. Chapter VII presents a summary and

conclusions of the study.

CHAPTER II

THE PANAMANIAN ECONOMY, THE PUBLIC SECTOR,
AND THE TAX SYSTEM

In comparison to economic development in most Latin American
countries, the development of the Panamanian economy has been unique.
The principal factor contributing to its uniqueness is the relation
of Panama to the international world economy, which has been shaped
by the Panama Canal. Its currency unit, the balboa, also has been
at a par with the U.S. dollar since 1904, and is completely con-
vertible. These characteristics have tied Panama to the movement of
the world economy.

Of all the factors responsible for the economic growth of
Panama, during the recent past, the chief source of growth is found
in the foreign sector. During this period, the government has been
engaged in preparing a more adequate environment for the activities
of the private sector, and in giving tax incentives to import sub-
stitution industries. The tax system was also used to channel
resources from the private sector for the regular government pro-
grams, such as education, health protection and public works.

This chapter considers these changes by presenting a summary

of the Panamanian economy in three parts: (1) the economic

12

13

development of Panama from 1969 to 1975, (2) the public sector, and

(3) the tax system.

The Economic Development of Panama
from 1969 to 1975

 

 

The Republic of Panama is a small developing country with an
area of 47,906 square miles. This area includes approximately 8
percent within the Panama Canal Zone. Its population, estimated at
1.7 million in 1975, is growing at an annual rate of approximately
2.8 percent. Close to 50 percent of this population lives in urban
areas, mainly Panama City.

As has been mentioned before, the economic growth of Panama
has been deeply influenced by its geographical position, and closely
tied to world trade and commerce. The 1960's was a period of rapid
economic growth which broadened the productive base of the economy.
The gross domestic product (GDP) at constant prices increased at an
average annual rate of 8 percent. During the same period, the
average real per capita income increased at an annual rate of 5
percent.

The two dynamic variables which contributed to this out-
standing performance of the economy were: (1) a high increase in
the export of goods and service, from the level of 8/.153 million
in 1960 to B/.390 million in 1970, an increase at an annual rate of
9.8 percent in real terms; and (2) the development of import sub-
stitution industries, such as food manufacturing and light indus-

tries.

14

Income from banana exports, canal earnings, tourism and the
international operations of the Colon Free Zone constituted the

1 Banana exports and income from the

chief elements of growth.
Panama Canal increased from B/.52 million in 1960 to B/.184 million
in 1969, representing about 55 percent of the increase in exports
for the period 1960 to 1969.

The positive effect of the import substitution industries
is evident from observing the sectorial GDP annual rates of growth
for 1960 to 1969: manufacturing, 10.3 percent; construction, 8.4
percent; power, water and gas, 12.1 percent; transport 10.5 percent;
and banking and financial activities, 14.4 percent. The policies
that the government instituted to make Panama a center for inter-
national banking also reinforced the dynamic performance of the
economy.

The dynamism is indicated in the coefficient of investment
to gross domestic product (I/GDP), which rose from 19.0 percent in
1960 to 28.0 percent in 1969. The rate of growth of gross invest-
ment in annual terms averaged 13.1 percent in this period.

Even though there was a favorable trend in the economic
growth in Panama during the 1960's, the economy entered the 1970's
with an imbalance in its economic base. A high proportion of the

country's economic activities are found concentrated in the cities

of Panama and Colon; these cities account for 48 percent of the

 

1Ministry of Planning and Economic Policy, Plan Nacional de
Desarrollo 1976-1980, vol. 1: Objectivos, Politicas y Metas
Globales y SectOriaTes (Panama, 1976), p. 240.

 

15

population and about 45 percent of the nation's income. The majority
of the national output has been generated through manufacturing,
utilities, commerce and the service sectors. 0n the other hand, the
primary sectors, such as agriculture and mining, declined in
importance. The percentage of GDP accounted for in the agricultural
sector declined from 23.1 percent in 1960 to 19.4 percent in 1969.
Over the same period, growth in manufacturing, construction, and
utilities increased their share of the GDP, from 20.9 percent to
26.0 percent, and growth in the transport, commerce and banking
sectors increased their overall share from 21.0 percent to 24.0
percent of GDP.

In addition, although the per capita income was doubled
during this period, this indicator obscures the unequal distribution
of income and wealth existing in Panama. This distribution resulted
in a considerable proportion of the population living in conditions
of poverty in both rural and urban areas of the country.

The Direccion de Estadistica y Censo conducted a survey for
1970, which revealed a sharp distortion in the distribution of income
and wealth in the country. It was found that the highest 30 percent
of the population received 73 percent of the income, while the lowest
30 percent of the population received only 3.8 percent of the total

income.2

 

2Contraloria General de la Repfiblica, Direccién de
Estadistica y Censo, Estadistica Panamefia 1970. Distribucidn del
Ingreso en Panama,_l970, Table 17(Panama, 1971), p. 58.

 

16

A similar condition was presented by the census data for
1970. In that year, 10 percent of the families in Panama reported
having a monetary income of above B/.6,000, 25 percent reported
monetary income of above B/.2,400, 53 percent reported a monetary
income above B/.1,700, and the remaining 47 percent received less
than B/.1,700.

The census report also showed that the agriculture sector
was the one most adversely affected by low income. It showed that
the agricultural land is divided into 52,400 units of less than 5
hectares. About one-third of these farm units was engaged in trade,
while the remaining two-thirds were subsistence farms. Most of
these small agricultural units did not receive any financial credit
or technical assistance.

Panama started the 1970's with an unequal distribution of
income and wealth which was close to the average observed in Latin
American countries. This indicates a high concentration of income
received by a relatively small proportion of the population. A
comparison of the distribution of income found in Panama and Latin
America is shown in Table 1.

Table 1 shows that the lowest 20 percent of the population
received only 1.6 percent of the income in Panama, while the same
proportion of population received 3.1 percent of the income in Latin
American countries. At the same time, the highest 5 percent of the
population receives 30.5 percent of the income in Panama, while the
same proportion of population for Latin American countries receives

33.4 percent of the income.

17

TABLE l.--Distribution of Income in Panama and Other Latin American
Countries.

 

Percentage of
Percentage of .
Percentage of Income in Income 1n

"‘9

 

Lowest 20 percent 1.6 3.1
Next 30 percent 10.2 10.3
Next 30 percent 28.4 24.1
Next 15 percent 29.3 29.2
Highest 5 percent 30.5 33.4

 

SOURCE: Contraloria General de la Repfiblica, Direccion de
Estadistica y Censo, "Encuesta de Ingresos 1970," and "Lineamiento
para Alcanzar Mayor Empleo en América Latina," CIES (OEA) 1971.

As compared to the 1960's the Panamanian economy during the
first part of the 1970's showed a slower rate of growth. The average
compound annual rate fell to 5 percent in real terms for the period
1970 to 1975.

The economy of Panama during this most recent period has
been adversely affected by both domestic and foreign factors. The
domestic factors involved a slowdown in the exports of goods and
services, banana sales, sales to the Panama Canal Zone, tourism,
operations of the Colon Free Zone, and the import substitution sec-
tor. While this slowdown in the domestic activities was taking
place, the economy was sustained until 1973 by a boom in the construc-

tion industry made possible by the financial support of the banking

18

system. The average annual rate of growth of the construction sector
was 12 percent during the period from 1970 to 1973.

Another domestic factor which contributed to the decrease in
the rate of growth of the economy was the passing of the Labor Code
in 1972 and a reform in the housing laws. The new Labor Code led to
a new pattern of relationship between employers and employees, and
it stabilized jobs for the workers, as no worker could be fired with-
out the Labor Ministry's consent. The housing 1aw froze the rent of
rental housing for rents up to B/.1OO monthly, which restricted
private investment in low-income housing construction.

By 1974, several foreign factors also had adversely affected
Panama's economy. Worldwide inflation resulted in significant
increases in Panamanian import prices. This had a severe impact,
because Panama imports about 37 percent of its consumption needs.

The energy crisis also had a severe impact. The increase in
oil prices alone resulted in a net loss of B/.128 million for the
period from 1973 to 1975. The energy price increase was responsible
for 14 percent and 26 percent of the balance-of-payments deficit in
1974 and 1975 respectively. For 1974, the negative effect of the
energy crisis and world inflation was reflected in a wholesale price
index increase of 30.2 percent.

The recession in developed countries that reduced the volume
of Panama's exports, the worldwide inflation, and the reduction of
domestic economic activity resulted in a decline of the real growth
of the GDP in Panama. Table 2 presents the sectorial gross domestic

product at 1960's constant prices from 1970 to 1976. The gross

19

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N

.acmcmswpmcap

 

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mmcmwu cm wanna; .omcwu x muwumhumumm mu :cwuuwcmo .mum—auamm m— at —mcmcmw mwgopocucou "mum:Om

 

 

 

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.Ammuwta oom_ Sceumcou ca mmon_mm mcocppwz ccv Fekmp op o~m_ .mcouumm s3 austere

 

mmeoo mmogm11.~ m4m<h

20

domestic product from manufacturing decreased from B/.l76.4 million
in 1974 to B/.l74.9 million in 1975, while the gross domestic product
in construction decreased from B/.79.4 million in 1974 to B/.66.5
million in 1975. As a whole, the gross domestic product for the
economy increased only from B/.l,130.l million in 1974 to B/.l,l37.2
in 1975. Preliminary information indicates that the GDP rate of
growth for 1976 decreased to zero percent.

As private investment decreased, the government sought to
compensate for the decline by developing a policy of increases in
investment expenditures in infrastructure, such as hydroelectric
power, a new airport and sugar mill, roads and housing construction
for low-income groups. Public sector investment grew at a rate of
20 percent annually during the period from 1970 to 1975, while priv-
ate investment decreased at the rate of 2.0 percent annually. It is
significant that the ratio of public sector to total gross fixed
investment was 2.6 percent in 1970, but in 1975 the ratio had risen
to 50 percent.

Table 3 presents the aggregate demand and aggregate supply
of Panama's economy at 1960 constant price for the years 1970 to
1976. For the public sector, the fixed gross capital formation
increased from B/.59.0 million in 1970 to B/.l46.6 million in 1975,
and to B/.155.4 million in 1976. Public sector consumption increased
also from B/.102.4 million in 1970, to B/.148.0 in 1975, and to
B/.150.8 million in 1976.

21

 

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"mmpmcowumz
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111 I
II- I1

 

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22

The Public Sector

 

The public sector in Panama is composed of the central govern-
ment, the autonomous agencies, certain public enterprises and the
municipalities. The autonomous agencies are a group of wholly-owned
government institutions which provide a variety of services ranging
from utilities, transportation, health, education and entertainment.
Some of these entities are subsidized institutions, while others are
public companies or national monopolies which provide revenue—earning
services not requiring operating subsidies.

The public enterprises are either wholly owned by the govern-
ment or have mixed ownership. They were created to develop specific
projects which enhance output through the production of goods and
services for export and for import substitution.

The expenditures of the central government are the biggest
element in total public sector expenditures. Table 4 presents the
central government expenditures from 1970 to 1975. Central govern-
ment expenditures increased from B/.l76.1 million in 1970 to
B/.306.2 million in 1975, an average annual rate of increase of 11.7
percent. 0n the other hand, the spending of all municipalities
increased from B/.8.7 million in 1970 to B/.18.0 million in 1975.
Although the local governments cooperate with the central government
in matters relating to the achievement of social welfare, it is
obvious from the data that the responsibilities of the municipali-
ties in Panama is relatively unimportant.

One reason for this is that there has been a tendency on the

part of the central government to absorb traditional municipal

23

TABLE 4.--Centra1 Government Expenditures by Departments, 1970 to
1975 (in Millions of Balboas).

 

 

 

 

Departments 1970 1971 1972 1973 1974 1975
National Assembly 0.1 0.1 1.1 1.3 2.0 3.5
Controller General 3.3 3.2 3.3 3.3 3.9 4.3
Presidency 3.1 3.3 3.7 2.5 3.2 1.6
Government and Justice 25.3 25.7 28.7 29.3 34.7 40.3
Foreign Affairs 3.4 3.5 3.7 4.3 .5 5.1
Finance and Treasury 4.6 4.7 4.9 4.8 5.5 6.0
Education 37.4 43.3 50.2 53.6 62.0 68.5
Commerce and Industry 2.3 2.1 1.9 2.0 2.2 2.5
Public Works 14.7 12.3 13.2 13.3 14.1 14.8
Agricultural Development 6.0 5.9 6.2 8.3 9.5 10.3
Price Regulation 0.3 0.3 0.4 0.4 0.6 0.6
Public Health 19.5 19.8 23.6 24.8 28.6 31.2
Labor and Welfare 1.8 1.9 2.0 2.0 2 1 2.4
Judicial Branch 1.9 2.1 2.0 2.0 2 2 2.5
Public Ministry 1.1 1.2 1.2 1.2 1.5 1.8
Electoral Court 0.8 1.0 2.2 1.3 1.5 1.7
Housing - - - - 3 2 4.2
Planning - - - 1.3 1 6 1.9
Unforseen Expenses 0.2 0.2 0.1 0.0 0.0 -

SUB-TOTAL 125.8 130.6 148.4 155.7 182.6 203.2
Subsidies 24.1 20.5 25.9 21.8 29.6 38.2
Interest on Public Debt 11.3 19.3 22.3 27.2 43.3 41.6

Pub1ic Debt Amortization 14.9 17.2 17.4 21.5 19.7 23.2
TOTAL 176.1 187.6 214.0 226.2 275.4 306.2

————————————————
———————————————————_

 

 

SOURCE: Contralorfa General de la Republica. Direccion
de Estadfstica y Censo, Panama en Cifras Ahos 1970-1976 (Panama,
Octubre 1976), p. 148.

24

functions directly or by establishing new autonomous institutions.
As an illustration, water supply and garbage removal, which are
municipal functions in many countries, are services provided by
autonomous institutions in Panama.

Table 4 shows that only four central government departments
accounted for 77 percent of the central government expenditures in
1975 excluding subsidies and public debt services. These are the
Ministry of Education, the Ministry of Government and Justice, the
Ministry of Public Health, and the Ministry of Public Works.

Table 5 shows public sector expenditures compared to the
gross domestic product from 1970 to 1975. The proportion of total
public sector expenditures to gross domestic product varied con-
siderably from 1970 to 1975. The lowest ratio was 17.8 percent in
1971, and the highest was 26.8 percent in 1975. This variation was
due principally to an expansion of public investment during the years
of economic recession. For example, public sector capital expendi-
tures were 36 percent of total public sector expenditures in 1970,

but were 52 percent in 1975.

The Public Debt
Central government expenditures exceeded government revenues
from 1970 to 1975. The lowest deficit of B/.1.2 million occurred in
1973, while the highest deficit of B/.16.0 million occurred in both
1970 and 1972. Government deficits from 1970 to 1975 were the
result of three major factors: (1) the increased cost of goods and

services needed for the administration of the government and for

25

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26

social services; (2) the increase in interest payments due to increased
government debt and the high interest paid on new government loans, and
(3) the relative weakness of the revenue system because of the economic
recession.

Table 6 shows the central government operations, the public
debt, and the relationship of the public debt to the gross domestic
product. Central government debt increased steadily from B/.285.5
million in 1970 to B/.710.4 million in 1975. Close to 45 percent of
the debt was acquired from 1973 to 1975, a period when the economy was
in the depth of the economic recession. In addition, the public debt
service also increased steadily from B/.26.2 million in 1970 to
B/.65.8 million in 1975. The public debt service charges of 1975 were
almost two and one-half times the service charges of 1970.

Comparing the debt interest payments to current government
revenues, Table 6 shows that this relationship increased considerably
from 7.1 percent in 1970 to 16.0 percent in 1974, and to 14.0 percent
in 1975. Interest payments depend on both the size of the debt and the
average interest rate. These two factors resulted in the B/.85.0
million of interest paid in 1974 and 1975. About 69 percent of the
central government external debt outstanding was borrowed at an
interest rate of 9 percent or more.

The burden of the public debt in the economy had been
increasing, as can be observed by the ratio of the public debt to the
gross domestic product from 1970 to 1975. The ratio of the public
debt to the gross domestic product was 27.3 percent in 1970, 31.6

percent in 1973, and 36.7 percent in 1975.

27

 

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28

The increase in the level of the public debt reflects the
new role played by the government in promoting the social and
economic development of the country. This function is manifested by
the steadily increasing investment by the public sector. Government
investment has been financed primarily by international development
loans, public sector savings, suppliers credits and private lenders.

Before 1973, public sector investment was concentrated on
the development of Panama's highway system, housing, education,
health and sanitary services. After 1973, public sector investment
emphasized infrastructure, the production of goods and services, and

special sectors such as electricity and agricultural production.

The Tax4§ystem

Panama's revenue system, classified according to the way the
revenue statistics are reported, has three categories of receipts:
(1) indirect taxes, (2) direct taxes, and (3) proprietory and miscel-
laneous income. This statistical classification departs somewhat
from the conventional theory of taxation.

Conventional theory of taxation assumes that indirect taxes
are largely shifted, while direct taxes are believed to resist
shifting. However, there are direct taxes, such as taxes on real
estate, which are believed to be shifted at least in part to renters,
and income taxes on corporations likewise may be shifted in part to

consumers. 0n the other hand, business license fees, an indirect

29

tax, also resist shifting in some situations.3 In this study, the
statistical classification is used for convenience only, and does
not imply the probability of shifting or non-shifting of the taxes.

Panama relies basically on indirect taxes, even though their
relative importance to total ordinary government revenues has
declined during the period from 1970 to 1976. Table 5 presents the
ordinary government revenues from 1970 to 1976. The proportion of
indirect taxes to total ordinary revenues has changed from 41.8
percent in 1970 to 37.9 percent in 1975, and to 39.8 percent in
1976.

Within the indirect taxes, custom duties alone represented
about 20 percent of the total ordinary revenues of the government,
and 52 percent of total indirect taxes in 1975. Custom duties
includes taxes from both imports and exports. Before 1974, about
one percent of total revenues from custom duties represented income
from the tax on banana exports, but the proportion of taxes from
exports to total custom duties increased to 17 percent in 1974, to
24 percent in 1975, and to 17 percent in 1976. The income from
exports increased due to the increase in the tariff on exported
bananas in 1974. The new tariff on banana exports resulted in an
average increase of B/.10 million annually from 1974 to 1976.

On the other hand, revenues from imports increased from

B/.36.9 million in 1970 to B/.50.8 million in 1974. For the most

 

3Bernard P. Herber, Modern Public Finance, the Study of
Public Sector Economics, 3rd ed. (Homewood, 111.: Richard D. Irwin,
Inc., 1975), pp. 149, 161.

30

recent years of 1975 and 1976, however, the import tax revenues was
only at a level of B/.44 million. Even though import tax revenues
is one of the major sources of government revenues, the share of
this tax to total government revenues has been decreasing steadily
from 1970 to 1976. Import tax revenues to total ordinary government
revenues have decreased from 23 percent in 1970 to 19.6 percent in
1973, and to 15 percent for both 1975 and 1976.

Although imports were continually increasing from B/.326.4
million in 1970 to B/.738.3 million in 1976, the tax from these
imports was decreasing relatively because of two factors: (1) the
high proportion of exemptions, an average of 18 percent of total

4 and (2) the decrease in the average

imports from 1970 to 1976,
effective tariff on imports, from 16 percent in 1970 to 8 percent in
1976.

The reduction of the average effective tariff on imports
resulted from the existence in the Panama custom duties schedule of
a high proportion of specific rates (tariffs based on the quantity
of goods imported rather than on ad valorem). During periods of
inflation, as was experienced by Panama from 1970 to 1975, the
revenue from specific rates does not increase as the value of the

imported goods increases. The main sources of revenues from custom

duties originate from the imports of foods, automobiles, radios,

 

4Goods are exempted under Decree Law Number 12 of 1950,
Decree Law Number 25 of 1957, and Cabinet Decree Number 172 of
1971.

31

television sets, refrigerators, chemical products, and other
manufactured goods.

Excise taxes is the next most important source of revenue
among the indirect taxes. Taxes on alcoholic beverages, gasoline
and tobacco are the major revenues produced within the excise taxes.
About 90 percent of total excise taxes depend upon these three taxes.
Revenues from excise taxes increased from B/.22.8 million in 1970 to
B/.39.0 million in 1974, and to B/.48.4 million in 1976. In 1974,
there was an increase in the gasoline tax, and the introduction of a
new tax on soft drinks.

Other indirect taxes involve principally a stamp tax. About
10 percent of total indirect taxes was obtained from stamp taxes
during the period from 1970 to 1976.

Except for automobiles, some durable goods, and some
alcoholic beverage taxes, the remaining indirect taxes have a
regressive impact on the low-income groups in Panama. Luxury goods
are generally taxed at a low rate to promote tourism. In 1976, all
the imported goods related to tourism activity were declared free
of duty by the government. The existence of the Canal Zone and the
Free Zone of Colon, however, created special custom duty problems.
Both areas are sources of contraband activity.

The existence of high protective tariffs and the restriction
of imports through a quota system of such products as foods, shoes,

and clothing has produced a regressive tax burden on the population

32

in the form of higher prices. At the same time, high protective
tariffs and quotas on these products have reduced revenues for the
government.

Direct taxes, the second major source of government revenues,
consists of personal and corporate income taxes, the property tax and
inheritance and gift taxes. Total direct taxes increased from
B/.62.l million in 1970 to B/.114.4 million in 1975, but decreased
to B/.108.4 million in 1976. The share of direct taxes to total
ordinary government revenues remained almost constant at 38 percent
from 1970 to 1976.

Within direct taxes, the income tax (personal and corporate)
is the principal source of revenue. The proportion of income tax to
total indirect taxes fluctuated between 86 percent to 89 percent
from 1970 to 1976. Since the income tax liability is based on
source rather than on residence, all income arising within Panama is
taxable, and all income arising outside Panama is exempt.

Panama has a single income tax law which applies to both
individuals and corporations. Each of these entities has its own
progressive tax schedule. For individuals, there are 20 taxable
income brackets. Rates range from 2.5 percent up to B/.1,000 to
56 percent over B/.200,000. In 1976, the minimum rate was raised

5 The income tax is close

to 2.8 percent for income up to B/.2,000.
to a gross income levy on salaries and wages, but for professionals

it has the characteristic of a net income tax on profits.

 

5Republic of Panama, Law Number 75 of December 22, 1976,
Article 2.

33

There are five taxable income brackets in the tax schedule
for corporations. Corporate income up to B/.15,000 is taxed at a
15 percent tax rate, while income over B/.500,000 is taxed at the
maximum rate of 50 percent. In 1976, the corporate tax schedule was
reduced to four taxable income brackets, with the lowest bracket of

B/.30,000 being taxed at 20 percent.6

Corporate earnings are
assumed to be taxed at full at the business level. Thus, dividends
are not subject to taxation at the individual level.

The Fiscal Code defines gross taxable income in broad terms,
including all forms of compensation for personal services, rents,
profits and interest. On the other hand, the definition includes a
long list of exemptions: (1) income earned by virtue of special
contracts with the government; (2) income received by charitable,
religious and non-profit institutions; (3) income received from
foreign countries; (4) income from international maritime commerce
of merchant vessels registered in Panama; (5) interest derived from
Panamanian government securities, and in saving accounts maintained
in banking institutions registered in Panama; (6) lottery prizes and
other income from games of chance operated by the Panamanian
government; (7) amounts received as compensation for labor, accidents
and insurance in general, and pension and social security benefits;
(8) salaries and fees paid to members of the consular corps accedited

to Panama; (9) income earned by personnel abroad as royalties from

individuals located in the Free Zone of Colon; and (10) interest

 

6Republic of Panama, Law Number 76 of December 22, 1976,
Article 1.

34

earned from loans granted for the construction of housing for low-
income families.

From taxable income, the taxpayer is allowed to deduct
personal exemptions as follows: (1) B/.600 for each individual
filing single returns; (2) B/.1,000 for married couples filing
jointly; (3) B/150 for each dependent minor or adult student sup-
ported by the taxpayer because of mental or physical incapability;
and (4) medical expenses that exceed 5 percent of taxable income.

A recent law allows an exemption for all individuals whose
taxable income is below B/.1,000. For professionals, the law
provides an exemption of net taxable income up to B/l,000 if the
gross income does not exceed more than B/.3,000 yearly.7

In another income tax reform of 1976, deductions from tax-
able income were allowed for: (1) interest payments up to B/.3,600
annually on the mortgage of owner-occupied houses located within
Panama; (2) interest payments on educational loans; and (3) certified
medical expenses incurred exclusively within Panama that exceed 5
percent of taxable income.8

Capital gains from bonuses given in corporate stock are
excluded from taxation if they do not constitute a regular source of
income. Capital gains from the sale of land, buildings and other

assets are taxed only when these assets are realized. No statistics

 

7Republic of Panama, Law Number 75, of December 22, 1976,
Articles 2 and 3.

8Republic of Panama, Law Number 76, December 22, 1976,
Articles 3 and 4.

35

are available on the amount of assets held and sold in order to
evaluate the characteristics of capital gains taxation in Panama,
but the law obviously provides a bias in favor of upper-income
groups.

Dividends and interest are treated differently in the income
tax law of Panama. Dividends are taxed at a 10 percent rate when
distributed by the corporation, but they are exempt when received by
individuals. 0n the other hand, interest payments on the bonded
indebtedness of the corporation are deductible before determining
the income tax at the business level, but are taxable at the
individual level. Interest received from an individual is taxable,
while interest from savings accounts in banking institutions and
from government bonds is exempt.

Panamanian income tax law provides a general rule for
deductions: deductible expenses are payments for all items incurred
in the production of income and in the conservation of resources.

At the same time, individuals receiving salaries and wages are not
permitted to deduct any incidental costs involved in earning income,
such as membership fees in professional societies. Therefore, the
deductions from gross income are reserved almost exclusively to tax-
payers involved in business activities.

For corporations, all ordinary and necessary business
expenses are permitted as deductions, but qualifications are made
for the following expenses: (1) personal or living expenses of the
taxpayer and his family; (2) the cost of repairs made to real or

personal property if depreciation is allowable on the same property;

36

(3) the cost of any improvement made to real or personal property
must be depreciated rather than deducted in full; (4) amounts spent
on travel for recreation, club dues, fairs, entertainment and gifts
not directly related to the business activity of the firm; (5)
bonuses paid to employees are deductible providing that they do not
exceed the amount of one month's salary or a maximum of B/750 per
employee; (6) expenses of local film distribution related to the
producing enterprises; (7) payments sent or credited by persons
located in the Free Zone of Colon to persons abroad as royalties;
and (8) any other expenses, which although legally deductible,
cannot be satisfactorily verified to the income tax administration.

From Table 7, it may be seen that income tax collections
increased from B/.54.5 million in 1970 to B/.101.8 million in 1975,
but decreased to B/.96.3 million in 1976. The average annual growth
rate for income tax collections was 8.5 percent from 1970 to 1976.
However, the rate of inflation was 10.6 percent for the same period.
Thus income tax collections actually decreased in real terms from
1970 to 1976.

The contribution of income tax collection to total ordinary
government revenues fluctuated between a minimum of 30.3 percent to
a maximum of 34.3 percent from 1970 to 1976. The decrease in real
terms of income tax collections and the fluctuations in relationship
to total ordinary government revenues reveals deterioration of this
tax as a source of government revenues. Some of the factors that
have contributed to the weak performance of Panamanian income tax

collections are: (1) the long list of exemptions, (2) the special

7
3

 

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38

treatment of such types of income as capital gains and interest, and
(4) tax evasion.

The property tax is also considered to be a direct tax in
the Panamanian system of classification. Table 7 shows that the
property tax has a weak collection record, rising from B/.6.9
million in 1970 to B/.11.7 million in 1976. In relation to total
ordinary government revenues, the property tax share had been
approximately constant at 4 percent from 1970 to 1976.

The property tax is relatively narrow in Panama. All land
and buildings, unless exempted by law, are taxable. 0n the other
hand, all personal property and intangibles are exempt. The base
of application of the property tax is the value of the property as
declared by the owner or as assessed by the Direccidn Catastral of
the Ministry of the Treasury. The tax is applied at a nation-wide
rate, and the rate is established by law. Three major factors
contribute to the low collection level: (1) a wide number of
exemptions, (2) low assessment, and (3) special tax incentives for
new construction.

Property tax exemptions include: (1) properties of the
national government, municipalities, and municipal corporations;
(2) properties of the autonomous institutions of the national
government; (3) properties used for religious, social public wel-
fare, or other purposes of a non-profit nature; (4) properties of
private schools, having a contract with the Ministry of Education
to grant from 5 to 25 permanent scholarships to low-income

Panamanian students; (5) properties of private hospitals, having a

39

contract with the Ministry of Health to care for any sick person in
the event of emergency and to give free hospitalization each year to
25 low-income Panamanians; (6) property exempt in accordance with
international treaties or agreements; (7) properties constituting
the Patrimonio Familiar;9 and (8) properties of a value of not more
than B/.1o,ooo.10

For the assessment of properties, the owners of land,
houses, apartments or buildings for business purpose simply declared
and registered their value on an official form. This property value
usually is lower than the real value of the property. When a prop-
erty is purchased, the purchase price declared is legally the
assessed value,but taxpayers typically declare low sales prices in
order to save taxes. There is little supervision in the administra-
tion of the tax. The regulations require only that when a property
is sold, that the new value cannot be lower than that previously
declared.

Through tax reform action in 1976, the property tax rate
schedule was reduced from five to four brackets, and the graduated
tax rates were increased by 40 percent as compared to the previous
rates in effect since 1960. The new property tax schedules adopted

in 1977 are as follows:]]

 

9A small quantity of land given by the government to a
farmer and his family.

10
Article 1.
11

Republic of Panama, Law Number 78 of December 22, 1976,

 

Ibid., Article 2.

40

 

Assessment (PEEEEEt)
B/.10,000 to B/.20,000 1.40
B/.20,000 to B/.50,000 1.75
B/.50,000 to B/.75,000 1.95
B/more than B/.75,000 2.10

Tax incentives for new construction, adopted for development
purposes, have contributed to the weak property tax collection.
These exemptions include: (1) all new construction during the
period January 1, 1960 to December 31, 1967; (2) by Law No. 100 of
October 4, 1973, all property tax for 20 years for new housing up
to B/.20,000, and (3) by Law No. 68 of December 22, 1976, an exten-
sion for 10 years of the property tax exemption for all houses,
buildings or improvements in which construction starts within 16
months from January 1, 1977.

The remaining source of revenue from direct taxes in Panama
is the inheritance and gift taxes. The collection of these taxes
provides only a small contribution to total ordinary government
revenues. Their contribution fluctuated between B/.0.4 million and
B/.l.0 million from 1970 to 1976.

The small collection from these taxes results from the
reduction of the tax base due to exclusions, exemptions, and
deductions. For example, the inheritance or receipt of gift property
from outside of Panama is not taxable. On the other hand, there is
no tax on the estate; that is, in death taxation, what is received

is taxed, not what is left.

41

The administration of these taxes also contributes to their
weakness. There is no formal trial between the government and the
heirs in an inheritance tax case, in which there is required testi-
mony by witnesses and arguments by lawyers. The process is simply
between the government and the opposing estate representative, in
which the latter submit briefs, the briefs are examined and then a
judgment is made on the written material.

Beside taxes, the government has the following sources of
ordinary revenues: (1) revenues from the sale of public services
and from government monopolies; (2) rents and royalties, (3) the
Panama Canal annuity, and (4) miscellaneous revenues. The revenues
from these sources rose from B/.3l.l million in 1970 to B/.65.5
million in 1976. These amounts represented a share of total
ordinary government revenues which rose from 19.4 percent in 1970
to 22.7 percent in 1976.

It is beyond the scope of this study to undertake a detailed
analysis of each of the above-listed sources of government revenues.
However, it is important to mention that revenues from public
services and government monopolies arise in large part from autono-
mous agencies and public enterprises. There are 22 of these govern-
ment institutions. Most of them rely to a great extent on their own
revenues derived from the sale of public utilities, the operation of
a national lottery and other gambling activities, and from a sugar
mill. As indicated in Table 5, the contribution from these institu-
tions to the ordinary revenues of the government increased from

B/.16.8 million in 1970 to B/.34.1 million in 1976.

42

From the above descriptive outline, it is obvious that
direct taxes in Panama have a narrow scope because of a combination
of evasion and various reductions of the base through exclusions and
deductions. The tax burden to gross domestic product was only 11
percent on an average from 1965 to 1975. These factors affect in a
negative way the current expenditures of the government, and create
a pressure to create more taxes. The recent introduction of a retail
sales tax was based on the need of resources to finance current cen-

tral government programs, including the public debt service for 1977.

Summary

The purpose of this chapter was to present an overview of
the economic development of the Panamanian economy from 1970 to
1975, as well as a descriptive outline of the public sector and the
tax system. It shows that during the 1970's Panama's economy
maintained a high rate of growth, but this was achieved with a
distribution of income and wealth that was markedly unequal. From
1970 to 1975, the distribution of income and wealth is virtually the
same, even though the government has promoted more expenditures for
social programs.

The public sector has emphasized a policy of tax incentives
to promote private investment, and has increased its current expendi-
tures for social programs such as education, health and housing.
Because of a recession and rising inflation during 1974 to 1976, the
public sector has engaged in investment to promote exports and

infrastructure in order to strengthen the productive capacity of the

43

country. However, investment in infrastructure has been financed
largely through foreign loans, both from private and international
financial institutions. This has increased the public debt service
to 21.8 percent of total ordinary government revenues in 1975.

On the other hand, the tax system was unable to raise the
required resources for the government's program. The tax system is
generally regressive with a narrow taxable base. Almost every tax
has extensive exemptions, deductions and exclusions. In the case of
the income tax, the long list of exemptions, the special treatment
of capital gains, dividends and interest, as well as evasion, have
reduced the tax base, and affected in a negative way the vertical
and horizontal equity of the tax. These elements also show that the

income tax in Panama discriminates in favor of unearned income.

CHAPTER III

THE THEORY OF TAX EXPENDITURES

Tax expenditures are a means by which the government sub-
sidizes the private sector indirectly. Problems associated with tax
expenditures were the subject of a study in the United States in
1968 by Stanley S. Surrey, Assistant Secretary of the Treasury for
Tax Policy. In analyzing the tax structure and the government's
indirect system of promoting economic activities in the United
States, he revealed some reasons why the country's tax base has
tended to decrease. As a result of his study, Surrey recommended
the need for a full accounting in the government's budget of the
special provisions granted to taxpayers by the federal government
in determining their net taxable income.1

This new approach of viewing the government's intervention
through its taxation policy offers an opportunity to review govern-
ment participation in developing as well as developed economies.
This chapter, by using the experience of the United States, will

consider this newly-developed theory of tax expenditures.

 

1U.S. Congress, Joint Economic Committee, Annual Report of
Secretary of Treasury, Fiscal Year 1968, 9lst Cong.,lst sess.,
1969, p. 322.

 

44

45

Tax Incentives

 

The principle of tax incentives is based on the conception
that the government serves as a vehicle to promote certain actions
by the private sector aimed at attaining public objectives which are
considered to be desirable for national welfare. Usually, a tax
incentive policy is designed to promote economic development through
the stimulus of some economic activity.

To stimulate economic activity, tax incentive may be made
available to the three major groups of decision-makers: households,
businesses and the government. For households, tax measures may
affect the selection of certain occupations, patterns of consump-
tion, or type of investment. From a business point of view, tax
incentives may influence the geographical location of firms, the
productive technology used, or a businessman's decision to remain
in, enter, or leave an industry. Tax incentives for business also
may shape the package of wages to be offered; that is, how much
will be in cash or in other forms of remunerations. Finally,
federal-level tax incentives may affect the flow of state and local
government resources to business firms.

In a broad sense, the principal purpose of tax incentives
is to provide monetary assistance or benefits through the tax law
so as to make a desired course of action financially more attractive
to the taxpayers involved, and thereby induce them to take that

action.2 This purpose may be achieved in a number of ways:

 

2Tax Institute of America, Tax Incentives (Mass: Heath
Lexington Books, 1969), p. 11.

46

(1) investment credits may provide the financial means to purchase
machinery and equipment; (2) generous bad debt reserves may support
the growth of savings in order to accummulate resources for invest-
ment; (3) a corporate surtax exemption may assist small bUsinesses
as a relief provision; (4) generous depreciation allowances may
encourage research or the establishment of new firms in an industry;
(5) charitable deductions may foster philantr0py; and (6) the
preferential tax treatment of pension plans may increase resources
for a broader pension coverage.

Each tax incentive is a provision justified basically
because it will improve efficiency, growth or equity. For example,
an investment tax credit may be adopted to increase capital forma-
tion and thus accelerate the rate of growth in the economy.
Accelerated depreciation increases the amount of capital available
for reinvestment, which may provide more jobs, income and consump-
tion expenditures. Equity is achieved by tax incentives which
encourage donations to charitable and educational institutions, or
to health care organizations.

Even though tax incentives are defended as instruments to
achieve equity and growth in the economy, growth as a goal probably
has prevailed in the fiscal policy of developed as well as develop-

. . 3
1ng countries.

 

3Richard M. Bird and Oliver Oldman, eds., Reading on
Taxation in Developing Countries (Baltimore: The John Hopkins
Press, 1975), p. 339.

 

47

There are some arguments which cite the virtue of tax
incentives in their promotion of certain social programs. One
could argue that the magnitude of social problems requires the
assistance of the government in seeking solutions. In this assist-
ance, the government employs incentives to encourage the participa-
tion of the private sector, especially business, in contributing
to the solutions. Thus, the incentives are a way to attract
private sector involvement in social programs. Along these lines,
the tax incentives for training labor proposed in the U.S. Senate
was defended by the argument that the tax system should be used for
social purposes, and the government should encourage business to
participate by providing the incentives needed to lower the high
cost incurred by private enterprises in hiring, training, and
providing services for low-skilled labor.4

However, there is a fallacy in this argument. This fallacy
is that there is an alternative to tax incentives, which is the use
of direct subsidies, and the option of using one or the other device
should be compared.

Another argument in favor of tax incentives maintains that
this instrument is relatively simple, and that it involves less
governmental supervision. This means that there is no need for

additional government bureaucracy. Proponents of tax incentives

 

4U.S. Congress, House of Representatives, Employment Incen-
tive Act of 1969, 5.2192, 9lst Cong., lst sess., May 16, 1969,
Congressional Record, 115:12875.

48

also maintain that they can be introduced promptly, as soon as they
are enacted.

Another argument maintains that tax incentives are an
instrument that encourages private decision-making instead of
government decision-making. Encouraging private participation, it
is maintained, can achieve a better solution for many social prob-
1ems because of the variety of responses which result. Such plural-
ism is preferred, it is argued, to a system of government-centered
decision-making.

In the process of resolving an economic or social problem,
tax incentives may affect both the equity of the tax structure and
the allocation of resources. The following illustrations indicate
these effects. Tax incentives may affect the equity of the tax
structure by providing a greater benefit to high-income taxpayers
than to low-income taxpayers. In addition, those who are outside
the tax system for any reason--because they have experienced losses,
or are exempted from taxes, or have incomes too low to qualify--do
not benefit from tax incentives. With regard to the personal income
tax, tax benefits for the aged or the sick do not reach those who
are too poor to pay income taxes, and tax credits for educational
expenses do not help poor families with incomes below the taxable
level. Finally, deductions for mortgage interest or charitable
contributions favor high-income taxpayers more than low-income
taxpayers; they are, in effect, upside-down subsidies.

Emphasizing the distributive effect of tax expenditures,

Philip Stern has shown the vertical inequity of the average tax

49

saving per family in Table 8.5 This table shows that a poor family
with an annual income under $3,000 received only $16 from the
"welfare" programs in 1972, while a rich family with an income
above $1,000,000 received $720,490.

Tax incentives also affect the allocation of resources.
Consider, for example, the effect of the favorable tax treatment of
capital gains in the planning and programming for urban renewal.
Urbanization is a principal source of increased land value. Special
tax treatment of capital gains allows the landowner preferentially
lower tax rates than apply to normal taxable income. Such treatment
encourages land speculation to obtain capital gains benefits from
the appreciation in the value of land. While a physical improvement
yields an annual return subject to normal tax rates, the potential
reward is greater for securing a change which will be reflected in
price and taxed at favorable capital gains rates.

The special treatment of such gains may encourage specula-
tion not only in real estate, but also in stocks of high-risk
ventures. Undue speculation with capital assets may interfere with
the orderly flow of financial capital into useful channels. The
favorable tax treatment of capital gains increases the after-tax
earnings on assets, and thereby may encourage people to invest in
assets which may appreciate in value. This behavior may have dis-

torting effects on saving, investment and economic efficiency.

 

5Philip M. Stern, The Rape of the Taxpayer (New York:
Vintage Book, 1974), p. 6.

50

TABLE 8.--Distribution of Tax Expenditures, 1972.

 

 

Average Yearly Average Increase
Income Level "Tax Welfare" in Weekly
Payment "Take Home Pay"
Over $1,000,000 $720,490 $13,855.58
500,000 - 1,000,000 202,751 3,899.06
100,000 - 500,00 41,480 797.69
50,000 - 100,000 11,912 229.08
25,000 - 50,000 3,897 74.94
20,000 - 25,000 1,931 37.13
15,000 - 20,000 1,181 22.71
10,000 - 15,000 651 12.52
5,000 - 10,000 339 6.52
3,000 - 5,000 148 2.85
Under 3,000 16 0.31

 

) SOURCE: Philip M. Stern, The Rape of the Taxpayer (New York,
1974 , p. 6.

 

51

The U.S. system of hospital payment under the programs of
Medicare and Medicaid is another example of an inefficient allocation
of resources through tax incentives. Because the government pays a
full reimbursement to hospitals for the cost associated with the
Medicare and Medicaid patients, there is a tendency to over-use
hospital services. This increases hospital cost for patients.

Tax credits for purchasing machinery for pollution control
may also be distorting. If they encourage the use of certain kinds
of equipment for control to the exclusion of other methods of pollu-
tion control, the result may be an inefficient choice of materials
for the manufacturing process.

Tax incentives in some cases permit windfall gains to tax-
payers, because the taxpayers may receive support from the government
for doing what they would normally do. The tax credit program to
hire unskilled labor, for example, may benefit employers who for one
reason or another would have hired these employees anyway.

Tax incentives also have been used as instruments to avoid
the personal and corporate income tax. In a survey of 142 U.S. cor-
porations in 1974, it was found that eight companies did not pay a
federal income tax and some companies were able to receive refunds
from the Internal Revenue Service through tax credits.6 Table 9
shows that these eight companies paid no federal corporate income

taxes despite their total profits of $644 million.

 

6U.S. Congress, House of Representatives, Corporate Tax
Study 1974, 94th Cong., lst sess., October 7, 1975, Céngressional
RecordT121:H9755.

 

 

52

TABLE 9.--Corporations Paying No Federal Income Taxes, 1974

(Millions of Dollars).

 

 

eases. “'91:; 1......
Ford Motor Co. $351.9 $(56.7)
Lockheed Aircraft Corp. 29.8 0
Honeywell 98.9 ( 2.2)
U.S. Industries, Inc. 17.9 ( 2.8)
American Airlines 26.8 0
Eastern Airlines 17.6 0
American Electric Power Co. 163.7 (19.3)
Allstate Insurance Co. _l§Z;§ (16.8)
TOTAL 643.9 --

 

SOURCE: U.S. Congress,
sional Record, 121:H9755.

 

House of Representatives, Corpor-
ate Tax Studyjl974, 94th Cong., lst sess., October 1975, Congres-

The same study found that 18 companies reported $5.3 billion

of net income before tax, which was taxed at an effective rate of

only 10 percent or less. A comparison for the years 1973 and 1974

of the sample of tax returns investigated is shown in Table 10.

It may be noticed in Table 10 that that average effective

income tax rate for all the companies surveyed was 22.6 percent in

1974, which was not even one-half of the 48 percent highest corpor-

ate rate.

in the effective tax rate from 1973 to 1974.

It may also be noticed that there is a decreasing trend

53

TABLE 10.--Net Income and Federal Income Tax of a Corporate Tax
Sample, 1973 and 1974 (Billions of Dollars).

 

 

1973 1974
Number of corporations in sample1 143 142
Adjusted net income before federal
income tax 45.7 45.9
Approximate current federal income
tax 10.8 10.4
Approximate effective tax rate
(percentage) 23.6 22.6

 

1Including manufacturing, mining, transport, utilities,
retailing, banks, and grain companies.

SOURCE: U.S. Congress, House of Representatives, Corpor-
ate Tax Study 1974, 94th Cong., lst sess., October 7, 1975,
Congressional Record, 121:H9756.

54

Tax incentives also have affected the distribution of income
and have thus distorted the equity of the tax system. Tax incentives
have become a means to avoid taxes. The concept of tax expenditures
may be used to study these means of avoidance. This concept is
defined as follows:

Tax expenditure has been used to describe those special
provisions of the federal income tax system which repre-
sent government expenditures made through that system

to achieve various social and economic objectives. The
special provisions provide deductions, credits, exclusions,
exemptions, deferrals, and preferential rates, and through
these tax benefits serve ends similar in nature to those
served by direct government expenditures and loan pro-
grams.7

The income tax law establishes the base to measure net
taxable income. This income tax base is designed to promote certain
social and economic objectives such as increased saving or invest-
ment for economic growth. In many cases, however, the achievement
of these objectives through tax incentives to the private sector
result in a higher cost than that cost obtained through direct
government spending or through loans.

Because of the special provisions, the personal and corporate
income tax bases are altered significantly from the standard and

accepted definition of net taxable income. Numerous kinds of income

are excluded from taxation altogether, while others are included in

 

7Tax Institute of America, Tax Incentives (Mass.: Heath
Lexington Books, 1969), p. 3.

 

55

part. Various other types of expenditures by households give rise
to deductions which are subtracted from income.8

As deviations from the personal net income tax base, the
special tax provisions can take different forms, as capital gains,
social security benefits, interest from state and local government
bonds, life insurance premiums and employer payments for fringe
benefits. Other special personal expenses are charitable contribu-
tions, medical expenses and interest payments.

For business activities, tax expenditures are presented as
deductions from the actual cost of certain expenditures, such as
depletion allowances, bad debt reserves, expenditures for research,
exploration and discovery of natural resources, capital gains, and
tax credits.

It should be noted that these special tax provisions are
different from personal exemptions and special low-income allowances.
These provisions are part of the regular structure of the tax system
that are provided solely fOr equity purposes. All tax expenditures
do not include necessary business deductions for the determination
of net income.9

Until recent years, little has been known about tax expendi-
tures. Evaluating how these special tax provisions function to

attain the government's objectives has been difficult. Unlike

 

8U.S. Congress, Joint Economic Committee, The Tax Expenditure
Budget: Economic Analysis and the Efficiency of Government, 9lst
Cong., lst sess., 1970, pp. 82-91.

91bid., p. 86.

56

direct government spending, the federal budget until recently did
not report those revenues which were not collected due to the reduc-
tion of the tax base by the special tax provisions.

However, since 1968, the documentation of the extent of tax
expenditures and concern by the government has been increasing.
Comparison of these special tax provisions and their revenue cost
with direct expenditures for the same social and economic objectives
presents more completely the role of the federal government. This
was explained by the Treasury in the following way:

Since these expenditures serve ends similar to those which
are . . . served by direct expenditure programs . . . it
would be appropriate and instructive to juxtapose the tax
provisions and the (direct) expenditures in the same func-
tional category in order to understand better the purpose
to which public resources are allocated.10

Table 11 presents the tax expenditures estimates for fiscal
year 1976. These estimates disclose the impact of the government's
budget in the allocation of resources. Tax expenditures amounted to
an estimated $82.4 billion for this year, which represented about
25 percent of the amount of the direct expenditure budget of the
year.

Income security, health, commerce and transportation were

the functional categories with the greater amount of tax expendi-

tures. Nearly $32 billion was estimated for those activities.

 

10U.S. Congress, House of Representatives, Joint Economic
Committee, Annual Report of Secretary of Treasury, Fiscal Year 1968,
91st Cong., lst sess., 1969, p. 329.

 

57

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58

Individual Tax Expenditures

 

In a broad sense, all taxpayers and all types of income should
be treated alike. Of course, the general exception to this rule, mani-
fested in a progressive rate structure, is to treat every taxpayer
according to his or her ability to pay. But when the government
deviates from this general principle and uses the tax system to pro-
mote other special activities by allowing preferential tax treatment,
such as allowing special deductions, special credits, or preferential
tax rates, it is reducing the tax base. At the same time, this
preferential treatment also affects the equity of the tax system.

These special tax features (tax expenditures for individuals)
take different forms. A study for the Senate of the United States
has identified 57 individual tax expenditures totaling$58.2 billion
in 1974.H

Table 12 shows that 160,000 taxpayers with incomes over
$100,000 received tax expenditures of $7.3 billion, an average of
$45,662 per taxpayer, while 16 million taxpayers with income between
$10,000 and $15,000 received tax subsidies of only $8.9 billion, an
average of less than $600 for each taxpayer. Taxpayers in the lower
range of the income brackets, with an income under $5,000, constituted
about 12 million taxpayers. They obtained less than $3.0 billion of
tax relief, an average of only $250 for each taxpayer. The structure

of tax expenditures, as is presented here, clearly demonstrates that

the system of special tax treatment support, to a great extent,

 

nU.S. Congress, Senate, 94th Cong., lst sess., June 2, 1975,
Congressional Record, 121:59173-59177.

59

 

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60

taxpayers with high incomes. As a result, the progressivity of the

income tax system is reduced.

Capital Gains

Capital gains represent income generated from the increase
in the value of assets of a taxpayer. Capital gain from assets
which has been held by the taxpayer for more than the required
holding period typically are subject to a lower tax. Short-term
capital gains typically receive no favored tax treatment.

The Tax Reform Act of 1976 in the U.S. raised the holding
period defining short-term capital gains from six months to nine
months for assets sold in 1977, and to one year for assets sold
after 1977.

There are also alternative tax rates and exclusions deter-
mining taxes on capital gains. Individuals may exclude from taxable
income 50 percent of the excess of the net long-term capital gain
over the net short-term capital loss for the year. They may also
elect to have the first $50,000 of net capital gains taxed at an
alternative rate of 25 percent.

Table 13 presents capital gains tax expenditures estimates
using the special tax treatment previous to the changes enacted in
1976. This table applies to a period when capital gains were taxed
at one-half of the tax rate on other forms of income, with a
maximum rate of 25 percent. It is shown in the table that this
special treatment on income from assets generated $6.7 billion in

tax expenditures, but 47 percent of this amount is received by

61

TABLE 13.--The Effect of Capital Gains Provisions, Fiscal Year 1974.

 

Adjusted Gross Millions Tax Savings

 

Income Class of Dollars Percentage per Taxpayer
O - 3,000 86 1.3 21.20
3,000 - 5,000 66 1.0 8.71
5,000 - 7,000 138 2.0 16.68
7,000 - 10,000 241 3.6 21.09
10,000 - 15,000 413 6.1 25.89
15,000 - 20,000 345 5.1 35.00
20,000 - 50,000 1,262 18.8 140.12
50,000 - 100,000 1,013 15.1 1,546.56
100,000 & over 3,161 _gz;g 19,756.25
TOTAL 6,725 100.0 100.42

 

SOURCE: U.S. Congress, House of Representatives, Proceeding
and Debates of 94th Cong., lst sess., Congressional Record, 121:84.

 

62

taxpayers with a gross income of over $100,000. On the average,

the taxpayer in this bracket is saving almost $20,000 in taxes. On
the other hand, a taxpayer in the income bracket of $15,000 to
$20,000 is receiving about $35. This means that the rich gain most
from this special provision of the tax law. The principle reason
for this is that taxpayers with incomes of less than $20,000 have
capital gain income of less than five percent of their total income,
while with taxpayers with $50,000 of income, capital gains income
represents 62 percent of their total income.

In fact, the capital gains provisions have become one of
the principal mechanisms used by the rich to evade taxes. On this
issue, Philip Stern has noted:

Of all the various loopholes, none contributes so
flagrantly or so dramatically to the upside-down
"tax welfare" system as the preferential treatment
accorded so called "capital gains," the profits from
the sale of stock and bonds, buildings, land and
other kinds of property which are taxed at no more
than half the rates that apply to other kinds of
income.12

While the special treatment of capital gains is a source of
tax avoidance, it has been justified as a means to encourage tax-
payers in the high-income brackets to invest in risky economic

13 In this respect, Butters, et al., in a study on the

activities.
effects of taxation, concluded that the special capital gains pro-

visions were an important factor in encouraging venturesome

 

12Stern, The Rape of the Taxpayer, p. 13.

 

'3J. E. Stiglitz, "The Effects of Income, Wealth and Capital
Gains Taxation on Risk-Taking," The Quarterly Journal of Economics
83 (May 1969):263-283.

63

individuals to "shift funds out of relatively conservative invest-

ments offering little or no opportunity for capital appreciation,

and into some venturesome types of investment."14

However, this has not always been the case. Stiglitz, in
commenting on the effects of taxation on risk-taking, wrote:

The important point to observe is that even if one wished
to encourage greater risk-taking, and even if preferential
treatment of capital gains did this effectively, it is

not clear that preferential treatment of capital gains is
the most desirable way of encouraging risk-taking. 5

Exclusion of Interest on State
and Local Bonds

 

The U.S. federal tax law has established that taxpayers who
own state and local government bonds do not have to pay tax on
interest earned on these bonds. Like capital gains taxation, this
special tax treatment has had a special attraction for the rich.

This provision resulted in a reduction of $1.0 billion in
federal government revenues in 1974. About 82 percent of this tax
expenditure benefited those taxpayers with an income of over $50,000.
The rich taxpayer with income above $100,000 received through this
relief more than $3,400, while taxpayers earning income under
$10,000 received nothing. An average tax saving of $34,125 was

realized by 160 taxpayers at the top of the income distribution. On

 

14J. K. Butter, L. E. Thompson, and L. L. Bollinger,
Effects of Taxation on Investment by Individuals (Boston: Harvard
University Graduate School of Business Administration, 1953),
p. 42.

15Stiglitz, The Effects of Income, Wealth, and Capital Gains
Taxation on Risk-Taking, p. 274.

 

64

the other hand, about 8.3 million taxpayers with incomes between
$7,000 to $10,000 received one million from this tax relief result-
ing in a tax saving per taxpayer of only nine cents. Tax expendi-
tures from interest on state and local government bonds are pre-

sented in Table 14.

TABLE l4.--Tax Expenditures from Interest on State and Local Debt
Government, Fiscal Year 1974.

 

 

“11:31:85? 1111:1123... 51:13:12?
7,000 - 10,000 1 0.1 0.09
10.000 - 15,000 4 0.4 0.25
15,000 - 20,000 22 2.1 2.32
20,000 50,000 98 9.2 10.88
50,000 - 100,000 389 36.7 593.89
100,000 a over __;gg§ .JELJé 34,125.00
TOTAL 1,060 100.0 15.83

 

SOURCE: U.S. Congress, House of Representatives, Proceeding

and Debate of 94th Cong., lst sess., Congressional Record, 121:84.
I

 

Other Individual Tax Expenditures

Excess depreciation on housing and other assets, the deduc-
tion of medical expenses, the preferred treatment of mortgage
interest, and the deduction of property taxes on owner-occupied

homes are the remaining principal forms of individual tax

65

expenditures. These categories accounted for 25 percent of the
total of $58 billion in estimated tax expenditures in 1974.

Table 15 presents these other individual tax expenditures
classified by adjusted gross income class. The income class of
$100,000 and over received the highest tax savings per taxpayer for
each of the tax expenditures; that is, $593.75 for saving on mort-
gage interest, $1,331.25 on property taxes, $443.75 for medical
expenses, and $362.50 for excess depreciation.

On the other hand, the tax saving per taxpayer for the same
categories of tax expenditures for the income group of less than
$3,000 were only 25 cents in property taxes, 98 cents for medical
expenses, 26 cents for excess depreciation and an insignificant

amount for mortgage interest.

Corporate Tax Expenditures

During 1976, the corporate income tax rate was 20 percent
on the first $25,000 of taxable income, 22 percent on the next
$25,000, and 26 percent on the excess over $50,000. It was found
for 1973 and 1974 that the special provisions such as depletion
allowances, accelerated depreciation, investment tax credits, and
others reduced the effective tax rate by more than 50 percent for
those years (see Table 10).

Corporation tax expenditure averaged $23 billion for the

years 1974 to 1977. They were estimated to be $25 billion in 1977.

 

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66

 

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67

About 50 percent of total corporate tax expenditures were
attributable to depletion allowances, excess depreciation and

investment credits. Additional data on these are shown in Table 16.

Depletion Allowances

 

Gas, oil, and mineral extractive industries were allowed to
write off 22 percent16 of the selling price for ten years in order
to recover the cost of the value of depleted reserves. In 1975,
this allowance resulted in a tax reduction of about $2.5 billion.
Estimates for 1976 and 1977 are close to $1.6 billion for each year.
This subsidy results in a significant advantage for corporations in

the extractive industries as compared to firms in other activities.

Excess Depreciation Allowances

Depreciation represents the loss in value of plant and
equipment due to obsolescence or deterioration in the process of
production. Every firm can choose its own depreciation system,
whichever is more beneficial to the firm. Accelerated depreciation
provides corporations a reduction in tax liability by recovering
their investment in machinery and other capital goods in a rela-
tively short period of time. Excess depreciation provided $2.3
billion of tax reduction in 1976. The estimate for 1977 is expected

to save about $2.6 billion for corporations.

 

16The Tax Reform Act of 1975 modified the percentage deple-
tion allowance in the tax law, retaining the 22 percent depletion
allowance rate from 1976 to 1980, and then providing a reduction to
15 percent by two percentage points a year from 1981 through 1984,
when it reaches 15 percent.

68

Investment Credits

 

This special provision has been used to stimulate investment
by the private sector when the economy is suffering from a reces-
sion. During the 1971 recession, corporations could write off 7
percent of their new investment as a tax credit. This rate of tax
credit was increased to 10 percent in 1975 because of the high rate
of unemployment of about 10 percent.

The tax expenditures of $5.8 billion in 1975 reflects the
effect of the 10 percent investment tax credit allowed to the
private sector for their new investment in that year. Estimates for
1976 and 1977 show that this special tax provision will provide a
tax saving of close to $8.0 billion yearly to corporations (see
Table 16).

Although the corporations are receiving an increasing tax
saving due to these special tax provisions, the benefits are not
equally distributed among taxpayers. Taxpayers in the low-income
brackets are receiving almost nothing relative to the high-income
taxpayers. This problem is shown in Table 17.

These allowances substantially benefit the high-income
taxpayers whose earnings are over $50,000. They received 30 percent
of the total benefits in 1974. Taxpayers with over $100,000 a year
are saving an average of $1,281 each, while taxpayers with less than
$3,000 of income are receiving only 98 cents. As it may be noted in
Table 17, these corporate special provisions are highly pro-rich in

their distributional effects.

69

TABLE 16.--Corp0rate Special Tax Expenditures, Fiscal Years 1974 to
1977 (Millions of Dollars).

 

 

Detail 1974 1975 1976 1977
Total corporate tax
expenditures 19,120 22,270 25,845 25,460
Total special tax
expenditures 8,455 10,405 12,145 11,960
Depletion allowances 2,120 2,475 1,580 1,595
Excess depreciation 1,765 2,120 2,305 2,550
Investment credits 4,570 5,810 8,260 7,815

 

SOURCE: U.S. Congress, Committee on Ways and Means and Com-
mittee on Finance, Estimates of Federal Tax Expenditures 1975 and
1976 (Washington, D.C.: Government Printing Office, 1977), p. 8.

70

TABLE l7.--Distributioq of Benefits by Income Class for Special
Provisions, Fiscal Year 1974.

 

Adjusted Gross Millions of Tax Saving per

 

Income Dollars Percentage Taxpayer

O - 3,000 4 .3 .98
3,000 - 5,000 20 1.4 2.64
5,000 - 7,000 42 3.0 5.08
7,000 - 10,000 95 6.8 8.31
10,000 - 15,000 193 13.7 12.10
15,000 - 20,000 178 12.7 18.06
20,000 - 50,000 451 32.1 50.08
50,000 - 100,000 217 15.4 331.30
100,000 & over .__gg§ _14,§_ 1,281.25
TOTAL 1,405 100.0 20.98

 

1Includes excess percentage over cost depletion, deprecia-
tion on assets and buildings (other than rental housing) in excess
of straight line, and the investment tax credit.

SOURCE: U.S. Congress, House of Representatives, Proceed-
ings and Debates of 94th Cong., lst sess., Congressional Record,
121:84.

 

71

Although some of the tax incentive policies which the U.S.
government has followed has brought results contrary to the objec-
tives it had hoped to achieve, it is important to mention that most
of the tax incentive policies used have resulted from particular
economic or social problems that could not be solved by using
governmental budgets on a short-term basis. For example, the tax
incentive through accelerated depreciation was adopted in the United
States when the federal administration was anxious to encourage capi-
tal investment, and was rationalized on the grounds that it provided
a more realistic and uniform basis for depreciation. It was claimed
by the Treasury that standard depreciation did not adequately
reflect the effects of technology on the rate of obsolescence.
Similarly, the deferral of income from foreign subsidiary corpora-
tions controlled by U.S. citizens sought to maintain the neutrality
of the tax law on foreign and domestic sources of income.

The special provisions for the extractive industries were
introduced in the United States by the Revenue Act of 1918 with the
concept of discovery value depletion. The purpose was to permit the
recovery of tax-free income in excess of costs. The annual deduc-
tions for depletion were to be based on the value of property after
discovery. But the procedure was difficult to administer in the case
of the oil and gas industries. The concept of percentage depletion
as a percentage of net income, as is used today, is, of course,
quite different from the one previously used.

The tax incentives for exports adopted in 1971 allowed an

indefinite deferral of taxation of roughly 50 percent of the profits

72

from export activities. This provision was developed during the
late 1960's and the early 1970's, at a time when there was concern
over the balance-of-payments difficulties of the U.S. due to
declining exports. The measure was promoted as a means to remove
competitive disadvantages faced by U.S. exporters.17

In Latin America, the process of industrialization developed
during the 1950's and 1960's was encouraged by tax incentive such as
tax holydays, the tax exemption of reinvested profits, and the duty-
free importation of raw materials and capital goods. These measures
were designed to induce increased domestic investment and to attract
foreign investment.

In general, tax incentives are instruments for achieving
certain governmental goals such as promoting investment and increas-
ing business activities in certain economic sectors or specific
geographical areas in the country. Since tax expenditures involve
special revenue benefits as an inducement for undertaking these
activities, there is a need to evaluate the cost and benefit of

achieving social and economic goals through these tax expenditure

policies.

Summary

The purpose of this chapter is to review some aspects of the

theory of tax expenditures, based on the experience of the United

 

17Bruce E. Davie and Stephen A. Nauheim, "Report on United
States: On Tax Incentives as an Instrument for Achievement of
Governmental Goals," Studies on International Fiscal Law, vol. LXIa
Congress IFA (Jerusalem, 1976), pp. 317-334.

73

States. It has been observed that the tax incentive policies to
promote social and economic objectives have affected the equity and
efficiency of the tax system. The set of special provisions to
promote certain activities has provided additional resources for some
groups of taxpayers covered by the tax system. These have taken the
form of tax exemptions, deductions, special tax treatment, excess
allowances for depletion and depreciation, and tax credits. On the
other hand, the same economic and social goals promoted by these
special tax treatments could be achieved by government loans or
direct government subsidies to the private sector.

Unlike direct government spending, tax expenditures are not
subject to federal budgetary controls. Consequently, these special
tax provisions have become major loopholes for the avoidance and
evasion of the personal and corporate income tax, and have thus
reduced the tax base.

The distributional effect of tax expenditures is highly pro-
rich, and has provided tax shelters for the wealthy. At the same
time, this has resulted in the allocation of resources for purposes
other than what they were intended. For example, the special taxa-
tion of capital gains and the tax exemption of interest from state
and local government bonds have shifted resources from productive
investments to both speculative and riskless investments.

Along with this, equal income has not been equally taxed,
because the tax incentives discriminate against income from wages
and salaries. The latter income has been taxed at a higher rate

than unearned income.

74

As a by—product of the system of special tax provisions to
promote certain social and economic goals, the progressivity of the
tax system has been eroded. The rich and wealthy have received tax
shelters and benefits from the tax reductions and loopholes. Con-
sequently, they pay less taxes, and the burden of the tax system has

been shifted more to the middle- and lower-income groups.

CHAPTER IV

SAMPLE DESIGN TO DETERMINE THE INDIVIDUAL AND
CORPORATE TAX EXPENDITURES FROM PANAMA'S
INCOME TAX RETURNS

Individual Sample

The Computer Department of the Ministry of the Treasury
processed 35,998 individual income tax returns in 1975. From this
universe, a stratified sample of 2,237 taxpayers (6.2 percent of the
population) was drawn by using the economic activities reported by
the taxpayers as major strata. Nine major categories were selected.
These are: (1) agriculture, mining, transport, storage and communi-
cations; (2) manufacturing industries; (3) construction, power, gas,
water and other similar sources of income; (4) commerce; (5) real
estate; (6) services; (7) individual revenues; (8) professional
revenues; and (9) Colon Free Zone firms. Each of these major
categories were subdivided in sub-strata according to the economic
activity or level of income recorded in the tax returns.

Table 18 shows the criteria used to draw the stratified
sample. A general rule was followed: the sample elements for each
sub-stratum were selected randomly in those cases where large popula-
tions of returns were recorded in the sub-stratum; in those cases
where the populations were composed of a few elements, the whole
population was included in the sub-stratum of the sample.

75

76

TABLE 18.--Population and Sample of the Survey to Determine the
Individual Tax Expenditures from Panama's Income Tax
Returns, 1975.

 

Population Sample Expansion
Sector and Strata Size Factor
N n f

 

1. Agriculture, mining, transport
storage and communications

Stratum I: Agriculture 1,003 200 1/5
Stratum II: Mining 39 39 1/1
Stratum III: Transport, storage
and communication 374 _23_ 1/4
Sub-total 1,416 332
2. Manufacturing industries 55 55 1/1

3. Construction, power, gas, water and
other s1m11ar sources of 1ncome

Stratum I: Income less than

B/.30,000 241 121 1/2
Stratum 11: Income B/.30,001

and over 5 __5_ 1/1

Sub-total 246 126

4. Commerce

Stratum I: Income less than
B/.30,000 5,804 301 1/19

Stratum II: Income between
BAB0,00l and

B/.55,000 ll 11 1/1
Stratum III: Income of B/.55,00l
and over 6 6 l/l

Sub-total 5,821 318

77

TABLE 18.-~Continued.

 

Population Sample Expansion
Sector and Strata Size Factor
N n f

 

5. Real estate

Stratum 1: Income less than
B/.30,000 3,435 219 1/15

Stratum 11: Income between
B/.30,001 and

 

B/.55,000 27 27 1/1
Stratum III: Income of B/.55,00l

and over 6 __6_ 1/1

Sub-total 3,468 252

6. Services

Stratum I: Income less than

 

B/.30,000 368 122 1/4
Stratum II: B/.30,001 and over 2 ___g 1/1
Sub-total 370 124

7. Individual revenues

Stratum 1: Income less than
B/.30,000 10,833 473 1/23

Stratum II: Income between
B/.30,001 and

B/.55,000 257 65 1/4
Stratum III: Income of B/.55,001
and over 41 41 1/1

 

Sub-total 11,131 579

78

TABLE 18.--Continued.

 

Population Sample Expansion

Sector and Strata Size Factor
N n f

 

8. Professional revenues

Stratum I: Income of less
than B/.30,000 13,390 397 1/34

Stratum 11: Income between
B/.30,00l and

 

B/.55,000 63 16 1/4
Stratum III: B/.55,00l and

over 28 28 1/1

Sub-total 13,481 441

9. Colon Free Zone firms

Stratum I: Income of less than

 

B/.30,000 9 9 1/1
Stratum 11: Income of B/.30,00l

and over 1 _____1 1/1

Sub-total 10 10

TOTAL 35,998 2,237

 

SOURCE: Republic of Panama, Computer Department, Ministry of
the Treasury, Individual Income Tax Returns, 1975 (Panama City:
Ministry of the Treasury, 1975).

79

As it may be noticed in Table 18, the major stratum 1 are
subdivided into three strata: Stratum I, agriculture; Stratum II,
mining; and Stratum III, transport, storage and communication.
Agriculture includes a population of 1,003 taxpayers. The sample
includes 200 taxpayers, selected randomly by including one out of
every five from the population in agriculture. In mining, the
population of 39 taxpayers was included in the sample as Stratum 11.
In Stratum III (transport, storage and communication) the population
includes 374 taxpayers; the sample includes 93 by selecting one tax-
payer out of every other four from this stratum population.

For manufacturing industries, the whole population of 55
taxpayers was included as the major stratum two. In the major
stratum three (construction, power, gas, water and other similar
sources of income), the level of income reported by the taxpayers
was used to determine the strata. Stratum I recorded a population
of 241 taxpayers with reported income of less than 8730,000. The
sample included one taxpayer out of every two of this population.
Stratum II includes a population of five taxpayers with reported
income over BA30,00l; the sample includes this whole population.

For the remaining major strata (commerce, real estate,
services, individual revenues, professional revenues, and Colon Free
Zone firms) the elements of the sample for each sub-stratum were
selected by the same procedure explained above. The sub-strata are

determined by the level of income reported by the taxpayers.

80

Corporate Sample

 

Corporate income tax returns were classified in six major
economic activities. These are: (l) agriculture, mining, transport,
storage and communication; (2) manufacturing industries; (3) con-
struction, power, gas, water and other sources of income; (4) com-
merce; (5) real estate and banks; and (6) services.

Corporate income was the indicator selected to determine the
sample size. It was assumed that the income's variance was related
to the variance of the tax expenditures registered in each firm.
Income's variance was determined for those strata of large popula-
tion. Optimal allocation was the criterion used to estimate the
sample size of the strata. This criterion assumed that the sample
size for each stratum is proportional to the variance of the popula-
tion in the stratum. On the other hand, in those cases where the
population in the stratum consisted of only a few taxpayers, the
whole population was included in the sample. This occurred in
agriculture, mining, transport, storage and communication.

Table 19 shows the stratified sample structure for corpora-
tions. The Ministry of the Treasury processed a total of 8,582
corporate tax returns. Of this total, the random sample included
888 returns, that is, 10.3 percent of total corporate tax returns.
As it may be seen in Table 19, for the strata manufacturing, con-
struction, other sources of income and services, which reported over
B/40,000 of income, the elements included in the sample consisted of
one out of four returns of the total returns reported in the stratum.

For example, considering the manufacturing stratum, 463 tax returns

81

TABLE 19.--Population and Sample of the Survey to Determine the
Corporate Tax Expenditures from Panama's Income Tax
Returns, 1975.

 

 

Population Sample Expansion
Sector and Strata Size Factor
N n f
Agriculture, mining, transport
storage and communications
Stratum I: Agriculture 48 48 1/l
Stratum II: Mining 6 6 1/1
Stratum III: Transport, storage
and communication 78 _18_ 1/1
Sub-total 132 132
Manufacturing industries 463 129_ 1/4
Construction, power, gas, water
and other sources of income
Stratum I: Construction 281 73 1/4
Stratum II: Power, gas and
water 9 9 1/1
Stratum III: Other sources of
income 235 _jfl_ 1/4
Sub-total 525 143
Commerce
Stratum 1: Less than B/.lO0,000 4,186 197 1/20
Stratum II: Income of B/.lO0,00l
and over 226 _29_ 1/8
Sub-total 4,412 226
Real estate and banks
Stratum I: Real estate 1,843 119 1/15
Stratum II: Banks 10 ._10 1/1
Sub-total 1,853 129

82

TABLE 19.--Continued.

 

 

Population Sample Expansion
Sector and Strata Size Factor
N n f
6. Services
Stratum I: Less than B/40,000 1,108 115 1/10
Stratum 11: Income of B740,001
and over 89 _§§, 1/4
Sub-total 1,197 138
TOTAL 8,582 888

 

SOURCE: Republic of Panama, Computer Department, Ministry of
the Treasury, Corporate Income Tax Returns, 1975 (Panama City:

Ministry of the Treasury, 1975).

83

were reported. The sample included only 120, selected randomly by
choosing one out of every four of total returns reported in this
stratum.

In commerce, the Stratum I included 4,186 tax returns. The
sample included 197, selected randomly from one out of every 20 of
the total returns in the stratum. Stratum II consisted of 29
elements, selected randomly from one out of every eight of the 226
tax returns reported.

In Stratum 1, real estate, the sample included 119 tax
returns, obtained by selecting one out of every 15 tax returns from
the total of 1,843 reported in this group. Finally, in services,
Stratum I, the sample included 115 tax returns, obtained by
selecting one out of every 10 tax returns from 1,108 reported in

this group.

CHAPTER V

INDIVIDUAL TAX EXPENDITURES

The definition of personal income is the guideline to
determine what is a tax expenditure. The Haig-Simon definition of
personal income is a widely-accepted concept of income. This
definition states that personal income is the algebraic sum of
market value of rights exercised in consumption and the change in
value store of property rights between the beginning and the end of
a period in question. This definition allows deductions for current
expenditures directly related to the process of earning income. By
comparison, this study defines tax expenditures as those tax incen-
tives or special tax provisions which cause a deviation from this
widely-accepted definition of income.

Tax expenditures exclude current expenditures directly
related to the process of earning net income, i.e., expenditures for
a medical doctor's equipment or professional books. These are
treated as costs related to the process of earning income. The
other deductions excluded are personal exemptions. These deductions
reflect a government's policy to exempt income needed for basic

living expenses.

84

85

Panama's principal tax expenditures include donations to
educational and charitable institutions, dues paid to nonprofit
entities and associations, and mortgage interest payments of owner-
occupied homes.

Individual tax expenditures also include various kinds of
excluded income that is not reported by the taxpayer in his tax
return, such as: (1) prizes paid by government lotteries, (2) income
from games of chance operated by the government, (3) nontaxable
earnings of government employees, (4) certain income from individuals
the properties of individuals, (5) compensation paid by insurance
companies to individuals, (6) commissions paid by insurance companies
to individuals, (7) social security benefits, (8) compensation for
labor accidents, (9) pensions, and (10) interest payments from sav-

ings accounts.

Measurement of Individual Tax Expenditures

 

The measuring of individual tax expenditures is based on
information from individual tax returns for calendar year 1975.
Individual tax returns totaled approximately 36,000 taxpayers
reporting a total of B/.129.2 million in income and B/13.6 million
in tax liability. Panama's individual tax schedule has 20 taxable
income brackets of from less than B/.l,OOO to a taxable income
bracket of over B/.200,000. Table 20, obtained from the Computer
Department of Panama's Ministry of the Treasury, presents data for
the individual income tax. This table shows: (1) the number of

tax returns, (2) the income declared, (3) the tax liability, and

86

TABLE 20.--Distribution of Income Tax Returns by Income Brackets for

 

 

 

 

 

1975.

Income Number Total Amount Tax Effective
Brackets of Income Liabilit Rate
(Balboas) Returns (Balboas) (Balboas) (Percent)

l to 1,000 20,083 3,666,186 91,658 2.5

1,001 to 2,000 3,248 4,693,668 131,799 2.8
2,001 to 3,000 1,951 4,830,902 163,506 3.4
3,001 to 4,000 1,395 4,878,527 195,062 4.0
4,001 to 5,000 1,238 5,669,915 256,054 4.6
5,001 to 6,000 999 5,486,895 289,025 5.3
6,001 to 8,000 1,699 11,823,979 748,463 6.3
8,001 to 10,000 1,249 11,192,326 849,226 7.6
10,001 to 15,000 2,010 24,688,029 2,418,115 7.8
15,001 to 20,000 1,000 17,265,890 2,106,848 12.2
20,001 to 30,000 743 17,795,146 2,607,252 14.7
30,001 to 40,000 215 7,296,971 1,260,812 17.3
40,001 to 50,000 80 3,543,676 698,303 19.7
50,001 to 60,000 28 1,529,982 336,514 32.0
60,001 to 70,000 20 1,284,552 308,084 24.0
70,001 to 80,000 15 1,120,330 291,923 26.1
80,001 to 90,000 11 938,456 263,761 28.1
90,001 to 100,000 4 377,961 112,781 29.8
100,001 to 200,000 10 1,220,541 423,081 34.7
Over 200,000 0 O O ___51
TOTALS 35,998 129,193,812 13,552,268 1 .5

SOURCE: Ministry of the Treasury, Computer Department.

87

(4) the effective tax rate by income brackets. Tab1e 21 shows the
same data by percentages.

In determining tax expenditures, no judgment is made about
the desirabi1ity of any specific provision, or about the effective-
ness of this tax approach re1ative to other methods of achieving
government goa1s.

It was necessary to measure each tax expenditure in iso1a-
tion. Therefore, the amount of each deduction was added back to
ca1cu1ate the taxab1e income. Then, the difference in tax 1ia-
bi1ities between the existing structure of tax rates and this new
higher 1eve1 of tax 1iabi1ities is taken as the amount of each tax
expenditure.

Determining each tax expenditure is a difficu1t and time-
consuming task without the he1p of a computer, for it requires that
each deduction on the tax return be recorded. In Panama, the Min-
istry of the Treasury's Computer Department maintains records on
g1oba1 data on1y, with the fo11owing information for each tax
return: (1) the code of the taxpayer, (2) the main source of income,
(3) the taxab1e income bracket, (4) the gross income, (5) the amount
deducted, (6) the net taxab1e income, and (7) the tax 1iabi1ity.

The unrecorded breakdown of deductions 1imited the use of
the computer to work with 36,000 tax returns in order to determine
the tax expenditures. Therefore, for the purpose of this study, a
random stratified samp1e method was used to determine Panama's tax
expenditures. This method was se1ected because of the high1y skewed

distribution of income shown in Tab1es 20 and 21.

88

TABLE 21.—-Distribution of Income by Income Brackets, 1975 (Percen-

 

 

tages).
Income Brackets Number of Dec1ared Tax
(Ba1boas) Returns Income Liabi1ity

1 to 1,000 55.8 2.8 0.7
1,001 to 2,000 9.0 3.6 1.0
2,001 to 3,000 5.4 3.7 1.2
3,001 to 4,000 3.9 3.8 1.4
4,001 to 5,000 ' 3.4 4.5 1.9
5,001 to 6,000 2.8 4.8 2.1
6,001 to 8,000 4.7 9.2 5.5
8,001 to 10,000 3.5 8.7 6.3
10,001 to 15,000 5.6 19 1 17.8
15,001 to 20,000 2.8 13.4 15.5
20,001 to 30,000 2.1 13.9 19.2
30,001 to 40,000 0.6 5.6 9.3
40,001 to 50,000 0.2 2.7 5.2
50,001 to 60,000 0.1 1.2 2.5
60,001 to 70,000 0.1 1.0 2.3
70,001 to 80,000 0.0 0.9 2.2
80,001 to 90,000 0.0 0.7 1.9
90,001 to 100,000 0.0 0.3 0.8
100,001 to 200,000 __g_.g _g_._g .91
TOTALS 100.0 100.0 100.0

 

SOURCE: Ministry of the Treasury, Computer Department.

89

These tab1es show that the income brackets of 1ess than
B/.1,000 and up to B/.8,000 accounted for 85 percent of the tax
returns and 13.8 percent of the tax 1iabi1ity. The remaining income
brackets of B/.8,000 through B/.200,000 account for on1y 15 percent
of the taxpayers whi1e accounting for 86.2 percent of tota1 tax
1iabi1ity. With a popu1ation of this type, stratification by income
brackets usua11y is more effective in determining the estimate of

the popu1ation than a simp1e random samp1ing method.

Estimate of Individua1 Tax Expenditures
from Non-Reported Income, 1975

 

 

The tax 1aw exc1udes from tax 1iabi1ity a 1ong 1ist of
individua1 income items, such as prizes from the nationa1 1ottery,
gamb1ing made avai1ab1e by the government, non-taxab1e earnings of
government emp1oyees, interest from savings accounts, commissions
paid by insurance companies to individua1s, compensation paid by
insurance companies to individua1s, etc.

Tab1e 22 presents an estimate of tax expenditures due to
individua1 non-reported income for 1975. These items accounted for
B/.168.3 mi11ion of individua1 non-reported income. Assuming an
average effective tax rate of 10.5 percent of an estimate of
individua1 tax expenditures resu1ts in B/.17.7 mi11ion. This amount
represents 7.8 percent of tota1 tax revenue of B/.227 mi11ion in
1975.

It is important to note that the main source of tax expendi-
tures from individua1 non-reported income are prizes from the

nationa1 1ottery of B/.9.2 mi11ion, winnings from the horse race

90

TABLE 22.--Estimate of Individua1s' Tax Expenditures from Non-
Reported Income, 1975 (in Mi11ions of Ba1boas).

 

 

Tax
Non-Reported Income Amount Expenditures
Prizes from the nationa1 1ottery, B/.88.0 B/.9.24
winnings from the race track, 23.5 2.47
prizes from gamb1ing (casinos) 25.4 2.67
Non-taxab1e earnings of
government emp1oyees 5.2 0.55
Interest from savings accounts 7.4 0.74
Commissions paid by insurance
companies to individua1s 6.3 0.68
Compensations paid by insurance
companies to individua1s 12.5 1.31
TOTAL 168.3 17.68

 

SOURCE: Repub1ic of Panama, Contra1orfa Genera1 de 1a
Repfib1ica, Direcci6n de Estadfstica y Censo, Situaci6n Economica,
Hacienda P6b1ica y Finanzas. Afio 1975 (Panama City: Contra1orfa
Genera1 de 1a Rep0b1ica, 1975), pp. 82, 85, 86, 94, 145 and 160.

91

track of B/.2.5 mi11ion, and prizes from gamb1ing (casinos) of
B/.2.7 mi11ion.

Tax Expenditure Estimates from

Socia1 Security Benefits,_1975

Socia1 security benefits inc1ude: (1) compensation payment
for 1abor accidents, (2) pension payments on retirement, (3) pension
payments because of 1abor disabi1ity, (4) pension payments to widows
and survivors, and (5) payments due to motherhood.

These payments amounted to near1y B/.4O mi11ion for 1975.
Tab1e 23 presents a summary of the payments from socia1 security
benefits approximated at B/.4.2 mi11ion. No information cou1d be
obtained on the income structure of the recipients of socia1
security benefits. The obstac1e of having a breakdown by income
groups benefiting from socia1 security payments 1imited a more
precise estimate of these tax expenditures.

The Panamanian socia1 security system inc1udes both emp1oyees
as we11 as emp1oyers in the system. The who1e range of taxab1e
income and income tax rates are represented in the socia1 security
system. The difficu1ty of determining the income brackets of the
socia1 security recipients 1eads to the need to use the individua1
average income tax rate to estimate the socia1 security tax expendi-
tures.

The average income tax rate for individua1s was 10.5 percent
in 1975. App1ying this tax rate to the B/.39.8 mi11ion payment on
socia1 security benefits resu1ts in B/.4.2 mi11ion in tax expendi-

tures fOr this year.

92

TABLE 23.--Tax Expenditures Estimates from Socia1 Security Benefits,
1975 (Thousands of Ba1boas).

 

 

Benefits ggggggzng: Amount Expe131tures
Compensation payment .
for 1abor accidents 34,807 2,207 232
Pension paymentsz 25,814 33,501 3,518
Motherhood subsidies 6,372 _;g,1g§_ __j§1[
TOTALS 39,811 4,181

 

SOURCE: Repub1ic of Panama, Contra1oria Genera1 de 1a
RepOb1ica, Direcci6n de Estadistica y Censo, Panama en Cifras Afios
1971 a 1975 (Panama: Contra1orfa Genera1, 1976), pp. 174 and 175.

 

 

1Estimated using the average individua1 income tax rate,
which was 10.5 percent for 1975.

2Inc1udes pension payments to retirement 1abor disabi1ity,
and payments to widows and survivors.

93

Itis important to notice that tax expenditures are under-
estimated by using the individua1 average income tax rate. This is
so because of the erosion of the tax base due to tax evasion,
specia1 deductions, and other specia1 tax privi1eges a11owed in the
income tax system. These e1ements tend to reduce the rea1 average

income tax rate of the tax system.

Tax Expenditure Estimates from Income
Derived from IndiVidua1 Properties '

Income derived from individua1 properties shou1d be inc1uded
in the individua1 income tax base. Part of this income is not
recorded either in the government income tax statistics or in the
income tax returns.

The Panamanian government on1y taxes the private ownership
of 1and, bui1dings, and other permanent constructions attached to
the 1and. The property tax rate schedu1e is app1ied to both corpora-
tions and individua1s. The property tax rate is 10w, from a minimum
of 1.40 percent for a property va1ue of B/.10,000 to a maximum tax
rate of 2.10 percent for a property va1ue of over B/.75,000. Private
non-profit institutions are exempted from the property tax. Revenues
from this tax accounted for on1y 5 percent (B/.11.9 mi11ion) of
tota1 tax revenue in 1975. As it may be noticed, property other than
1and and bui1dings traditiona11y has been omitted from the property
tax system, as we11 as the income derived from the ownership of these
properties. These features of the property tax system 1ead to expend-

itures that need to be measured.

94

In attempting to measure tax expenditures from income
derived from individua1 properties, two ways may be fo11owed:
(1) undertake a survey of property owners to determine an indicator
of income derived from properties; and (2) the use of nationa1 income
statistics that have an estimate of the different sources of nationa1
income. This study used the information from the nationa1 income
statistics due to the time and the cost imp1ied in undertaking an
income survey.

Tab1e 24 presents an estimate of tax expenditures derived
from income due to individua1 properties.. The estimate is based on
the item "income from property ownership from househo1ds and private

1 As it

non-profit institutions" of the nationa1 income statistics.
may be noticed, this item inc1udes some non-individua1 property
income, such as income of hospita1s, 1abor unions, sports associa-
tions, and income from charitab1e institutions.

Tab1e 24 shows that income derived from individua1 property
accounted for B/.106.2 mi11ion in 1975. Tax expenditure estimates
accounted for B/.11.2 mi11ion. This estimate was determined by
app1ying the 10.5 percent individua1 average income tax rate to the
amount of income derived from individua1 property registered in the
nationa1 income statistics in 1975. It may be observed that tax

expenditure estimates cover a1most the same amount of revenues from

the property tax in 1975, which amounted to B/.11.9 mi11ion.

 

1Contra1orfa Genera1 de 1a Repfib1ica, Direcci6n de
Estadistica y Censo, Situacion Econ6mica,fiCuentas Naciona1es, Afios
1973 a 1975 (Panama: Contra1orfa Genera1, 1976), pp. xiii, 12.

 

95

TABLE 24.--Tax Expenditures Estimate from Property Income, Years
1973 to 1975 (Mi11ions of Ba1boas).

 

 

Year Property Income Tax Expenditures1
1973 71.3 -

1974 81.4 -

19752 106.2 11.2

 

SOURCE: Contra1oria Genera1 de 1a Repdb1ica, Direcci6n de
Estadfstica y Censo, Situacion Econdmica, Cuentas Naciona1es, Afios
1973 a 1975 (Panama: Contra1oria Genera1, 1976), p. 12.

1Estimated using individua1 average income tax rate of 10.5
percent for 1975.

 

2Pre1iminary.

96

Individua1 Tax Expenditures Derived
from Income Tax Returns

A random samp1e of 2,237 individua1s representing 6.2 per-
cent of 36,000 taxpayers was the basis for estimating individua1 tax
expenditures from the income tax returns in 1975. Tab1e 25 presents
the individua1 tax expenditure estimates obtained through the review
of the deductions a11owed by the income tax 1aw. Individua1 tax
expenditures amounted to B/.2.2 mi11ion in 1975.

The major individua1 tax expenditures are: (1) the deduc-
tion of interest on mortgages of owner-occupied homes, representing
B/.1.5 mi11ion, or 68 percent of tota1 tax expenditures; (2) the
deduction of property taxes, accounting for B/.447,000, or 20.5
percent of tota1 tax expenditures, and (3) the deduction of medica1
expenses, accounting for B/196,000, or 9 percent of tota1 expendi-
tures. Other tax expenditures, such as donations to schoo1s and to
re1igious and charitab1e institutions, and other deductions,
accounted for on1y 2.5 of tota1 tax expenditures.

Tab1e 26 presents the tax expenditures by income group.

This tab1e shows that individua1 tax expenditures are concentrated
on taxpayers in the income range of B/.10,000 and over. About 80
percent of the B/.2.2 mi11ion of tax expenditures is accounted for
in this income range, and benefits on1y 4,136 taxpayers, represent-
ing 11.5 percent of tota1 taxpayers. 0n the other hand, 20,083
individua1s inc1uded in the income range under B/.1,000 represent
55.8 percent of tota1 taxpayers and obtain on1y 0.6 percent of

individua1 tax expenditures.

TABLE 25.--Estimate of Individua1 Tax Expenditures from the
Individua1 Income Tax Returns, 1975 (in Ba1boas).

 

 

Amount Percentages
Education
Donation to schoo1s 293 0.01
Seminar attendance expenses 88 0.00
Donations to art institutions 9 0.00
Training expenses ____14 ELLE;
Sub-tota1 394 0.02
Hea1th
Medica1 expenses 195,781 8.95
Re1igious Institutions
Church donations 1,338 0.06
Re1igious associations 2,002 0.09
Other donations 565 0,93_
Sub-tota1 3,905 0.18
Charitab1e Institutions
Asy1um donations 286 0.01
Other donations ___§41_ 9,9g_
Sub-tota1 627 0.03
Nonprofit Institutions
Contributions to professiona1
associations 8,416 0.38
Socia1 c1ubs 2,182 0.10
Other contributions 1,92 _0._23_
Sub-tota1 15,553 0.71

 

98

TABLE 25.--Continued.

 

 

Amount Percentages
Investments
Mortgage interest payments .
on owner-occupied homes 1,490,620 68.21
Property tax deductions 447,223 20.46
Sp1it of business profits
between partners 4,317 _ngg;
Sub-tota1 1,942,160 88.87
Other Deductions
Bonuses to emp1oyees 24,730 1.13
Unspecified donations 1,340 0.06
Christmas donations 1,002 Q;Q§_
Sub-tota1 27,072 1.24
TOTAL B/.2,185,493 100.00

 

SOURCE: Repub1ic of Panama, Computer Department, Ministry
of the Treasury, Individua1 Income Tax Returns, 1975 (Panama City:
Ministry of the Treasury,71975).

99

 

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100

Considering the tax saving per taxpayer, Tab1e 26 shows that
215 taxpayers in the income range of B/.30,000 to B/.40,000 receive
about B/.2,600 each; 20 taxpayers in the income range of B/.60,000
to B/.70,000 receive c1ose to B/.3,900 each; 15 taxpayers in the
income range of B/.70,000 to B/.80,000 receive c1ose to B/.2,000
each, whi1e taxpayers in the 1ow-income range under B/.1,000 obtain
on1y 63 cents. C1ear1y, the benefits from individua1 tax expendi-

tures are very unequa11y distributed among taxpayers.

Summar

The Haig-Simon definition of income has been used as the
basis for determining those deductions for current expenditures
direct1y re1ated to the process of earning income as compared to
those deductions a11owed by the income tax system as a measure to
promote certain activities. These specia1 tax provisions tend to
deviate wide1y from the accepted definition of income, and at the
same time affect the equity and neutra1ity of the tax system.

In Panama, the specia1 tax provisions (tax expenditures) in
genera1 terms take the fo11owing forms: (1) individua1 non-reported
income due to activities promoted by the government; (2) socia1
security benefits; (3) property income; and (4) specia1 deductions
a11owed by the income tax 1aw as ref1ected in the individua1 income
tax returns.

It is estimated that these four major categories of
individua1 tax expenditures accounted a1together for estimated tax

expenditures of B/.35 mi11ion in 1975, and represented 16 percent of

101

the tota1 income tax revenue. Non-reported individua1 income tax
represented B/.17.7 mi11ion in tax expenditures; socia1 security
benefits, B/.4.2 mi11ion; property income, B/.11.2 mi11ion; and
deductions from individua1 income tax returns, B/.2.2 mi11ion.

The ana1ysis of individua1 specia1 tax deductions from the
income tax returns through a samp1ing method showed that the
benefits from tax expenditures are not equa11y distributed. It was
found that taxpayers in the high-income range received an extra-
ordinary share of tax expenditures as compared to taxpayers in the
1ow-income range. Panama's individua1 tax expenditures are high1y

pro-rich.

CHAPTER VI

CORPORATE TAX EXPENDITURES

The accepted definition of income for business accounting
which a11ows business cost deductions from gross income in the
determination of net income is the framework for ca1cu1ating tax
expenditures. As defined beofre, tax expenditures are those tax
incentives or specia1 provisions in the income tax system which
cause the current income tax base to deviate from the wide1y-accepted
definition of income.

The specia1 provisions or tax incentives a11ow business
expenditures in excess of actua1 costs. In other cases they take
the form of tax credits. In Panama, corporate tax expenditures take
the form of an investment tax credit, a tax credit to promote export
industries, and an emp1oyment tax credit. They a1so inc1ude such
individua1 tax expenditures as donations to educationa1 and char-
itab1e institutions, and dues paid to nonprofit entities. They a1so
inc1ude such non-reported income as interest payments from government

securities.

Investment Tax Credits
The first investment tax credit was enacted in 1976 through
Law Number 70 of 1976. This incentive a11ows a preferentia1 tax rate
of one percent of capita1ized dividends of corporations. According

102

103

to Artic1e 733 of the Fisca1 Code, dividend distributions are taxed
at the rate of 10 percent.

Tab1e 27 presents the tax expenditures due to capita1ized
dividends in 1977. It is shown that 330 corporations reported
B/.49.1 mi11ion of capita1ized dividends. At the rate of a one per-
cent dividends tax, on1y B/.491,000 was reported as taxes. This
imp1ies a tax expenditures of B/.4.4 mi11ion for the period of
January 1 to September 30, 1977.

TABLE 27.--Dividends Capita1ized Due to Investment Tax Credit, 19771

(in Thousands of Ba1boas).

 

 

Capita1ized Nugger Tota1 Tax
Dividends Cozpora- Ca5123112ed Percentage Expenditures
1ons

Less than B/.10,000 20 112.6 0.2 10.2
B/.10.000 - 19,999 25 382.8 0.8 34.5
20,000 - 49,999 78 2,779.3 5.7 250.1
50,000 - 99,999 80 6,904.6 14.1 621.5
100,000 - 499,999 113 24,176.0 49.2 2,175.8
500,000 and over _14 14,738.9 _30_._0_ 1_,_3_2£._5_
TOTAL 330 49,094.2 100.0 4,418.6

 

SOURCE: Repub1ic of Panama, Ministry of the Treasury
(Panama City: September 1977).

1January 1 through September 30, 1977.

104

Export Tax Credits

 

The export tax credit was enacted in Panama on December 30,
1974 as a po1icy designed to promote the export of non-traditiona1
goods. These are products other than bananas, shrimp, sugar and
011, as we11 as particu1ar goods 1isted in the 1aw. The tax credit
is 20 percent of the va1ue added of the goods exported. The export
tax credit certificates can be used on1y to pay import and direct
taxes. The tax credit certificate is issued by the Ministry of
Treasury and given to the exporter when the exports are made.

A reform of the export tax credit was introduced through
Law Number 71 of December 22, 1976. This reform a11ows the export
tax credit certificate to be transferab1e and not subject to
interest payments by the government. On the other hand, the export
tax credit certificate can be used on1y within nine months after
issue.

Since 1975, exports of non-traditiona1 products subject to
the tax credit certificate have increased dramatica11y. These
exports tota1ed B/.1.1 mi11ion in 1975, B/.2.3 mi11ion in 1976, and
B/.10.1 mi11ion in 1977.

Tab1e 28 shows tota1 exports compared to the exports subject
to export tax credits from 1975 to 1977. As can be seen, exports
subject to the tax credits were 0.6 percent.in1975, L2 percent in1976,
and 5.5 percent in 1977 as a ratio of exports (exc1uding oi1).

Tab1e 29 presents detai1 for the main products e1igib1e for
export tax credits. During 1975, on1y a few e1igib1e products were

exported. These were B/.337,000 of c1othing; B/.787,000 of tobacco,

105

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106

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107

paper, wooden f1owers and p1astic products, and B/.17,000 in p1ywood.
From 1976 to 1977, a 1arge increase in the exports of these goods

was reported, and new products a1so were exported. C1othing

exports increased to B/.1.7 mi11ion in 1976, and to B/.4.1 mi11ion

in 1977; tobacco, paper, wooden f1owers and p1astic products
registered B/.370,000 in 1976 and B/.1.5 mi11ion in 1977; and p1ywood
exports reported B/.521,000 in 1977. New products exported are food,
B/.19,000 in 1976 and B/.158,000 in 1977, and chicken eggs for
breeding, B/.35,000 in 1976, and B/.315,000 in 1977; and 1eather,
B/.93,000 in 1976 and 8.3.4 mi11ion in 1977.

Export tax credits to promote non-traditiona1 export
products has provided a new source of tax expenditures in Panama.
Tab1e 30 presents the amount of tax expenditures due to export tax
credit certificates from 1975 to 1977. As indicated, these tax
expenditures have risen from B/.210,000 in 1975 to B/.310
in 1976, and to B/.1.3 mi11ion in 1977. The principa1 amounts of
tax expenditures are for c1othing, tobacco, paper, wooden f1owers,
p1astic products, and 1eathers.

Corporate Tax Expenditures Derived
from Income Tax Returns

 

The specia1 treatment and deductions a11owed by the Panamanian
Fisca1 Code that do not represent direct costs of firms 1ead to corpor-
ate tax expenditures. The tax expenditures found in a random samp1e
of income tax returns are deductions for the purpose of education and

hea1th, contributions to charitab1e institutions, contribution to

108

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109

re1igious and nonprofit institutions, and deductions re1ated to
investment.

Tab1e 31 presents an estimate of the corporate tax expendi-
tures found in the corporate income tax returns for 1975. It is
shown that tax expenditures accounted for an amount c1ose to
B/.3.3 mi11ion. Of this amount, a1most 25 percent of B/.815,000
are due to contributions to non-profit institutions, such as profes-
siona1 associations, unspecified contributions, and socia1 c1ub
contributions. 0n the other hand, B/.1.1 mi11ion or 34 percent are
tax expenditures due to mortgage interest payments of owner-occupied
homes. Bonuses to emp1oyees, Christmas donations to emp1oyees, and
unspecified donations accounted for BAJ.1nfi11ion or 34 percentcfi tota1
tax expenditures. Tax expenditures re1ated to education, hea1th,
re1igious and charitab1e institutions accounted for 2 percent of
tota1 tax expenditures.

The ana1ysis of tax expenditures by income groups disc1oses
that there is a concentration of tax expenditures in the high-income
ranges. This feature is shown in Tab1e 32. As it can be seen,
8,582 corporate income tax returns were reported to the Ministry of
the Treasury in 1975. Of this tota1, 83.6 percent reported an
income of 1ess than B/.15,000 in 1975, and received on1y 6 percent
of tota1 tax expenditures. 0n the other hand, taxpayers with an
income in the range of B/.100,000 and over accounted for 1.7 percent
of tota1 corporations, or 146 firms. These firms received 55.2
percent of tax expenditures. Furthermore, taxpayers in the income

range of 1ess than B/15,000 received on1y B/.22.88 per taxpayer,

110

TABLE 31.—-Estimate of Corporate Tax Expenditures from Corporate
Income Tax Returns, 1975 (in Ba1boas).

 

 

Amount Percentages
Education:
Research expenses 15 0.00
Donations to schoo1s 8,980 0.27
Scho1arships 11,473 0.35
Seminar attendance expenses 1,210 0.04
Donations to art institutions 2,747 0.08
Training expenses 20,220 0.62
Sub-tota1 44,645 1.36
Hea1th:
Medica1 expenses 436 0.01
Hea1th institutions 497 O 02
Hea1th associations 1,106 0.03
Sub-tota1 2,039 0.06
Re1igious institutions:
Church donations 677 0.02
Re1igious donations 1,655 0 05
Other donations 2,349 0.07
Sub-tota1 4,681 0.14
Charitab1e institutions:
Handicapped institutions donations 832 0.03
Orphan donations 179 0.01
Asy1um donations 10,558 0 32
Other donations 9,565 0.29
Sub-tota1 21,134 0.64
Non-profit institutions:
Contribution to professiona1
associations 428,537 13.05
Socia1 c1ub contributions 11,341 0.35
Other contributions 375,091 11.42
Sub-tota1 814,969 24.82

111

TABLE 31.--Continued.

 

 

.Amount Percentages
Investments:
Mortgage interest payments on
owner-occupied homes 1,112,941 33.88
Sp1it of business profits
between partners 82,122 2.50
Property tax deductions 68,395 2.08
Sub-tota1 1,263,458 38.46
Other deductions:
Bonuses to emp1oyees 953,387 29.02
Unspecified donations 112,520 3.43
Christmas donations to emp1oyees 67,966 2.07
Sub-tota1 1,133,873 34.52
TOTAL 3,284,799 100.00

 

SOURCE: Repub1ic of Panama, Computer Department, Ministry
of the Treasury, Corporate Income Tax Returns,_¥ear 1975 (Panama

City: Ministry of theETreasury, 1975).

112

 

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113

whi1e taxpayers in the income range of B/.100,000 to B/.500,000
received an amount of B/.12,661.60 per taxpayer, and each of the 22
taxpayers who reported an income of B/.500,000 received an average
of B/.11,079.59.

Tab1e 33 presents corporate tax expenditures by economic
activity for 1975. The tab1e shows that manufacturing receives
B/.1.4 mi11ion or 42 percent of tota1 tax expenditures, whi1e
commerce received B/.908,400 or 27.7 percent, and rea1 estate and
banks received B/.471.200 or 14.3 percent. The concentration of tax
expenditures in the above mentioned economic activities correspond

to the major economic activities of the country.

TABLE 33.--Corporate Tax Expenditures by Economic Activity, 1975
(in Thousands of Ba1boas).

 

Economic Activity Tax Expenditures Percentage

 

Agricu1ture, mining, transport,

storage and communication 247.0 7.5
Manufacturing 1,380.0 42.0
Construction, e1ectricity, gas,
water 69.2 2.1
Conlnerce 908 . 4 27 . 7
Rea1 estate and banks 471.2 14.3
Services 209.0 __§,4_
TOTAL 3,284.9 100.0

 

SOURCE: Repub1ic of Panama, Computer Department, Ministry
of the Treasury, Corporate Income Tax Returns, Year 1975 (Panama
City: Ministry of the Treasury, 1975).

114

Summary

Corporate tax expenditures in Panama inc1ude an investment
tax credit, tax credit for export industries, emp1oyment tax
credits, and specia1 deductions in the income tax return permitted
by the Fisca1 Code.

The estimated tota1 of corporate tax expenditures accounted
for B/3.5 mi11ion in 1975. Deductions from income tax returns
reported B/.3.3 mi11ion. There is no information avai1ab1e in 1975
about emp1oyment tax credit. This information wi11 be reported for
the first time in the corporate income tax return for 1977.

The study of a random samp1e of the corporate income tax
returns revea1ed that tax expenditures are not equa11y distributed
among taxpayers. The tax saving from the specia1 deductions is
high1y favorab1e to high-income taxpayers. At the same time,
manufacturing, commerce, rea1 estate and banking are the economic

activities benefiting the most from corporate tax expenditures.

CHAPTER VII

SUMMARY AND CONCLUSIONS

The purpose of this study is to measure tax expenditures in
Panama for the year 1975. Tax expenditures represent government
spending for particu1ar activities or groups made through the tax
system through tax incentives, deductions, exc1usions from income,
specia1 tax rates, credits against taxes, and other simi1ar devices.

Tax incentive po1icies in Panama have been oriented basica1ty
to promote growth and encourage private sector invo1vement in
economic activity. At the same time, it was found that these
po1icies have contributed to an increased concentration of income,
have reduced the tax base, and increased the prob1ems of obtaining
resources needed for government programs. These tax expenditures
a1so have faciIitated tax avoidance and evasion.

It was found in this study that the Panamanian tax system
a1so depends to a great extent on indirect taxes. As a resu1t, a
1arge proportion of the popu1ation, especia11y 1ow- and medium-
income groups, bear an undue burden of the tax system. Some tax
incentives he1p to exc1ude from the tax system certain kinds of
incomes. These phenomena 1ead us to conc1ude that these are
inefficiencies in the Panamanian tax system which contribute to an

inequa1ity in income distribution.

115

116

The overview of Panama's economy during the 1960's revea1ed
that, even though there was a high rate of economic growth, the
period was characterized by an increasing ma1distribution of income
and wea1th. During the 1970's, the wor1d-wide inf1ation, the oi1
crisis, and nationa1 se1f—interest po1icies affected negative1y the
performance of the economy. Consequent1y, the tax system became
unab1e to marsha11 adequate revenues for the current government's
expenses. Another part of the prob1em was that a1most every tax has
extensive exemptions, deductions, and exc1usions, which not on1y
affects negative1y the vertica1 and horizonta1 equity of the tax
system but a1so reduces the tax base.

This study presents a new approach for viewing government
po1icies to promote economic and socia1 objectives through indirect
tax measures rather than through direct expenditures. Basica11y,
tax incentives tend to provide monetary assistance or benefits
through the tax 1aw so as to motivate a desired course of action
which is financia11y more attractive to the taxpayers. To fu1fi11
this purpose, the financia1 assistance can take the form of invest-
ment credits, generous bad debt reserves, a surtax exemption,
generous depreciation a11owances, charitab1e deductions, or prefer-
entia1 tax treatment, and simi1ar devices. These incentives
genera11y have been justified as a mechanism to improve efficiency
and growth. That is, investment tax credits, as an examp1e, may be
adopted to increase capita1 accumu1ation, and consequent1y to

acce1erate the rate of growth in the economy. Acce1erated

117

depreciation may increase the capita1 avai1ab1e for reinvestment
that may provide more jobs, income and consumption.

It is important to notice that, a1though tax incentives as
instruments to achieve efficiency and growth in the economy,
growth as a goa1 may have prevai1ed in the fisca1 po1icy of deve1oped
as we11 as deve1oping economies. In the process of reso1ving
economic and socia1 prob1ems, tax incentives may affect both the
equity of the tax system and the a11ocation of resources. That is,
tax incentives may affect the equity of the tax system by providing
a greater benefit to high-income taxpayers than to 1ow-income
taxpayers. Besides, those who, for any reason, are outside of the
tax system, do not benefit from the incentives.

Tax incentives a1so affect the a11ocation of resources.
Favorab1e tax treatment of capita1 gains increases the after-tax
earnings on assets, encouraging peop1e to invest in assets which may
appreciate in va1ue. Consequent1y, this may encourage specu1ation,
and interfere with the order1y f1ow of financia1 capita1 into usefu1
channe1s. In other cases, these incentives permit windfa11 gains to
taxpayers, because the taxpayers may receive support from the govern-
ment for doing what they wou1d norma11y do.

Tab1es 34 and 35 present a summary of Panama tax expenditure
estimates for 1975.

Panamanian individua1 tax expenditures were B/.35 mi11ion in
1975. This amount represents 16 percent of the tax revenues of the
government. Non-reported income, property income, socia1 security

benefits and specia1 deductions a11owed in the individua1 income tax

118

 

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121

TABLE 35.-~Summary of Panama Tax Expenditures, 1975 (in Mi11ions of

 

 

Ba1boas).
Amount Percentage

Individua1
Non-reported income 17.68 45.6
Socia1 security benefits 4.20 10.8
Property income 11.20 28.9
Deductions from income tax returns _g,gg_ '__§,Z
Sub-tota1 35.28 91.0

Corporate
Investment tax credits1 0 0
Export tax credits2 0.21 0.5
Deductions from income tax returns _3_.31 _§,§
Sub-tota1 3.49 9.0
TOTAL 38.77 100.0

 

SOURCE: Tab1es 22, 23, 24, 25, 27, 30 and 31.

1Tax expenditure estimate due to investment tax credit is
B/.4.4 mi11ion for 1977.

2Tax expenditure estimate due to export tax credits is
B/O. 31 mi11ion for 1976 and B/.1. 31 mi11ion for 1977.

122

returns are the major tax expenditures. The ana1ysis of individua1
tax expenditures from the income tax returns showed that the benefits
from the specia1 provisions are very unequa11y distributed. It was
found that taxpayers in the high-income range are benefiting much
more than 1aw-income taxpayers.

Corporate tax expenditures accounted for 873.5 mi11ion in
1975, c1ose to 2 percent of tota1 government tax revenue. Ana1ysis
of a random samp1e of 888 income tax returns for corporations
revea1ed B/.3.3 mi11ion of tax expenditures due to specia1 tax
deduction a110wed in the income tax 1aw. This figure may be under-
estimated because of the difficu1ties invo1ved in measuring some of
the income tax deductions.

As in the case of individua1 tax expenditures, corporate tax
expenditures are not equa11y distributed among corporations. Tax
savings from the specia1 provisions benefit the 1arge corporations
the most.

Panamanian corporate tax expenditures wi11 increase because
of new tax incentives enacted in December of 1976. These invo1ve an
investment tax credit, an emp1oyment tax credit, incentives to
tourism industries, and the reform of the tax credit to non-
traditiona1 exports.

This study of Panamanian tax expenditures has shown the need
to be more concerned about tax incentive po1icies. There is a need
to eva1uate the benefits and costs to the economy. There is a
specia1 need to be concerned about the distributiona1 impact of tax

expenditures. It is important to determine to what extent specia1

123

tax provisions, exc1usions and deductions are promoting tax evasion
and avoidance, and causing a misdirection and wastage of resources

as we11 as socia1 inequities.

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124

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